Can banks and fintechs co-exist? A look into the future

Over the past five years, fintech has experienced rapid growth due to their ability to offer faster financial services - more convenient and affordable than traditional banks. It has forced traditional banks to re-look their strategies and adopt newer technologies such as Artificial Intelligence, Blockchain, Data Analytics, and more. Fintech players have been able to provide personalized services, reach a much broader customer base and drive innovation in the BFS industry, thanks to the dynamic growth and adoption of disruptive technologies across the industry. 

Today's big question is whether traditional banks and fintechs can co-exist, offering consumers greater flexibility and choice. While often seen as competitors, there are enough and more examples of how both banks and fintech players can co-exist. One example of a successful bank-fintech partnership is JPMorgan Chase's collaboration with the fintech firm OnDeck. Through this partnership, JPMorgan Chase is able to offer its small business customers access to OnDeck's lending platform while OnDeck benefits from JPMorgan Chase's established brand and customer base. The collaboration between SBM Bank and Drip Capital to offer trade financing solutions for MSME exporters in India is yet another example of how traditional banks and fintech can collectively provide solutions contextualized to customers' present needs. 

Of banks, fintech and embedded finance 

Bank/fintech partnerships are furthering the growth of the financial services industry, nurturing greater innovation and inclusivity. The proliferation of these partnerships has also led to the emergence of a new finance/banking model called Embedded Finance/ Embedded Banking.

With a CAGR of 16.4%, the embedded finance market is expected to be worth US$ 248.4 billion by 2032. Incorporating financial services into non-financial products/services, embedded finance is bringing about a paradigm shift in the financial services industry. It allows customers to experience native 'Fintech' through regular digital platforms. 

A famous example is the widespread adoption of UPI in India. The Unified Payments Interface(UPI) was developed by the National Payments Corporation of India (NPCI) primarily to facilitate inter-bank peer-to-peer (P2P) and person-to-merchant (P2M) transactions. UPI has been through a tremendous transformative journey, the latest being the collaboration of UPI and PhonePe to facilitate international transactions, now available to G20 countries. There are more plans to harness UPI across international borders, thanks to the support from several other fintechs.

ONDC (Open Network for Digital Commerce), is also gaining popularity in India. Backed by the Indian Government, it is an open network facilitating businesses to directly sell to their customers with a set of voluntarily adopted standards. Having just commenced operation in September 2022, ONDC has already piqued several banks' interest, with 9 banks picking up stakes in the network. Many banks are looking at leveraging this network to connect their customers with an ocean of sellers.  

While these partnerships can be expected to proliferate, they come with their own set of regulatory arbitrages that potentially benefit the fintechs. Regulatory bodies globally have been taking note of gaps that could edge out smaller banking firms and reduce the choices for customers. They are actively working on creating a safe space for banks and fintechs to co-exist, collaborate, and provide superior financial experiences to the end customers. 

One such move has been the introduction of a regulatory sandbox where banks can partner with fintech and test emerging technologies in a regulatory environment that is more dynamic, and evidence based. Most central banks have created sandboxes, providing necessary infrastructure and innovation support to onboard fintechs. According to a World Bank study, about 73 sandboxes exist across 57 jurisdictions as of 2020. In early January 2023, the Reserve Bank of India (RBI) opened a regulatory sandbox to 6 firms comprising of banks and fintechs to develop solutions to prevent and mitigate financial fraud.

Global regulatory approaches to co-existing of banks and fintech:

For banks and fintech to collaborate and thrive with the evolution of digital ecosystems and platform-based business models, more regulations will be vital to this success. Bank/fintech partnerships come with potential risks that can impact financial stability and integrity. It is challenging for policymakers to reach a common ground whereby the risks are mitigated, and the benefits of fintech are maximized. 

In the United States, fintech is regulated by various regulatory agencies, including the Office of the Comptroller of the Currency, the Federal Reserve, and the Consumer Financial Protection Bureau. The regulatory environment in the US is designed to foster innovation while protecting consumers and maintaining financial stability. In contrast, in countries like China, fintechs are subject to stricter regulatory oversight, including restrictions on foreign investment and the use of data. This approach has led to a more controlled and regulated fintech industry in China.

In India, the RBI has set up a Fintech division aligned under its payments and settlements department. This entity has enabled several regulations and directives to regulate the activities of fintechs, including their product offerings. These include Card Directions, Master Directions on Outsourcing Information Technology (IT) Services, to name a few. The RBI has also actively deployed SuperTech and RegTech to monitor financial transactions for anomalies. There also exist several laws applicable to the fintech sector, some of which include the Payments and Settlement Systems Act 2007, Guidelines on Regulations of Payment Aggregators, Master Directions on Prepaid Payment Instruments, KYC Directions, Data localization requirements, NPCI guidelines, all of which keep the customers' interest at the core and create a level playing field for both banks and fintechs. 

Coexistence can boost financial inclusion, innovation, and customer experience

Fintech companies are known for their agility to adapt to changing customer needs, while traditional banks have established customer bases and regulatory expertise. Together, they can offer a more comprehensive range of financial products and services accessible to a broader segment of the population, including the underbanked and unbanked. Their coexistence can bring about significant benefits in terms of financial inclusion, innovation, and customer experience.

In addition, fintechs open new sources of revenue and business opportunities for banks. By partnering with fintech companies, banks can leverage their innovative technology and unique business models to improve customer experience and operational efficiency while generating new revenue streams. For instance, banks can offer digital payment solutions, robo-advisory services, and other innovative financial products that meet customers' evolving needs. However, banks and fintech companies must work together to manage technology risks and ensure operational resilience while exploring new revenue sources and business opportunities.

-By P Venkatesh, Co-Founder & Director Maveric Systems Ltd.