It’s 2015 and most banking technology is awful. How many times have you waited in line at the bank for a simple transaction only to wait while the teller inputs your info in a 30-year-old clunky IT system. Chances are, most of your financial transactions are programmed in the 1959 COBOL language. In fact, you might get snail mail faster than an online payment from some banks who still use the Automated Clearing House System from the 1970s.
It’s kind of understandable. Proponents of the legacy systems say when you’re handling sensitive financial information for millions of people, it’s better to err on the side of safe than sorry. Plus, the cumbersome size and sheer expense of banking operations put limits on how much they can change. But that mindset is shifting…slowly…but surely. Over the past few years, there’s been a noteworthy spike in the creation of startups that are making financial transactions easier, cheaper and even safer.
And it’s happening across the entire financial landscape, from the way we pay our friends (can I just Venmo you?) to the source of our investment advice (robo advisors). The last few years have produced a steady stream of cool, new technologies that will have our grandchildren look at ATM vestibules the way we look at record players. The following is a deep dive into what took the FinTech revolution so long and why it’s lighting a fire under the biggest Wall Street firms.
Rising from the Ashes of the 2008 Meltdown
For decades, big banks have enjoyed a forcefield of governmental financial regulations that prevent newcomers to easily come in and disrupt their operations. But when the market crashed in 2008, banks created a deep hole in consumer trust and support. The combination of distrust in big banks and tech advancements like Cloud computing, open source, encryption and machine learning has been a perfect storm for FinTech startups to rise to the occasion. For instance, even though back-office automation service Firm58 was founded in 2005, it didn’t really take flight until the crash in 2008.
For banks, Firm58 was a good, cheap solution to build much-needed visibility in banking operations. One article in 2009 in Certification Magazine interviews the CTO of Firm58 who explains:
In these market conditions, I think a lot of these financial firms are trying to do a lot more with less. They’re not open to building in-house, proprietary systems anymore. They want to offload the IT cost; they don’t want to have a huge IT staff.
Still, since the crash, scrutiny has been high, making the financial industry one of the hardest industries for startups to break through. Just look at what happened to peer-to-peer (p2p) lender Prosper. When people couldn’t get loans from banks, they naturally looked to p2p lending as an alternative. But in 2008, the Securities and Exchange Commission (SEC) issued Prosper a cease-and-desist letter because the online platform did not register with the SEC. After closing shop for 9 months and paying $4 million in fees, they finally rerouted their business and are now rumored to follow competitor Lending Club into IPO.
The JOBS Act Oiled the FinTech Engine
The Jumpstart Our Business Startups (JOBS) Act in 2012 helped ease some hefty financial regulations. Because of the JOBS Act, anyone can invest in private projects just as if we were to buy stocks on NASDAQ. It opens up opportunities for companies to solicit publicly online and reach investors through new, 21st-century channels (like the Internet).
In fact, there are a host of new startups created dedicated to help FinTech startups navigate the startup world. GroundBreaker, for instance, not only helps real-estate firms raise money using the JOBS Act but also advises clients on how to get their legal documents in order, structure their company, and handle compliance. The JOBS Act truly helped spring finance into the 21st century. And it’s not just about introducing more competitive, innovative startups in finance. It’s also about being able to adopt new technology that, in 2015, most of us take for granted.
For instance, the Cloud has become something of an extension of our professional skills, says Jake Marmulstein of GroundBreaker, but for most real estate professionals, the most sophisticated tech they use is Powerpoint and Email. In technology time, that’s akin to the stone ages! Real estate professionals traditionally couldn’t advertise or attract investors to their deals in a scalable way.
“Crowdfunding is not a new thing for real estate professionals. Most real estate professionals raise money from a small pool of investors they know on a first name basis, or from institutional investors whose contributions count for a large portion of the needed equity in a transaction,” Marmulstein says.
But thanks to JOBS Act, real estate professionals can extend and scale their investor reach online.
Big Banks: ‘Silicon Valley is Coming’
The spike of FinTech startups may not be enough to pierce a major hole and kill off the multi-billion dollar industry on which banks are built. But, they are forcing banks to innovate. In a letter to shareholders, JP Morgan Chase CEO Jamie Dimon acknowledged that the FinTech revolution is something they’re proactively aiming to compete with.
“Silicon Valley is coming. Rest assured, we analyze all of our competitors in excruciating detail — so we can learn what they are doing and develop our own strategies accordingly,” Dimon says in the letter.
Here’s what’s really special about FinTech: They are not only making finance faster and cheaper but also creating new services and security checks that couldn’t be made possible otherwise. For instance, new machine learning algorithms that scrape Big Data offer a more accurate way to assess a borrower’s risk level than the traditional loan officer at your local bank.
Goldman Sachs predicted that FinTech startups could threaten up to $4.7 trillion in revenue and $470 billion in profits from traditional Wall Street firms. Consider the fire lit under their feet. So, many big banks are making three strategic moves to stay relevant:
#1 Big Banks Building Strong Tech Teams
Big banks are creating their own new software platforms comparable to FinTech innovations. For instance, Charles Schwab recently released a free automated, algorithm-based portfolio advisor. This is basically a copycat of startups Betterment and Wealthfront. Likewise, Experian now offers an app that lets you track your credit on your smartphone…exactly like startup Credit Karma.
Goldman Sachs’s Symphony is the perfect example big banks’ focus on building in-house technology. Symphony is a cloud-based messaging workflow platform built internally for the firm. Most recently, they’ve even launched it externally as an open source platform as well.
To build quality new software, Wall Street has grown their tech teams significantly compared to just 10 years ago when banks were strapped for IT resources. Here’s a chart that breakdown the number of tech professionals versus total employees for two top banks today: Goldman Sachs and JPMorgan Chase. Both companies have more tech employees than Silicon Valley giants, like Facebook and Google!
#2 Can’t Beat ‘Em? Partner with ‘Em
Big banks are also keeping enemies very close. For instance, Spanish bank BBVA Ventures recently acquired Simple, an automated budgeting and savings service. Similarly, both JP Morgan Asset Management and SunTrust Banks are investing in Prosper, mentioned above. With extremely deep pockets, it’s often easier for banks to swoop in and buy innovative startups than create their own. Plus, the innovative features that boost speed, cost and convenience only helps big banks grow their business in the long run.
“Financial services-sponsored venture capital investment will continue to grow as institutions recognize that a go-it-alone approach of in-house development isn’t enough,” Jaidev Shergill, head of digital venture investing at Capital One, told Accenture.
#3 Let’s Build the Next Big Thing!
When they’re not copying or partnering with existing startups, some banks actually launched their own startup accelerators to race to the forefront of innovation. Just in the past two years or so, HSBC, Wells Fargo and Santander all launched startup in-house accelerators, allocating hundreds of millions of dollars for FinTech startup investment. Barclays partnered up with TechStars, a startup accelerator. And Deutsche Labs has 3 innovation labs. The idea is, if some of these companies are successful, they’d become great vendors for the banks. Theoretically, it’s a win-win.
It’s been a long, treacherous road for techie entrepreneurs to breath some life into banks’ mainframes of the 70s and there’s still more to be done ahead. Beaten down by pre-Internet governmental regulations, FinTech startups of the past decade have helped pave the way for the outpour of stealthy new technologies for payments, lending, investing and much more. Finally, finance and technology seem to be moving together.
It’s sparking a slow, steady overhaul of banking technology. While FinTech startups could never obliterate the concrete, giant banks, they have forced them to start revving up their technological engines and, at least, start to catch up to the 21st century.