A day in the life of the gentleman banker was once described by the 3-6-3 rule – accept deposits at three percent, loan money at six percent and tee off at the golf course at 3 p.m. The financial services industry can rightfully state that it has come a long way since then. It has implemented technological innovation and managed risk in a constantly changing economic environment over several decades. The gentleman banker has since evolved into a sophisticated financial risk manager who works within a complex framework of rules and regulations with tens of trillions of dollars of assets under management.
Fintechs have moved at a much faster pace than banks in some areas. They have disrupted the financial services industry with user-centric solutions enabled by technology. These solutions emulate products and services offered by financial institutions. However, these remarkable examples of innovation have largely ignored the elephant in the room – regulation.
Regulation is an inherent aspect of banking. 2017 will see the emergence of the next generation of innovation in fintech that addresses risk management and regulation for the bank. These include solutions that make better risk decisions at low cost and in compliance with regulation. Emerging technologies such as cognitive analytics, big data, machine learning and predictive analytics offer a lot of options for companies to manage their regulatory compliance risk. We expect that regulatory technology, also known as regtech, will emerge as a separate area of innovation in 2017.
Today, it is not unusual for large banks to spend more than $1 billion a year to manage risk and compliance and another $1 billion or more in implementing a compliance process. The impetus to invest in regtech has come from huge fines levied by regulators on banks for compliance violations in the last 10 years. There may be several initiatives to reduce banking regulation during 2017. However, the need to transform compliance processes will persist for the foreseeable future.
The momentum around regtech is showing up in IT budgets. Bain & Co estimates that regtech will account for 15-20 percent of “run the bank” budgets and 40 percent of “change the bank” projects going forward. Solution providers that are able to analyze regulation and technology will emerge as dominant players in 2017 and in years to come.
Meanwhile in 2017, banks and regulators alike will take significant steps to work with fintechs while protecting their respective charters. In a preview of the banking landscape in 2017 Jamie Dimon, CEO of JPMorgan Chase, wrote about Silicon Valley in its annual letter to shareholders. “It is unquestionable,” said Dimon, ”that fintech will force financial institutions to move more quickly, and banks, regulators and government policy will need to keep pace.” A few months later, the OCC, which supervises about 1,400 of the largest banks in the country, created an Office of Innovation to work with fintechs and create “responsible innovation.” Their objective is to participate in the innovation.
2017 will also see the emergence of API banking. BBVA, a Spanish bank, recently announced a set of APIs for fintech innovators to interface with their bank. The Open Bank Project is another initiative in this area that helps innovative fintechs work with banks through open source APIs. Such initiatives are the banking equivalent of the App Exchange from Salesforce and iPhone app store from Apple. They will lead to the foundation of an ecosystem for fintechs and traditional banks to cooperate in building innovative solutions to customers.
The new ecosystem of banks and fintechs can also produce some hybrid entities in 2017. Cross River Bank is an example. It is a community bank with less than $500 million in assets, which works with 15 fintech companies as well as with TransferWise for remittances and Coinbase for Bitcoin. In an endorsement of the future of banking and fintechs, Battery Ventures led an investment of $28 million in VC funding for the bank. Variations of Cross River Bank will appear in years to come.
In an ideal world, 2017 would see the confluence of efforts between the disruptors and incumbents into a newly defined ecosystem. In reality, this will be a chaotic learning curve for all concerned for the next five years. Understanding regulation will pay a very important role for all companies that want to be players in the financial services ecosystem beyond 2017. Meanwhile, the best advice we can give to fintechs that want to be players in the new ecosystem is to embrace regulation as a feature of the financial services industry and not a bug.