Banks See Challenges from Fintech Disruption

By Carl White, Federal Reserve Bank of St. Louis

Fintech firms have been labeled “disrupters.” Whether teaming up with financial institutions or going it alone, fintech firms — or neobanks1 — are rapidly gaining market share in several areas formerly dominated by financial institutions, such as payments and consumer loans. In 2013, according to TransUnion data, fintech companies accounted for 5% of the U.S. personal loan market. By 2018, these firms eclipsed banks with a 38% share of this growing market. Banks’ share of personal loans fell from 40% to 28% over the same period, while credit unions’ share declined 10 percentage points to 21%.

At the same time, the technological developments that spawned fintech, such as big data and artificial intelligence, have also greatly benefited traditional financial institutions — whether they have contractual relationships with fintech firms or not. Innovation has spurred new products, increased efficiencies and lowered costs for a range of players.

From a deposit standpoint, a review of the Federal Deposit Insurance Corp.’s Summary of Deposits shows that in 2019, U.S. banks classified more than 3% of their deposits as “cyber deposits” — those gathered through online-only branches. In 2020, these deposits represented more than 4% of all bank deposits nationwide. This innovation places an additional burden on banks, however, as they are required to uphold the same regulatory standards for their digital bank operations as they do for their traditional operations.

When Is a Bank Not a Bank

Most fintech firms are not — and do not aim to be — fullservice financial institutions. They do not meet the definition of a bank — an institution that takes demand deposits and makes loans. They typically market their narrow range of products to specific market segments, such as students, small-business owners and freelancers. Some seek to serve the under- and unbanked who may not want or need a bank to meet some objectives, such as savings, person-to-person payments and small-dollar loans. These firms frequently partner with traditional financial institutions using a variety of models that benefit both providers.

Other fintech firms have modeled themselves more like banks, with some seeking bank or bank-like charters. This trend has prompted some concern about unequal regulation and any resulting competitive advantages nonbank firms might gain. This is especially true of very large companies like Walmart, which filed a trademark application in late March for a venture the company says could offer services such as credit card issuance, financial portfolio analysis and consulting, credit and debit card transaction processing, mobile payments and virtual currency transaction processing.

Issues for Policymakers and Regulators

As competition intensifies and banks continue to lose market share in certain product groups, risks are also moving outside the banking system. While that may seem like good news, there’s a flip side. As Jamie Dimon, Chairman and CEO of JPMorgan Chase, recently noted, “Banks are reliable, less-costly and consistent credit providers throughout good times and in bad times, whereas many ... (competing) credit providers … are not. More important, transactions made by well-controlled, well-supervised and well-capitalized banks may be less risky to the system than those transactions that are pushed into the shadows.” This development could complicate federal policy responses to financial crises and other events.

To remain viable in an ever-more digitized environment, banks are extending the use of these technologies to their whole operations, including regulatory compliance and risk management. Regulatory technology, dubbed RegTech, is increasingly being used by banks to detect fraud and comply with anti-money laundering rules, among other uses. Bank supervisors must be able to evaluate banks’ use of RegTech, and they are also beginning to deploy new technologies (SupTech) to improve efficiency in data collection and analysis. This transition will require resources, including human capital.

The Road Ahead

It is clear that financial activity will continue to move outside the traditional, regulated financial sector of commercial banks and other financial institutions. Technology is a double-edged sword for banks: It expands the menu of available services and makes the provision of services cheaper, but it also paves the way for new competitors. The challenges banks face from an ever-increasing number of competitors are many, but so too are the opportunities. Banks remain a vital conduit for the conduct of monetary and fiscal policy, for example. They proved indispensable in assisting the federal government’s response to the pandemic, playing a major role in the rollout of the Paycheck Protection Program and other Small Business Administration programs. Banking will evolve, but banks aren’t going anywhere.

About the author: Carl White is Senior Vice President, Supervision, for the Federal Reserve Bank of St. Louis. IBA Associate Member.

1. The term neobank typically refers to companies that use applications — desktop or mobile — to offer financial services to customers.