Digital banks, big in the U.K., have a trust problem in the States.

“Challenger banks,” as they’re called across the pond, include the likes of Monzo, Starling, Tandem and Atom — completely digital banks built on new technology as opposed to the outdated infrastructure of legacy banks. They usually tout better interest rates, lower fees, if any, and better service. They have an have an easier time creating a good customer experience because they don’t build on the rusty rails of the existing financial system, making the way they operate more efficient and the user experience more enjoyable.

That model hasn’t really caught on in the U.S., though, where startups are mostly building technology-based solutions for payments, investing and lending – anything that doesn’t require opening a bank account with an unknown entity. Building that type of business profitably is hard: the cost of customer acquisition is high and complying with complex financial regulations can be a big undertaking.

But beyond that, U.S. customers are still largely distrusting of startups when it comes to handing over all their deposits, and digital banks are waiting for that doubt to wear away, said banking and payments consultant Faisal Khan. Customers responded well to startups that give them convenience by connecting to their existing bank accounts, like Venmo for easy peer-to-peer payments or Moven for personal finance management. Even startups that take micro deposits like savings app Digit or micro-investing app Acorns have become popular among early adopter types.

Digital banks, however, need to create a stronger value proposition that will actually motivate customers to break a habit or create a new one and store larger volumes of their money with them – especially with legacy banks partnering more closely with startups and acquiring their services.

Making a profit
BankMobile, a rare U.S. success story, offers a compelling case study. With about 2 million accounts since its 2015 launch, it has grown so quickly Customers is selling it to Flagship Community Bank in Clearwater, Florida. (The Durbin Amendment of the Dodd-Frank Act requires companies with more than $10 billion in assets cap their interchange fees at 44 cents, and Customers’ asset size is just below that. BankMobile’s revenue comes mostly from interchange fees on debit cards.) The $175 million deal is expected to close before the end of the third quarter.

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Luvleen Sidhu, president and chief strategy officer, said one of the main reasons BankMobile has been so successful is it is acquiring new customers at a low cost – about $10 per account, she specified, compared to the roughly $300 she said it generally costs to acquire a customer returns come out to “maybe $85 a year” in revenue.

“A lot of people are trying to utilize technology to bring an antiquated model into the 21st century,” she said, acknowledging the similarity of many fintech products and the importance of delivering a valuable solution. “The question is whether they’re successful at doing that and how you measure success. But if you’re not doing it profitably, it’s not a sustainable model.”

The reason most fintech startups aren’t building profitable businesses is obvious but important: It’s expensive and they don’t have easy access to funding like banks do. Many want to “make the world a better place,” and in fintech that often means bringing financial access to unbanked customers or offering low- or no-fee accounts for lower income people. Those ventures often don’t take off in a truly transformational way. But as existing financial institutions know well, lower income customers are not as profitable and the same is true for fintech companies, Sidhu said.

“It comes down to profitability,” she said. “Lower income customers are not as profitable. It’s the same for fintech companies:  A lot of these models don’t have low cost funding like a bank does – they have to lend to customers but then have to borrow from hedge funds – therefore they have to partner with banks or banks have to acquire them.”

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Most startups understand that now. Financial technology as a concept is not new but the rise of the movement around “fintech” began with companies bent on disrupting legacy financial institutions. Today both sides understand each is necessary to the other’s success and are eagerly working together.

That’s perhaps part of the reason the U.S. doesn’t really have “challenger banks” – a term generally saved to qualify U.K. startups; U.S. startups are joining banks, not challenging them. Simple was eventually sold to Spanish banking giant BBVA, Moven is now partnering with TD Bank and BankMobile was born from a bank.

Customers need a better value proposition
Digital banks haven’t taken off in the U.S. yet but that doesn’t mean they won’t. However, it will take more than a better customer experience enabled by technology to motivate customers to open an account or switch from their current bank, despite their general dissatisfaction with the current financial system, Khan said. These new experiences need to focus more on customer behavior – something banks get but startups need to work on more. What will ultimately make a digital bank stand out from legacy banks that are improving digitally is the way it handles data.

“Technology is not an edge, it’s a temporary advantage and if a challenger bank can acquire technology so can a bank,” he said. “The one that’s able to get customers is the one that understands behavior well. It’s not about technology or price – and banks understand behavior very well.”

The bank of the future will understand how people use data in their everyday lives – on social media and not just in their financial affairs – and make it easy for them to manage their money in the same platform, Khan said. For example, if one day everyone with a Facebook account also has a bank account with Facebook, making one a natural extension of the other, that might be even more appealing to customers than a bank or digital bank, both of which currently act as designated environments for banking.

The value proposition and difference around brand awareness or trust is not worth it to consumers to make the switch from a legacy bank to a digital bank and that trust is what drives their behavior, said Jeffrey Brown, global banking and financial services lead at Genpact.

“The successful fintechs are the ones who think about a different customer experience or value proposition or solve a different problem than the existing guys,” he said. “Digital and artificial intelligence are just tools by which they deliver that but there’s nothing inherent about the technology driving the ones that are successful.”

That’s why it’s important to remember a tech giant like Facebook or Amazon could get into banking services before a digital bank even takes off, Khan said. If it’s a competition for customer trust, the tech company could beat out all the banks.

“Banks today are asking your institutional association not your social association,” Khan said. “There are many steps from legacy to seamless total data integration.”

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