Banks face competition from start-ups

Technology is a double-edged sword for banks. Most are focused on providing the latest digital banking applications to their customers and investing in whizzy new technology, such as finger pulse scanners and digital cheque imaging. But they also face growing competition from tech-savvy rivals.

Apple’s announcement this month that it aims to revolutionise the world of credit card payments with the launch of Apple Pay, a service that allows customers to make payments by waving their iPhones over a terminal, is widely seen as a wake-up call for banks.

Most senior bankers knew the challenge was coming. “[They] all want to eat our lunch,” Jamie Dimon, chief executive of JPMorgan Chase, said in February, referring to the big technology groups, such as Apple, Google and Facebook. “I mean every single one of them, and they’re going to try.”

Harry Nelis from Accel Partners, the venture capital firm that backs several financial technology start-ups including the UK peer-to-peer lender Funding Circle, says: “There are certain parts of the financial services industry where the big technology groups are well positioned to play and Apple’s latest move is a sign of that.”

Yet responding to this challenge is hard for banks, many of which have vast IT systems dating back to the 1960s and 1970s that are prone to problems and expensive to maintain. Furthermore, as people check their accounts more regularly on tablets and smartphones, it puts additional strain on those systems.

A report from the British Bankers’ Association and EY, the consultancy, found that in the UK alone, almost £1bn of mobile and internet transactions are being processed every day. This year, more than 15,000 people a day have downloaded banking applications in the UK. At the same time, the use of traditional branches has fallen sharply.

A wave of “fintech” start ups has emerged, seeking to disrupt banks’ business models. They are particularly prevalent in London and companies such as TransferWise, Zopa and WorldRemit have become significant actors on the global stage in recent years.

Consultants responsible for improving banks’ systems say that merely accessing some archived data has been a challenge because of the obsolete formats used.

Also, as banks have expanded through acquisitions, they have tended to bolt new systems on to existing ones, rather than undertake the more disruptive and costly process of fully integrating them. The result is hugely complex IT networks that it may be impossible to untangle.

Often, banks find themselves relying on systems that are unsupported by their IT vendor or cannot be supported by internal staff, yet which are still critical to their operations.

For instance, after Lloyds Banking Group acquired Halifax Bank of Scotland in 2008, it chose to move its new customers on to its core system, rather than invest in building an entirely new platform. In contrast, Nationwide chose the more costly and time-consuming route of investing in a new core system from SAP and Accenture.

UK banks say they are spending billions of pounds on IT each year. State-backed Royal Bank of Scotland and Lloyds seem to face the biggest IT problems. They say they invest about £2bn a year.

The Financial Conduct Authority, the Prudential Regulation Authority and the Bank of England are conducting a joint review into the resilience of lenders’ systems and how bank boards are dealing with the risks of failures.

The review, which is expected to take about a year, follows a number of high-profile glitches, including a shutdown at RBS in 2012 that meant millions of customers could not access their accounts for weeks.

After the outage, RBS admitted it had underinvested in its IT systems and said it would spend an additional £450m over the next three years. Technical glitches can be very damaging for banks’ reputations. Even news of a small failure that lasts only minutes can be spread quickly to millions of people via social media.

Figures from Celent, the research company, show that less than a quarter of the $180bn that banks spent on IT last year was for new investment – the rest was devoted to maintaining existing systems. Asian banks devoted the highest proportion of all IT spending to new investments at 30 per cent, followed by US banks at 24 per cent, while European banks had the lowest proportion at 13 per cent.

As the banking behemoths are weighed down by creaking legacy systems, it leaves them vulnerable to competition from high-tech upstarts.

As Antony Jenkins, Barclays chief executive, admitted in a recent speech: “We are on the leading edge of a technology revolution in financial services. We can see opportunities and threats all across our business.”

Financial technology start-ups in the UK and Ireland raised more than $700m from investors between 2008 and 2013, according to research from Accenture.

The founders of these firms see banks as slow-moving and complacent. They say financial institutions have failed to understand that, while the mainstays of their businesses – such as current accounts and investment services – are not under threat, other less lucrative sectors are under attack.

One founder described the process as “death by a thousand cuts”, with each fintech company taking a small slice of a bank’s business, adding up to a significant proportion of its overall revenues.

However, fintech companies have slowly changed their attitudes to the banks. Whereas banks were once seen as the enemy, the fledgling groups have come to realise that the two need to work together.

For example, Samir Desai, chief executive of Funding Circle, a peer-to-peer lender, was behind a landmark partnership with Santander, the Spanish bank that has agreed to send the London-based start-up some customer leads in return for promotional work.

“Evolution has taken place,” he says. “Our early messaging was anti-bank, and banks were a bit dismissive of what we’re doing. There’s been growing up on both sides.”

Hiroki Takeuchi, chief executive of GoCardless, a UK start-up that helps small business set up direct debit payments, says: “It may end up with a situation where banks providing core business infrastructure. I don’t think the current account is going away soon. But by partnering with fintech companies, banks can offer provide better services overall.”

Mr Takeuchi adds: “If you believe that people will keep money in banks, fintech companies will have to go through the banks rails. You have to work within the banking system. That is frustrating.

“Even with Bitcoin, where you’ve got a currency outside the banking system, you need a way to load up real currency into that Bitcoin account.”

Mike Ward, head of OzForex in Europe and North America, says the Australia-based online foreign exchange dealer has grown rapidly by selling currencies at cheaper prices than most banks.

The Sydney-listed company, which used to be 51 per cent owned by Macquarie, the global investment company, handled A$13.6bn ($12.2bn) of foreign exchange transactions last year. “It’s easy for us to undercut the banks,” says Mr Ward. “But online forex providers have only a 5 to 10 per cent share of the market. So, we have a long runway before the banks start responding to our challenge.”

This story was updated on September 24 2014