The Digital Disruption: Banks, FinTech and the BigTech
A decade ago, the world’s ten largest banks by assets were based either in Europe or the United States, while currently, the top ten ranks are dominated by six Asia-based banks. The banking industry has witnessed many radical changes since the Global Financial Crisis of 2008 such as low interest rates (0 and negative in some instances), increased regulation, higher capital requirements and stricter compliance and low credit growth. The crisis, coupled with digital disruption, has challenged the profitability of many old banks as they are barely covering the cost of capital. How the list of top ten banks by assets would look like in another decade remains a legitimate question for the pundits since innovation in this sector has certainly taken everyone by surprise.
Banks perform two major functions in an economy- one, is maturity transformation and liquidity provision i.e., taking deposits and disbursing loans and secondly, payment and transaction services. Both functions rely heavily on information processing, especially the latter. With the digital revolution, the processing of this information has witnessed a complete change. Digital disruption in the financial sector is driven by factors both on the supply side, mostly technological developments, and on the demand side, accompanied by changes in consumer expectations of service. APIs have enabled service improvements, faster payments, and have provided support for easier unbundling of services. They have become the standard for data sharing in so-called open banking applications.
While banks have traditionally focused on the product, new entrants emphasise the customer, putting pressure on banks’ traditional business model. Traditionally, banks believed in maintaining a relationship with customers and from there selling more products to their customer base. This advantage of banks is being eroded by FinTech due to reduced switching costs on account of the digital revolution. The story does not end here, as the world has seen the entry of major BigTech firms into this sector. BigTech platforms’ primary business is technology and data, and unlike FinTech firms, they also have important scale and scope economies, large installed customer bases, established reputation and brands, deep pockets from retained earnings, and unfettered capital access.
BigTech firms can disrupt this sector in two ways- one, by becoming banks in due course of time leveraging their economies of scope and bundling their offerings with existing banks and two, by becoming multisided platforms focusing on a bunch of profitable banking activities. In the former, they would leverage their information, which would be superior from traditional banks, on consumer spending habits, preferences using AI and algorithms while in the latter, they would offer platforms to deal with different financial institutions.
Consider the case of India, where Google Pay and Walmart-owned PhonePe are leading in UPI payments, ahead of Paytm. Amazon, too, is not far behind by offering services through Amazon Pay, the industry is bracing for intense competition as WhatsApp is also eyeing this space. While the long run impact of entry of BigTech in this sector is not clear yet, certainly the traditional banks need to think out of the box, redefine their agility and nimbleness to compete with the new entrants who seem to have an edge over them in some aspects of banking.