Financial institutions (FIs) and fintechs have historically been at odds. Each viewed the other as competition with no hope for collaboration. According to Q2’s Jonathan Price, EVP, Emerging Businesses, Corporate & Business Development, if you asked the CEO of an FI about the role fintechs and brands would play in the financial services market two years ago, “you probably would have had a somewhat adversarial view, maybe even dismissive.” But not anymore. “You have that conversation with any bank CEO now, and no one’s dismissing it.”
Instead, FIs and fintechs are starting to look at each other as potential collaborators, thanks in large part to technology advancements such as banking as a service (BaaS), open-source development, and fintech marketplaces inside digital banking. Price recently sat down with Tearsheet to discuss these emerging partnerships and outline the benefits to each party and the broader economy. Listen to the full podcast here.
Let’s start by examining the old paradigm, where FIs and fintechs didn’t get along. FIs looked at the situation and saw that both sides were after similar customers, which threatened market share and positioning that FIs had an incumbency on. On the other hand, fintechs viewed traditional players as a set of commoditized services that didn’t adequately address the pain points of end users. The fintechs felt they could solve user problems better, faster, and more efficiently than the FIs, whereas FIs prioritized maintaining their advantage: owning the relationship with end users.
The relationship between FIs and fintechs is changing.
Recently, FIs and fintechs have begun to view each other in a different light. In large part, this is due to “new business models that are facilitating a different level and type of interaction between these players,” says Price. We’ll look at a couple of these new business models and then talk about their broader impacts.
Banking as a service
Also known as embedded finance, BaaS is a division of duties between a fintech or brand, an FI, and a platform vendor (such as Q2). Fintechs who want to offer banking services like checking accounts and debit cards can work with these other two parties to bring them to life. While the fintech works on building a great user experience, the FI focuses on backend financial matters such as regulation, and the platform vendor provides the technology that allows this partnership to occur.
Q2 Innovation Studio
While Q2 Innovation Studio offers a number of different pathways to FIs to help them facilitate faster innovation, we’ll focus on the embedded fintech component here. In essence, fintechs are now able to build their products inside the digital banking environment. How is this different than a direct partnership? Because Q2 has over 450 bank and credit union clients on its digital banking platform, a single integration is all that’s needed to activate a fintech’s technology across all these institutions.
The beauty of these new business models is that they allow FIs and fintechs to focus on what each is good at. While the fintech may be good at designing products and optimizing the user experience — challenging areas for some FIs — they sometimes struggle with banking infrastructure, the regulatory system, and how to launch and manage banking products. That’s where the FI comes in. Price says, “For the fintech to have to stand up an organization around [banking services], and then also figure out how to actually manage [them] — when that’s not what their core business is — it’s a real challenge. So the bank is really bringing that to the fintech.”
In the case of Innovation Studio, the fintech doesn’t have to worry as much about customer acquisition. By offering their services within digital banking, they’re going after a focused and highly engaged audience who already trusts their FI. The fintech can leverage some of that trust to deliver their products efficiently.
Each side has strengths and weaknesses that complement the other, so partnership is the next natural step. FIs are starting to recognize how the ecosystem is converging, and they want to get involved.
What’s in it for each party?
When it comes to banking and fintech products, speed to market is king. Whether a fintech is bringing third-party apps into the digital banking environment or a payroll company is launching a debit card, the faster one can move, the better. Rather than developing technology in-house at an FI, or seeking a bank charter at a fintech, it’s easier to partner to make these realities come to life much sooner.
For FIs, it’s all about engagement, customer retention, and diversification of revenue. Having fintech apps built into digital banking gives account holders more reasons to log in and engage with your bank or credit union. The more customers that engage, the less likely they are to switch to another FI. Regarding revenue diversification, this can come in a couple different ways. One could serve as a partner FI in a banking as a service arrangement or offer fintech apps within digital banking for purchase using Q2 Innovation Studio. Either way, partnership with fintechs and brands must occur in some capacity.
Fintechs get the efficiency that comes from only doing what they do well (product design and user experience management), as well as customer acquisition cost improvements that a model like Innovation Studio provides. Regarding this latter point, Price says, “If you give [fintechs] access to 18 to 20 million end users through a single point of integration, that’s a pretty attractive channel for a fintech or brand that’s trying to build their business that can avoid some of the costs of setting up a large distribution sales network.”
For the end user, it’s all about democratization of services. “You have the best of both worlds, where you can get the optimal costs, but also speed and the best solution,” says Price. Typically, these services are binary: you’re either sacrificing cost for quality or vice versa. As services democratize and new segments begin to open, such as the underbanked, you’ll start to see increased competition that results from increased choice. This will drive better innovation for end users — which is great for the broader economy as well.
What’s the cost of not partnering?
This change is happening. The market for partnership-enabled services is growing around fintechs and FIs. For those who fail to get on board, they’re looking at lower revenue, which means lower levels of investment and innovation. Consumers will flee to other platforms who are more tech forward and who have engaged in these partnerships.
It’s still early days for these new forms of partnership, especially Innovation Studio. But we can expect a massive increase in activity in these areas. The demand is clearly present. In fact, Price says, “When we made the case to our board to fund and invest in this initiative around Q2 Innovation Studio, the data we saw was that the average small business in the United States was spending $200,000 a year on 20 disparate applications to run the small business around the FI.” The technology to centralize these many disparate applications is finally here, and when Q2 added the Experian solution to Innovation Studio, we saw thousands of users adopt the app in just the first few weeks. And with 16% of the US population underbanked, banking as a service is quickly gaining steam as the solution that finally brings people into the banking system.
For more information on Q2 Banking as a Service, check out our eBook, The Age of Abundant Banking: How to stay innovative when every company offers a debit card. And if you’d like to learn about Innovation Studio, you can read more here.
