23/2/2017 Cutting through the noise around nancial technology | McKinsey & Company

Financial Services

Article
February 2016

Cuttingthroughthenoisearound
financialtechnology
By Miklos Dietz, Somesh Khanna, Tunde Olanrewaju, and Kausik Rajgopal

Wetrackmorethan2,000start-upsofferingtraditionalandnewfinancialservices
thoughweestimatetheremaybeasmanyas12,000.Hereshowbanksshouldrespond.

B
ankinghashistoricallybeenoneofthebusinesssectorsmostresistantto
disruptionbytechnology.SincethefirstmortgagewasissuedinEnglandinthe
11thcentury,bankshavebuiltrobustbusinesseswithmultiplemoats:ubiquitous
distributionthroughbranches;uniqueexpertisesuchascreditunderwriting
underpinnedbybothdataandjudgment;eventhespecialstatusofbeingregulated
institutionsthatsupplycredit,thelifebloodofeconomicgrowth,andhavesovereign
insurancefortheirliabilities(deposits).Moreover,consumerinertiainfinancial
servicesishigh.Consumershavegenerallybeenslowtochangefinancial-services
providers.Particularlyindevelopedmarkets,consumershavehistoricallygravitated
towardtheestablishedandenduringbrandsinbankingandinsurancethatwereseen
asbulwarksofstabilityevenintimesofturbulence.

Theresulthasbeenabankingindustrywithdefensibleeconomicsandaresilient
businessmodel.Inrecentdecades,bankswerealsohelpedbythetwintailwindsof
deregulation(inaperiodusheredinbytheDepositoryInstitutionsDeregulationAct
of1980)anddemographics(forexample,thebaby-boomgenerationcameofageand
entereditspeakearningyears).Intheperiodbetween1984and2007,USbanksposted
averagereturnsonequity(ROE)of13percent.Thelastperiodofsignificant
technologicaldisruption,whichwasdrivenbytheadventofcommercialInternetand
thedot-comboom,providedfurtherevidenceoftheresilienceofincumbentbanks.In
theeight-yearperiodbetweentheNetscapeIPOandtheacquisitionofPayPalbyeBay,
morethan450attackersnewdigitalcurrencies,wallets,networks,andsoon

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attemptedtochallengeincumbents.Fewerthan5ofthesechallengerssurviveas
stand-aloneentitiestoday.Inmanyways,PayPalistheexceptionthatprovestherule:
itistoughtodisruptbanks.

Thefintechmoment

Thismaynowbechanging.Ourresearchintofinancial-technology(fintech)
companieshasfoundthenumberofstart-upsistodaygreaterthan2,000,compared
with800inApril2015.1Fintechcompaniesareundoubtedlyhavingamoment(Exhibit
1).

Exhibit 1

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Globally,nearly$23billionofventurecapitalandgrowthequityhasbeendeployedto
fintechsoverthepastfiveyears,andthisnumberisgrowingquickly:$12.2billionwas
deployedin2014alone(Exhibit2).

Exhibit 2

Sowenowaskthesamequestionweaskedduringtheheightofthedot-comboom:is
thistimedifferent?Inmanyways,theanswerisno.Butinsomefundamentalways,
theanswerisyes.Historyisnotrepeatingitself,butitisrhyming.

Themoatshistoricallysurroundingbanksarenotdifferent.Banksremainuniquely
andsystemicallyimportanttotheeconomy;theyarehighlyregulatedinstitutions;
theylargelyholdamonopolyoncreditissuanceandrisktaking;theyarethemajor

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repositoryfordeposits,whichcustomerslargelyidentifywiththeirprimaryfinancial
relationship;theycontinuetobethegatewaystotheworldslargestpaymentsystems;
andtheystillattractthebulkofrequestsforcredit.

Somethingshavechanged,however.First,thefinancialcrisishadanegativeimpacton
trustinthebankingsystem.Second,theubiquityofmobiledeviceshasbegunto
undercuttheadvantagesofphysicaldistributionthatbankspreviouslyenjoyed.
Smartphonesenableanewpaymentparadigmaswellasfullypersonalizedcustomer
services.Inaddition,therehasbeenamassiveincreaseintheavailabilityofwidely
accessible,globallytransparentdata,coupledwithasignificantdecreaseinthecostof
computingpower.TwoiPhone6shandsetshavemorememorycapacitythanthe
InternationalSpaceStation.Asonefintechentrepreneursaid,In1998,thefirstthing
IdidwhenIstartedupafintechbusinesswastobuyservers.Idontneedtodothat
todayIcanscaleabusinessonthepubliccloud.Therehasalsobeenasignificant
demographicshift.Today,intheUnitedStatesalone,85millionmillennials,alldigital
natives,arecomingofage,andtheyareconsiderablymoreopenthanthe40million
GenXerswhocameofageduringthedot-comboomweretoconsideringanew
financial-servicesproviderthatisnottheirparentsbank.Butperhapsmost
significantlyforbanks,consumersaremoreopentorelationshipsthatarefocusedon
originationandsales(forexample,Airbnb,Booking.com,andUber),arepersonalized,
andemphasizeseamlessoron-demandaccesstoanaddedlayerofserviceseparate
fromtheunderlyingprovisionoftheserviceorproduct.Fintechplayershavean
opportunityforcustomerdisintermediationthatcouldbesignificant:McKinseys
2015GlobalBankingAnnualReviewestimatesthatbanksearnanattractive22
percentROEfromoriginationandsales,muchhigherthanthebare-bonesprovisionof
credit,whichgeneratesonlya6percentROE(Exhibit3).2

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Exhibit 3

Fintechattackers:Sixmarkersofsuccess

Whilethecurrentsituationdiffersfromthedot-comboom,thefailurerateforfintech
businessesisstilllikelytobehigh.However,inaminorityofcases,fintechsthatfocus
ontheretailmarketwillbreakthroughandbuildsustainablebusinesses,andtheyare
likelytoprofoundlyreshapecertainareasoffinancialservicesultimatelybecoming
farmoresuccessfulthanthescatteredandlargelysubscalefintechwinnersofthedot-
comboom.Absentanymitigatingactionsbybanks,infivemajorretail-banking
businessesconsumerfinance,mortgages,lendingtosmallandmedium-size
enterprises,retailpayments,andwealthmanagementfrom10to40percentofbank
revenues(dependingonthebusiness)couldbeatriskby2025.Attackersarelikelyto
forcepriceslowerandcausemargincompression.

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Webelievetheattackersbestpositionedtocreatethiskindofimpactwillbe
distinguishedbythefollowingsixmarkers:

Advantagedmodesofcustomeracquisition

Fintechstart-upsmuststillbuildthemostimportantassetofanybusinessfrom
scratch:customers.Banksalreadyhavethem,andattackerswillfinditdifficultto
acquirethemcost-effectivelyinmostcases.Fintechattackersaresubjecttothesame
rulesthatapplytoanye-commercebusinesses.Overtime,akeytestofscalabilityis
thatgrossmarginsincreasewhilecustomer-acquisitioncostsdecrease.Duringthe
dot-comboom,eBay,acommerceecosystemwithplentyofcustomers,wasableto
reducePayPalscostofcustomeracquisitionbymorethan80percent.Fintech
attackersthistimearoundwillneedtofindwaystoattractcustomerscost-effectively.
Inthepaymentspoint-of-sale(POS)space,severalfintechattackers,suchasPoynt
andRevel,areseekingtocapitalizeonanindustrydisruptiontherolloutofEMV
(Europay,MasterCard,andVisatheglobalstandardforchip-baseddebit-andcredit-
cardtransactions)intheUnitedStatesandtheresultingaccelerationofPOS
replacementcycles.Theyareattemptingtoleveragedistributionfrommerchant
processorsandotherswithexistingmerchantrelationshipstoacquiremerchantsas
customersmorequicklyandlessexpensivelythanwouldotherwisebepossible.

Step-functionreductioninthecosttoserve

Theerosionoftheadvantagesofphysicaldistributionmakesthisadistinctivemarker
forthemostdisruptivefintechattackers.Forexample,manyfintechlendershaveup
toa400-basis-pointcostadvantageoverbanksbecausetheyhavenophysical-
distributioncosts.Whilethisputsapremiumontheimportanceofthefirstmarker,it
alsoenablesfintechbusinessestopassonsignificantbenefitstocustomerswith
regardtocostandtimetoprocessloanapplications.

Innovativeusesofdata

Perhapsthemostexcitingareaoffintechinnovationistheuseofdata.Forexample,
severalplayersareexperimentingwithnewcredit-scoringapproachesrangingfrom
lookingatcollegeattendedandmajorsforinternationalstudentswiththinorno
creditfilestotrustscoresbasedonsocial-networkdata.Manyoftheseexperiments
willfail,stress-testedbycreditandeconomiccycles(itisnothardtolendbasedon
differentunderwritingcriteriawhentimesaregood;thehardpartisgettingthe

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moneybackwhentimesaretough).Butbigdataandadvancedanalyticsoffer
transformativepotentialtopredictnextbestactions,understandcustomerneeds,
anddeliverfinancialservicesvianewmechanismsrangingfrommobilephonesto
wearables.Creditunderwritinginbanksoftenoperateswithacase-lawmind-setand
reliesheavilyonprecedent.Inaworldwheremorethan90percentofdatahasbeen
createdinthelasttwoyears,fintechdataexperimentsholdpromisefornewproducts
andservices,deliveredinnewways.

Segment-specificpropositions

Themostsuccessfulfintechattackerswillnotbeginbyrevolutionizingallofbanking
orcredit.Theywillcherry-pick,withdisciplineandfocus,thosecustomersegments
mostlikelytobereceptivetowhattheyoffer.Forexample,Wealthfronttargetsfee-
aversemillennialswhofavorautomatedsoftwareoverhumanadvisers.LendingHome
targetsmotivatedinvestment-propertybuyerslookingforcost-effectivemortgages
withanacceleratedcycletime.Acrossfintech,threesegmentsmillennials,small
businesses,andtheunderbankedareparticularlysusceptibletothiskindofcherry-
picking.Thesesegments,withtheirsensitivitytocost,opennesstoremotedelivery
anddistribution,andlargesize,offeramajoropportunityforfintechattackerstobuild
andscalesustainablebusinessesthatcreatevalue.Withinthesesegments,many
customersareopentoinnovative,remotefintechapproachesnotofferedby
traditionalbanks.

Leveragingexistinginfrastructure

Successfulfintechattackerswillembracecoopetitionandfindwaystoengagewith
theexistingecosystemofbanks.LendingClubscreditsupplierisWebBank,and
PayPalsmerchantacquirerisWellsFargo.InthesamewaythatAppledidnotseekto
rebuildtelcoinfrastructurefromscratchbutinsteadintelligentlyleveragedwhat
alreadyexisted,successfulfintechattackerswillfindwaystopartnerwithbanksfor
example,byacquiringunderbankedcustomersthatbankscannotserve,oracquiring
small-businesscustomerswithasoftware-as-a-serviceofferingtorunthebusiness
overallwhileabankpartnersuppliesthecredit.ApplePayoffersatemplateforthis:
withtokenizationcapabilitiessuppliedbythepaymentnetworks,itseekstoprovide
anenhanceddigital-walletcustomerexperienceinpartnershipwithbanks.

Managingriskandregulatorystakeholders

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Fintechattackersareflyinglargelyundertheregulatoryradartoday,buttheywill
attractattentionassoonastheybegintoattainmeaningfulscale.Thosethatignore
thisdimensionofbuildingasuccessfulbusinessdosoattheirownperil.Regulatory
toleranceforlapsesonissuessuchasanti-money-laundering,compliance,credit-
relateddisparateimpact,andknow-your-customerwillbelow.Thosefintechplayers
thatbuildthesecapabilitieswillbemuchbetterpositionedtosucceedthanthosethat
donot.Morebroadly,regulationisakeyswingfactorinhowfintechdisruptioncould
playout.Althoughunlikelytochangethegeneraldirection,regulationcouldaffectthe
speedandextentofdisruption,iftherewerematerialshocksthatwarrantedstronger
regulatoryinvolvement,suchascybersecurityissueswithleadingfintechs.The
impactcouldalsovarysignificantlybycountry,givendifferentregulatorystances,
suchasAnglo-SaxonregulationondatausageversusotherEUcountries,payments-
systemdirectivesinEuropethatcausebankstoopenuptheirapplication
programminginterfacestononbanks,Brazilsregulatorystanceonpeer-to-peer
lending,andstricterregulationinsomeAsianmarkets.

Aswithdisruptorsinanymarket,theultimatetestofwhetherafintechplayer
succeedsorfailsiswhetherthesesixmarkerscombinetocreateasustainablenew
businessmodel.ConsiderwhatinventorymeansforNetflixorwhatstorefrontsarefor
Amazon.Asuccessfulbusinessmodelwouldchangethebasisofcompetitionanddrive
revenuesdifferently;forexample,dataadvantagesmaybemoreimportantthan
distribution,andrevenuesmaynotrelyontraditionalbankingspreadandfee
economics.Despitewhatislikelytobeahighfailurerateamongfintechs,thesmall
numberofwinnerswillhaveabusiness-modeledgethatsustainsthemthrough
economicandcreditcyclesandhelpsthembuildenduringbrands.

Banks:Sixdigitalimperatives

Banksaresubjecttoalotofnoiseaboutfintechstoday.Optimismregarding
technologyisatahigh,mobilityiswidelyregardedasagamechanger,andvast
amountsofcapitalarebeingdeployedinfintechs.Banksmaybetemptedtodismiss
thenoiseentirely,ortheymaypanicandoverreact.Werecommendamiddleground
thatfocusesonseparatingthesignalsthataretrulyimportantfromthenoise.
Specifically,thismeansthatbanksshouldbelesspreoccupiedwithindividualfintech
attackersandmorefocusedonwhattheseattackersrepresentandbuildorbuythe
capabilitiesthatmatterforadigitalfuture(Exhibit4).

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Exhibit 4

Usedata-driveninsightsandanalyticsholisticallyacrossthebank

Attackerspoweredbydataandanalyticsbetheyfintechs,largeconsumerecosystems
(suchasApple,Facebook,andGoogle),orsomeofthemoreprogressivefinancial
institutionsareopeningupnewbattlegroundsinareaslikecustomeracquisition,
customerservicing,creditprovision,relationshipdeepeningthroughcross-sell,and
customerretentionandloyalty.Considertheprovisionofcreditoneofbankingslast
bigmoats.Accesstolargequantitiesoftransactiondata,underwritingandcustom-
scoringcustomersforcreditworthiness,understandingandmanagingthroughcredit
andeconomiccyclestheseareuniqueassets,skills,andcapabilitiesthatbankshave
builtandleveragedovercenturies.Butnowthelarge-scaleavailabilityofnewandbig
data(andthefactthatbanksnolongerhaveamonopolyonsuchdata)ispushing
bankstoradicallytransformjusttokeepup.Buildingacomprehensivedataecosystem

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toaccesscustomerdatafromwithinandbeyondthebank,creatinga360-degreeview
ofcustomeractivities,creatingarobustanalytics-and-datainfrastructure,and
leveragingthesetodrivescientific(versuscase-law-based)decisionsacrossabroad
rangeofactivitiesfromcustomeracquisitiontoservicingtocross-sellingto
collectionsallarecriticaltoabanksfuturesuccess.

Createawell-designed,segmented,andintegratedcustomer
experience,ratherthanuseone-size-fits-alldistribution

Thedaysofbankingbeingdominatedbyphysicaldistributionarerapidlycomingtoan
end.Theproliferationofmobiledevicesandshiftingpreferencesamongdemographic
groupsmeanthatcustomersexpectmorereal-time,cross-channelcapabilities(such
asstatusinquiriesandproblemresolution)thaneverbefore.Physicaldistributionwill
stillberelevantbutfarlessimportant,andbanksmustlearntodeliverserviceswitha
compellingdesignandaseamlessunconventionalcustomerexperience.Banksmust
recognizethatcustomerexpectationsareincreasinglybeingsetbynonbanks.Why
doesamortgageapplicationtakeweekstoprocess?Whydoesittakeanextraweek(or
two)togetadebitcardonlineversusinabranch?Whycantacustomermakeareal-
timepaymentfromhisorherphonetosplitadinnercheck?Banksneedtorespondto
thesequestionsbyimprovingtheircustomerexperienceandmeetingtheircustomers
changingexpectations.Financialservicesistheonlybusinesswhereyoucanbe
rejectedasacustomer.Inanagewheremobiledevicesprovidereal-timetransparency
onjustabouteverything,itiscriticaltoprovidecustomerswithinformationaboutthe
statusofanapplicationorwhatotherdocumentsarerequired.Accountbalancesmust
beconsistentacrosschannels,andbanksshouldconsiderthereal-timeupdatingthat
anon-demandappsuchasUberprovidesandaimtodeliverthatleveloftransparency
whenitmatters.Suchinnovationprovidesopportunitiesforbankstoimproveand
differentiatetheircustomerscross-channelandcross-productexperiences.

Builddigital-marketingcapabilitiesthatequale-commercegiants

Today,banksareinafightforthecustomer,notonlywithotherbanksbutalsowith
nonbanks.Themoatsthathavehistoricallyprotectedbankswillnotevenbeginto
compensateforthewidegapinmarketingskillsthatcurrentlyexistsbetweene-
commerceplayersandbanks.Bigdataandtheadvanced-analyticscapabilities
describedabovearemerelythefoundationofdigitalmarketing.Masteringdigital

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media,contentmarketing,digitalcustomer-life-cyclemanagement,andmarketing
operationswillbecriticaltobankssuccess.Buildingthesecapabilitiesandrecruiting
andretainingdigital-marketingtalentwillrequireconsiderabletimeandinvestment.

Aggressivelymitigatethepotentialcostadvantageofattackers
throughradicalsimplification,processdigitization,and
streamlining

Afterthelastdot-comboom,bankssuccessfullyelectronifiedcoreprocesses.Now
theymustdigitizethem.Thedifferenceiscrucialanelectronicloan-processingand
fulfillmentprocessatabanklargelyimpliesthesharingandprocessingofPDFfilesof
paperdocuments.Weestimatethatthemajorityofthecostofprocessingamortgageis
embeddedinhighlymanualloopsofworkandrework.Digitizingamortgage
applicationwouldinvolvecreatingandmanipulatingdatafields,suchasborrower
incomeandliabilities,inalargelyautomatedmannerinthecloud.Thiswouldbea
multiyearprocessforbanks,asitwouldrequiretheintegrationofmultiplelegacy
systemsandpotentialreplatformingtoenabletrulydigitizedprocesses.
Simplification,digitization,andstreamliningopportunitiesexistacrosslargeswaths
ofbankingoperations.Thesoonerbanksattacktheseopportunities,themore
preparedtheywillbetocompetewithfintechattackersthathaveastructurallylower
costbase.Newtechnologieswillofferbanksopportunitiestotestandscaletoachieve
efficiencies.Forexample,asthehypesurroundingBitcoincurrencyfades,itisclear
thatthebabyinthebathwatermaywellbedistributedledgertechnologiesthat
enablemorecost-effectivestorageandrapidclearingandsettlementoftransactions
inthebankingbackoffice.

Rapidlyleverageanddeploythenextgenerationoftechnologies,
frommobiletoagiletocloud

ThetechnologyagendaforbanksandbankCIOshasbecomeevenmoredemanding
andcomplex.Firstandforemost,mobilefirstisnotjustabuzzworditisthe
clearestdirectivebankscouldreceivefromconsumersabouthowtheywantto
interactwiththeirserviceproviders.Second,banksmustfortifynotonlytheir
technologies,butalsotheirinternalprocessesandcultures,todefendcustomersdata
frombreaches.Third,thepaceofinnovationinbankingisacceleratingrapidly,
requiringbankstoincreasetheirspeedtokeepup,includingsoftwaredevelopment
throughtechniquessuchasagileandcontinuousdelivery.Finally,significantlyfaster,

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nimbler,anddramaticallylower-costversionsofprocessingandstoragetechnologies
arenowcommonplace.Banksneedtomoveontosuchplatforms,retiringand
replacinglegacysystemsquickly.Sincesuchsystemsareneithereasilynorquickly
replaced,manybanksmaychoosetomovetoatwo-speedarchitectureapproach
thatbuildsmoreflexiblelayersoftechnologyontopofexistingsystemsbutstilldraws
onandinteractswiththosesystemstoprovidethenextgenerationoftechnology
agilityandseamlesscustomerexperiences.Fromprovidingtrulyscalableapplication
architecturewithaparticularemphasisonmobiletoaddressingthecybersecurity
threatstheyfaceeverydaytolearningagiledeliveryandmodernizingtheir
infrastructure,bankshaveachallengingbutimportantroadaheadinbuildingnext-
generation-technologycapabilities.

Rethinklegacyorganizationalstructuresanddecisionrightsto
supportadigitalenvironment

Thetypicalorganizationchartofanybankwillshowamatrixofproductsand
channels,withphysicaldistributionusuallyleadinginsizeandscope.Theprofitsand
losses(P&Ls)thataccompanythesematricesvestpowerintheownersofthechannels
andproductsthataremostlikelytobeinthefiringlineoffintechattackers.These
attackersaretypicallyorientedtocustomermetricstieddirectlytotheirfinancial
performance.Incontrast,mostbankshaveconsensus-orientedculturesthatrequirea
longtimetobuildalignment.BanksmustcomplementtheirexistingP&Lswith
approachesthatenablefasteradaptabilitytoexternalchanges,andfosterculturesthat
supportspeedierdecisionmaking.Banksmustthinkhardabouthowbesttoorganize
tosupportthefiveprecedingimperatives,askingwhatorganizationalstructureand
decisionrightswillmosteffectivelysupportadata-andinsight-drivenoperating
model,adistinctivecustomerexperience,digitizedprocessesforgreaterefficiency,
andnext-generation-technologydeployment.Whatinnovationsshouldtakeplace
withinthebank?Whatshouldbedevelopedinincubatorsoreveninseparatedigital
banksunderseparatebrands?Shouldthebankhaveseparatelaboratoriesora
venture-capitalist-likeinvestmentvehicletobeabletoexperimentwithnew
technologies?

Takentogether,thesesiximperativescarrythesameoverallimplicationforbanksas
thesixmarkersdoforfintechs:along-termshiftinthenatureofcompetitionand
successfulbusinessmodels.Anoverarchingchallengeforbanksishowtoopenup
structurallywithrespecttohowtheyleveragepartnershipsandhowtheypermit
otherentitiestoaccesstheircapabilities.Thosebanksthatpursueathoughtful

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approachtomeetingthischallengewillbebestpositionedtoevolvetheirbusiness
modelsandfindnewsourcesofvaluefortheircustomerswhileperformingwell
financially.

Theageoffintechsishere.Willthistimebedifferentfromthedot-comboom?Will
mostfintechattackersfail?Willthefewattackerswhosucceedfundamentallyreshape
banking?Regardlessoftheoddsofsuccessforindividualfintechattackers,banks
mustseekimportantsignalsamidthefintechnoiseinordertorepositiontheir
businessmodelsandculturesforsuccess.Thereisnotimetolose.

ThisarticleisaneditedextractfromCuttingthroughtheFinTechnoise:Markersof
success,imperativesforbanks(PDF665KB).

1. We dene ntech players as start-ups and other companies that use technology to
conduct the fundamental functions provided by nancial services, impacting how
consumers store, save, borrow, invest, move, pay, and protect money.
2. The Fight for the Customer: McKinsey Global Banking Annual Review 2015 (PDF
126KB), September 2015.

Abouttheauthor(s)

MiklosDietzisadirectorinMcKinseysVancouveroffice,SomeshKhannaisa
directorintheNewYorkoffice,TundeOlanrewajuisaprincipalintheLondon
office,andKausikRajgopalisadirectorintheSiliconValleyoffice.

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