The banking industry is experiencing an unprecedented transformation. With 3,000 new fintechs and neobanks shaking up the traditional banking system, what does this mean for consumers and the financial services industry? These new banks may not be stealing large swaths of customer share from the Citibanks and Chases of the world, but mid-sized banks, including regional credit unions, will be feeling the squeeze soon unless they begin to innovate and focus on the customer experience and services the neobanks and legacy institutions are already providing.
With that stage set, these are the other ingredients the banking industry is working with right now:
- a long-term trend of industry consolidation
- regulatory easing, giving smaller banks more flexibility with less regulatory oversight
- a recent cooling of venture capital
- an increase in consumer choice when it comes to regional banking and how to manage their money, and finally;
- a global pandemic that has changed consumer behavior for good and may precipitate the beginning of the end of the branch banking model as we know it.
All of these ingredients add up to a recipe for opportunity for regional banking firms in general, but particularly for our beloved smaller regional banks and credit unions. I will explain why in a moment.
The state of regional banking today
First, let’s look at the state of affairs by the numbers. Over the past several decades, according to FDIC data, the banking consolidation rate has been 3.7% on average. In 1990, there were 15,158 banks, and in 2022 that number was just 4,796. With a bank failure rate of .3% over that time, this means fewer banks, and since the trend is driven by mergers, that means bigger banks at the top of the scale. But the “big” banks may be the top 10, top 20, or top 50, depending on your criteria.
That still leaves thousands of banks with millions of customers who see advertisements for innovative products from larger brands and wonder when their favorite bank may have something similar.
The 2018 Economic Growth, Regulatory Relief and Consumer Protection Act increased asset thresholds that trigger regulatory scrutiny from $50 billion to $250 billion, unlocking merger and growth opportunities previously unavailable to smaller banks.
As of November 2021, there were 10,755 fintech startups in the Americas alone. While certainly diverse in their added value, a large area of focus has been Payments, followed by Lending, Wealth Management, and Blockchain. This has led to many innovations, making payments – and banking in general – faster and more efficient.
The opportunity for banking transformation
However, for all of the great fintech companies around the world of all sizes, they are in various stages of maturity. Many are spending well ahead of revenue, focused instead on achieving the scale they need to operate profitably, which is literally what startups are supposed to do.
But the timing of capital market booms and busts can put startups in a precarious position when the VC money starts to dry up before scale has been achieved, as evidenced by some recent high-profile cram-down valuations and outright failures by startups unable to secure additional capital to fully realize their visions.
That said, the fintech space is still incredibly transformative for the banking industry, and near-term speed bumps are meaningless compared to the long-term value being created in the industry. The big winners here are consumers, who have seen innovative products brought to market that, let’s face it, would never have seen the light of day without the generous and important infusion of cash from VCs that built the fintech sector that transformed the entire banking industry for good.
Add to that the perfect timing of a pandemic that forced banks to rethink how they engage with consumers just as a wave of increased consumer choice was hitting the market, and we got banks, large and small, that simply had to adopt new technology either by buying or partnering, to answer the demand for consumer-centric products.
And now the economy is cooling off, and consumer anxiety is rising. When times are good, consumers don’t mind value-added services that, for instance:
A) make paying for things easier; or
B) provide access to additional credit; or
C) enable them to save money when they shop.
But when times are tight, consumers actively seek out these sorts of products, which is why some of the strongest fintech categories are those that answer these consumer concerns via:
1) Payments innovations,
2) BNPL, and
3) Loyalty and Cash Back rewards.
All of these categories are in high consumer demand with a softening economy looming on the horizon, and all of these categories are typically NOT among the products offered by smaller banks. But they certainly can be.
What’s next for the smaller players in the banking industry?
So, what does all of this mean? The big banks will weather the storm. They have the financial strength to endure an economic downturn, as well as the dry powder to invest strategically where needed.)
Fintechs may not fare as well, as external factors force them to seek safe harbors other than a new round of funding at a comfortably higher valuation for regional banking.
However, there is a huge opportunity for regional banks and credit unions to bolster their stature through technology that addresses those products that customers seek during slowed economic times.
Instead of competing for consumers directly in the market, many fintechs may find that the ultimate expression of their value at this time may be via an acquisition by, or a partnership with, a range of banks.
This is a win/win for startups and banks alike, and the timing is perfect. Entrepreneurs get to execute on their vision from within the relatively stronger position of a bank with a larger footprint and assets, while smaller and mid-size banks get to seize on the opportunity to level up their technology chops while valuations are not quite as astronomical as they once were.
Therefore, the most important trend in consolidation over the next few years may be among fintechs and smaller banks. Even aside from M&A, the competitive pressure on fintechs and smaller banks alike may make partnering more attractive than competing with one another.
The result could be that consumers get to remain loyal to a regional bank that gives them a more personalized experience without having to sacrifice innovation and technology-rich products offered by the massive banks. The effect could be that ALL banks, regardless of size, will rise with the tide, changing the historical zero-sum game of bank consolidation into one of expansion through the introduction of innovative new products that expand the industry in innovative ways, all to the net benefit of banking customers everywhere.