Relationship Banking comes full circle with the help of Fintech
Posted on 3rd June 2021 at 14:26
A simple narrative captivates writers, journalists and consultants – sometimes even bankers themselves – on the disruptive potential of fintech innovation. It begins with the lumbering, hulking colossus of the twentieth-century retail bank, with its legacy software and inflexible culture that is resistant to change. On the opposite side of the fence are the fintech innovators, led by young (often), fired-up entrepreneurs who understand tech, obsess about the customer experience, and have full coffers backed by seemingly unlimited venture capital investors. Battle lines are drawn. Comparisons to Kodak and Blockbuster are made. The victory of the innovators over the incumbents appears certain.
Or perhaps not.
The history of banking is a much more turbulent one than such a fable suggests. Technological change is less of a sudden emerging threat and more of a constant that has transformed, time and again, bank strategy over the centuries. And it is the incumbent banks – particularly smaller, nimbler banks – that are embracing the potential of the fintech revolution to return to what might well be banking’s oldest and earliest principles.
Banks emerged in late medieval Italy to service first the needs of the state and then, slowly over time, the landowning and wealthiest merchant classes. Individual lenders would place a table – or banco – in the market square of a town and ply their services like any other merchant. Products were individualised and specialised, built for an individual client, with loan books funded out of the banker’s own pocket. If he did not live up to his promises, the table was smashed – rotto – and his ability to do business in the town ended (this, ‘banco rotto’, becomes ‘bankrupt’). As the centuries went on, this form of finance spread across Europe, funding Polish palaces and Dutch merchant fleets alike.
As commercial banking evolved in the 18th century, the introduction of the modern cheque enabled a world of new products, including the first true savings accounts and personal loans targeted towards the affluent middle classes. Products for these clients were no longer bespoke, but they were still tailored for a client by a local banker or bank clerk, likely long apprenticed and with a broad understanding of the factors that governed how much, at what rate, and to whom he was permitted to lend. Banks large and small established branch networks, trained generations of staff and became embedded in their communities – if the Italians were the first community bankers, these were the first community banks.
This model survived, in large part unchanged, into the 1950s and 1960s. Then, spurred by technological advancements, first American and then European banks adopted the inaugural wave of computer technology. Risk, lending criteria, terms, legal departments and the creation and management of new products could be handled at a central base, increasing efficiency and decreasing the need for well-trained local bankers in the networks. At the largest banks, these were soon replaced by retail staff who were more marketers than bankers, and through the vast expansion of bank branch networks (now less reliant on expensive employees), they grew their market share considerably. Products were now standardised and generic, except for the very largest institutional and private banking clients.
With the arrival of the internet, the largest retail banks had made successful forays into digital banking but the business model has not really evolved. Community banks did well in some markets and less well in others, but the incumbent megabanks consolidated their gains and ruled branch networks that spanned their home markets and, in many cases, the globe. Even as branches began to close and banking moved online, the largest retail banks maintained – even grew – their market share until a new wave of entrepreneurs and investors decided to disrupt their business.
The fintech ‘horror story’ for incumbent retail banking – a new, digital challenger bank, unburdened by legacy technology and an expensive branch network, well-funded by venture capital, backed by strong marketing, capturing generations of internet-first customers – would appear destined to frighten equally the largest megabanks and smaller community institutions. Both, after all, are incumbents. In reality, however, fintech may be more of a boon than a curse for community banking; it might even, if you believe the whispers, be its salvation.
The growth of open-banking models, the rise in fintech scale-ups looking for established, licensed banking partners and the immensely rapid adoption of fintech to revolutionise processes from KYC to back-end banking infrastructure across the community banking sector allows regional banks not just to survive, but thrive in an age of digital disruption. JP Morgan writes that
“we now firmly believe that many regional banks are positioned to emerge as the endgame winners in the digital age of banking”
and indeed that
“we now view many regional banks as challenger banks themselves”.
If this language seems hyperbolic, it should not be. Only regional banks couple being nimble enough to embrace banking’s technological revolution with deep local relationships built over generations with individuals, families and businesses. By working together, fintechs looking to partner with banks and community banks looking to maximise technology, can leverage these relationships to provide bespoke products built for specific communities, at specific times, to serve specific needs. Picture an SMB relationship banker who has served a community for years coupling their knowledge of a client’s business with AI-backed data analytics that can help build exactly the financial product they need, in a way that doesn’t expose the bank to more risk than it seeks.
This, as JP Morgan puts it, is the relationship model “on steroids”. As we now know, though, this observation is less original than some might think. In a way, the community bank with a fintech strategy is leveraging technology to bring the attention, the knowledge, the creativity and the client-banker relationship that traces its way back to its Italian roots to a new generation of clients.
‘U.S. Mid- and Small-Cap Banks Technology Disruption Report’, JP Morgan, December 2020
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