Original post at Medium - 4 Collaboration Models between Fintechs & Incumbent Financial Institutions

When looking at the state of the financial services ecosystem, we can see a handful of different trends unfolding. For the past years, the rise of new fintech companies has changed the paradigm in the financial industry. New companies have come to market with dedicated, unbundled products. With better user experience and tailored products or services, those fintechs have rapidly gained traction from the broad public. From peer-to-peer payments, alternative lending, robo-advisors, or rental insurance, fintechs have disrupted the landscape of financial services — in the best way.

These new challengers are enhancing or entirely redoing what we knew of the financial services industry and shaking at the same time the incumbent — a.k.a the brick-and-mortar financial companies: hundred-year-old banks and insurance providers (“incumbents”). Incumbents have been challenged, and many are rethinking their strategies. But, as many said before, this transformation of the financial industry that first seemed like a turf war between fintechs and incumbents is now morphing into a more collaborative approach. Incumbents and fintechs are developing partnerships to provide the best possible experience to their mutual customers.

These partnerships between fintechs and incumbents have proven to be beneficial for both parties.

• Fintechs can gain access to established customer bases and infrastructure, which can be difficult and costly to build on their own.
• Incumbents, on their side, can take advantage of the innovative technologies and services offered by fintechs, helping them to stay competitive in an increasingly digital financial landscape.

In the rest of this article, I will look at different approaches that those companies are considering when looking at partnerships, and I will further discuss some of the benefits and drawbacks we’ve seen so far.

Models of Collaboration

Collaboration between fintechs and traditional financial services can be looked at from two different dimensions:

• The source of products and services that are being offered to the end customer: are they from the incumbents or the fintech?
• The channels by which those products and services are being distributed: are they using incumbents (e.g. bank branches) or the fintech channels?

If we put this approach on a graph with two axes — the distribution channels on the x, and the source of products and services on the y — we end up with a matrix that provides four potential models for collaboration.

The Legacy

Let’s start with the easy one and then let’s not talk about it anymore. The legacy distribution model is the approach used traditionally: financial institutions distribute their own products through their own channels.

Fintechs can provide tools and services to the bank more in the form of a vendor relationship. For instance, banks can use the services of third-party companies to enhance their customer experience. This is the case with Personetics, a fintech providing personalized customer engagement services to financial institutions like U.S. Bank, BMO, or Santander.

The Integrator

The integrator model looks at distributing fintech products via the financial institution channels. In other words, the model looks at enhancing the incumbent’s portfolio of products and services with best-in-class products from fintechs.

In this type of partnership, the fintech company provides its services to the incumbent financial institution, which integrates those services into its own platform. This allows the incumbent to offer its customers access to the fintech’s services while allowing the fintech to gain access to the incumbent’s customer base.

One example is the Deutsche Bank + Traxpay partnership. In 2020, Deutsche Bank decided to extend its trade financing capabilities and is now using Traxpay’s platform technology to expand its supply chain finance offering.

The Distributor

The distributor flips the approach over. It looks at the distribution of the financial institution’s products and services via the fintech’s channels. In other words, it looks at increasing the amount of potentially reachable customers by leveraging the fintech’s customer base.

In this model, the fintech companies provide additional channels to financial institutions while being able to benefit at the same time from extended offerings. Fintech will typically add a layer of personalization on top of the products and services being distributed to better target their segment. However, for this type of partnership to gain any traction, the fintech needs to have an existing, significant customer base.

One instance of this approach is Mint recommending credit cards through its channels. These credit card offers were personalized to the consumers based on the insights Mint was able to gather on the consumer through their personal financial management product.

The Infrastructure Provider

The last model — maybe the most interesting in my view — is when fintech products are distributed via fintech channels but are supported by legacy institution systems. This is the case when core banking services are provided by the incumbents for fintechs to create products on top of and then distribute them.

If you think about it, most fintechs do not have a bank charter and rely on incumbent banks to provide the deposit and lines of credit, for instance, to their customers while at the same time applying all the required regulatory oversight. This is true for most of the fundamental core services (e.g., managing deposits, keeping one’s general ledger, processing payments, or issuing debit and credit cards — and the list goes on).

Organizations such as Cross River Bank or Green Dot Bank are thriving with that model, offering a vast array of banking-as-a-service capabilities to other fintechs. Affirm’s savings accounts, for example, are held with Cross River Bank.

Overall, the specific model used for a partnership between a fintech and an incumbent financial institution will depend on the specific needs and goals of each party. Some partnerships may likely involve a combination of these models. I think we will see more of these kinds of partnerships in the months and years to come. Some will be a tremendous success, but many will just fail.

Now, we will discuss what benefits can be achieved through partnerships if those are successful, and lastly, we will take a look at some of the drawbacks that can bring a potential partnership down.

Drawbacks to Consider

Fintechs tend to be very good at very specialized aspects and rely on or outsource to third parties (i.e., other fintechs or service providers) to supply the rest of the non-differentiating capabilities. Financial institutions, on the other hand, own a vast range of services and tend not to provide highly specialized and personalized products or services.

At the same time, new challenger models have also emerged and we see incumbents bringing to markets new products (although getting shut down, Marcus is a good example of such an attempt), or big tech companies launching into the banking space (Apple launching its Apple Card, and more recently the Apple Pay Later product).

Partnerships between fintechs and incumbents can have challenges that lead to the failure of the venture. Things to keep in mind:

• Culture clashes: fintechs tend to be more agile and focused on innovation, while incumbents may be more risk-averse and look at long-term strategic planning. Differences in people’s habits and expectations, processes, communications, and pace can severely impact any partnership and make it very difficult for the two parties to work together.
• Technical interoperability issues: incumbents carry with them decades of technology legacy and debt. More often than not, financial institutions’ systems are redundant and extremely cluttered resulting from multiple mergers and acquisitions over their time. The risk-averseness can also lead to incumbents being unwilling to adopt newer technologies (e.g., cloud) whereas fintechs have long embraced them. These differences can make it difficult to integrate and interoperate the services and products of both parties, bringing delays and increased costs
• Loss of control: the partnerships between fintechs and financial institutions often involve the sharing of resources and technology which reduces the overall control one party has. Fintechs may lose control over their technology and how it gets used, while incumbents may lose control over their customer relationships and data. This can create friction between the two parties ultimately impeding the success of the venture.

Benefits can be Achieved

It is important to carefully consider the potential drawbacks and ensure that strategies are in place to address any challenges that may arise. If done correctly, I believe that partnerships between fintechs and incumbents can bring various benefits to both parties. Notably:

• Increased revenues: from increased sales thanks to the new channels or from strategic investments made in fintechs yielding positive returns if successful — the most obvious benefit of these kinds of partnerships is the potential for financial gain for both parties.
• Enhanced customer experience: through access to new innovative technologies and services, organizations can now roll out highly tailored and personalized services that create unique experiences for customers. These new approaches increase the stickiness an organization has with customers while improving the perceived value customers have of them.
• Expended customer bases: to access established customer bases fintechs can often benefit from partnering with incumbents. These behemoths have large and established customer bases through which, fintechs can expand their reach and grow their businesses.

In this article, we’ve discussed different approaches that fintechs and incumbents can consider when looking at collaborations, and addressed some of the benefits and drawbacks that can come from those relationships. Fintechs are able to gain access to established customer bases and infrastructure, which can be difficult and costly to build on their own, while financial institutions are able to take advantage of the innovative technologies and services offered by fintechs, helping them to stay competitive in an increasingly digital financial landscape.