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Banking and Fintech: What is the Right Fit?

As banks embrace digital transformation, they are being forced to wholly reconstruct their products and services. The emergence of finance technology, otherwise known as fintech, and the proliferation of alternative financial services models are disrupting the way the banking, payments and insurance sectors have traditionally done business.

How are banks responding?

Recent research from the ISG Index™ shows most major banks have increased their technology spend. In fact, the annual contract value of outsourcing deals in the financial services sector grew by more than 15 percent between the second half of 2015 and the first half of 2016 in the Americas alone.

Some banks have set up innovation funds to sponsor startups or acquire them. Others have decided to shift the way they think and consider fintech firms as partners instead of competitors so they can tap into their expanding ecosystem. Scotiabank, for one, has partnered with Kabbage—a fintech firm that uses an automated lending platform to provide funds directly to small businesses and consumers—to speed its loan processing, lower its rates and broaden its customer base. And German insurer Allianz is testing blockchain, or distributed ledger technology, for catastrophe bond trading.

This approach to the changing financial services market is worth noting. While banks bring an extensive customer network, large-scale operational capability, regulatory expertise and well-oiled operations, fintech firms bring innovation, nimbleness and a brass-tacks approach to new services.

To capitalize on the potential of a fintech partnership, banks should consider these Top 5 ideas:

1. Partnering with a fintech firm is like “sourcing” solutions. Banks should consider working with fintech firms as an opportunity to identify solutions that help them become more agile and achieve faster returns. Just as banks have sourced IT services from traditional IT firms like IBM and Indian-heritage service providers, they can now source a specific set of technology services from fintech firms. As startup fintech firms continue to make the world aware of their capabilities, banks should expect to see fintechs participate more and more in the sourcing process, and banks should use the sourcing process to understand and evaluate fintech solutions.

2. Look primarily for innovation. Finding the right fintech firm comes down to identifying which firms can innovate faster and which can offer the most meaningful services. The ultimate winner of the investment in innovation and service should be the end customer. Innovation in this context needs to result in better services—like faster payments and cheaper loans—that enhance the relationship between banks and their customers.

3. Exercise your right to be nimble. Most banks are burdened by legacy systems that keep them from being able to react quickly to market demands. Because fintech firms are not weighed down by older IT hardware and software, they can develop solutions quickly and continuously improve the user experience. Leveraging fintech firms can help a bank streamline the development process and speed the shift from legacy systems to new cutting-edge technology.

4. Evaluate the risk of not leveraging fintech. Banks should fully vet various alternatives, including the alternative of not partnering with fintech firms. The risk of not investing in new ideas can keep a bank from being competitive or even allow their competition to leapfrog them with new products or markets. The Royal Bank of Scotland was burdened with legacy IT that resulted in major outages and, now, it is behind its peers. We hear about new fintech solutions for banking every week. In today’s market, not moving fast enough comes with its own dangers.

5. Update your engagement model. There are several ways to engage with fintech firms: partner with them, buy them, create a joint venture or buy their solutions. Each bank will need to decide which engagement model will help them achieve their goals. When sourcing solutions from a fintech firm, banks should consider structuring an outcome-based engagement model so a partnering fintech firm shares the risk and rewards of the deal and has the right incentives to deliver results.

ISG helps banks navigate the changing fintech field and determine what path is right for them. Contact us to discuss further.