For years, there has been much talk about the impact of fintech startups like Monzo and Atom Bank on incumbent banks but little has been done to quantify the actual effects fintechs are having on big banks.
New data from The Bank of England (BoE), published as part of its 2017 stress test of the UK banking system, however, is shedding light on this subject.
In its report, the BoE identified several areas in which incumbent banks could be hurt by fintech upstarts and by how much in monetary terms. They are:
Reduced overdraft revenue
Major UK banks generate more than £2bn annually from overdraft fees. Fintech threatens this revenue in two key ways.
First, new tools that help bank customers better manage their finances could help many of them reduce their usage of overdrafts. Second, fintech upstarts could help consumers find other, cheaper sources of credit so that they don’t have to tap overdrafts.
Reduced fees from payment services
According to the BoE, payments income contributes approximately £0.8bn to UK banks’ annual pre-tax profits and this could decrease as the EU’s second payment services directive (PSD2) takes effect and non-bank payment providers offer bank customers alternative means of transferring money and making payments without their banks’ direct involvement in the transactions.
Higher customer acquisition and retention costs
The BoE says that fintech innovations, including those driven by PSD2, could make it more difficult for banks to acquire and retain customers. “For instance, in the future it may be possible for a customer to manage their finances with only minimal direct engagement with their banks,” the BoE wrote in its report.
To deal with the competition from fintech, the BoE estimates that banks may have to double their marketing spend, which would have the effect of reducing their annual pre-tax profits by £1bn.
More difficulty cross-selling
Data is worth its weight in gold for banks, and banks’ ability to cross-sell to their customers has been helped by banks’ “ownership” of their customers’ data. But thanks to PSD2, which lets customers give third parties access to their transaction and activity data, banks in the UK will increasingly find themselves competing with non-bank fintechs, many of which are focused on services that banks have traditionally cross-sold.
As a result, banks could find that they are unable to cross-sell as much, not only reducing revenue but weakening their relationships with customers.
Increased liquidity risk
Increased competition from fintechs for customer deposits could expose banks to increased liquidity risk if customers more frequently switch their deposits. This could also reduce banks’ net interest margins.
One way banks might be able to counteract this is to offer higher interest rates on savings accounts, which could have the effect of persuading some customers to move money from instant access accounts to time deposit accounts.
This, of course, will still come at a cost: the BoE estimates that if banks increased their time deposit rates by 25 basis points from the current average, it would reduce their pre-tax profits by £0.8bn.
Increased cyber security risk
With customers having the ability to grant access to their banking data under PSD2, banks will have greater exposure to cyber security threats such as hacking and data breaches.
While the Financial Conduct Authority (FCA) is working to mitigate these risks, namely by playing an oversight role in which it will vet third parties that will be accessing bank data, it’s impossible to fully eliminate cyber security risk. After all, the good guys have to be right all of the time; the bad guys only need to be right once.
Given how high the stakes can be – the recent hack of Equifax, for instance, could have costs in the billions of dollars – banks will have to invest significant sums – £4.9bn over the next seven years according to the BoE’s estimate – into cyber security.
The news isn’t all bad
While they may not be able to avoid some of the ill-effects of fintech disruption that the BoE has identified, incumbent banks do have a future – if they make wise decisions and investments today.
There’s no reason that banks can’t participate in the fintech trend by developing their own innovative new technologies, rethinking their customer experiences, looking at markets they have previously underserved, and partnering with or acquiring young companies that have built better mousetraps.