Community Banks and Fintech: A Complex Relationship

By: Denise Rinear

Community banks have long prided themselves on their high-touch, super-local service to their communities. Now, along comes a new generation of consumers with a preference for low-touch, technology-enabled banking. What is a community bank to do? Banks may assume that some variation of “getting into fintech,” “partnering with a fintech,” or “digital transformation” is critical to keeping the bank relevant. In the end, that may be the correct answer, but it really comes down to the assumptions the bank is making about why this type of change is valuable, optimal, and ultimately necessary. In the same way, risks are always found in the assumptions. Identifying and evaluating these assumptions should yield insights into whether this is a strategy that makes sense for the bank, and what risks it may represent. When a bank unpacks its assumptions about fintech, it can get to the heart of what fintech can and cannot do to make the bank stronger and more relevant to its customers. 

Some of what makes fintech companies and services attractive is that they represent “the new.” Your bank strategy can feel new to your customers when bank products and practices are refreshed and modernized. But modernization can occur on many fronts. Consumer engagement can be modernized without technology investment, sending a message that the bank understands and cares about connecting with its customers in a manner that speaks to them. So, we must always use caution with the assumption that technology, in any form, will automatically be a game changer. 

Fintech in Banking 

Technically, all banks are in fintech. But the term is most often used to describe firms that are using technology to disrupt or redefine the value of banking services. Fintech services are coming to market at a time when banks are aggressively looking for growth opportunities and competitive advantages. Banks that optimistically, or even naively, assume that fintechs have capabilities they lack may overlook certain limitations or risks in those capabilities. Many banks have been enticed to invest in a new product, service, partnership, etc., only to find disappointment in the end. Defining fintech and its true value is particularly important to community banks that are relatively small businesses, pursuing partnerships with often larger and/or more technologically savvy companies. Success will require clearly defining your bank, understanding how fintech opportunities may complement your market and business model, and being clear about the risks and rewards. 

The Fintech Opportunity 

One area your bank may be drawn to is fintech opportunities with the potential to be transformative. Some opportunities serve the customer directly with a product or service the bank isn’t able to profitably deliver. For instance, smaller loans have been a bank profitability challenge for some time. Partnering with a fintech that offers small dollar loans may drive additional revenue to the bank. For its depository customers, banks may want to provide added convenience with person-to-person payments, mobile deposit, and updated infrastructure and apps. The transformative promise of these services is to improve customer lives effectively enough to earn their trust and continued business.  

Another attractive possibility in fintech is its ability to be innovative but not necessarily disruptive. Definitions vary, but in general “innovative” is regarded as beneficial to the bank long-term, while “disruptive” can often be considered negative. These are not mutually exclusive, and in some contexts, both can be valuable in shaking up long-held views of how banking “should be done.” Fintech services promise to use technology to meet, even anticipate, fundamental, sometimes unexpressed customer needs. Banks that exceed customers’ expectations make them feel valued and can build long-term loyalty. 

A strategic plan focuses on potential changes to address competitive opportunities and threats. Value-added fintech services address the perceived threat that challenger banks and online or digital banks will render community banks irrelevant for a significant segment of customers. Any significant change, driven by an opportunity or a threat, will come with some disruption. But whether the change is ultimately transformative or innovative depends on how it is designed and delivered. Adding a simple product or two to your current suite of products may provide value but stop short of being transformative. An open source digital platform may be transformative, but it is likely to be disruptive as well. If being transformative is truly what you aspire to, you must ask yourself whether the current leadership is prepared to embrace such change, and take the risks needed to purposefully disrupt the bank they have already built. Beyond products and technology, the transformative promise of fintech requires change that starts at the top and eventually may result in changes in bank leadership, business model, and culture.

A wide range of services fall under the fintech umbrella. A crucial first step is to understand the purpose of any service and determine if the service is fit-for-purpose. Some fintech offerings are variations on existing products and services (i.e., “better, faster, cheaper”). A loan application app, save for any new feature capabilities, is simply an electronic variation on paper applications. Other services labeled as fintech may be platforms that improve how transactions are captured and processed. Investing in a utility service to improve a bank’s technology architecture is quite different from investing in a customer facing process improvement. In all cases, banks need to answer the same question: 

“Is my investment in this fintech solution a new business driver, a costcutting mechanism, or simply a cost of doing business?” 

Once the question above has been answered, the next step is to look at the assumptions underpinning this fintech choice, spoken or unspoken. This all has to start at the strategic planning process, because all strategy is based on a set of assumptions, and the risk always lies in these assumptions. 

Assumptions about Fintech

Legendary business consultant Peter Drucker said, “Plans are only good intentions unless they immediately degenerate into hard work.” Identifying the assumptions embedded in your strategy can be hard work. One or more may be undefined, or some may be defined but assume benefits that may never materialize, or risks that are greater than they appear. Below are some of the more common assumptions that we see and hear within the industry. These may be perfectly valid and accurate as they relate to your institution, but only through a careful review of your own identity, goals, and ambitions will your bank make wise choices about how emerging opportunities fit into your vision for the future. 

Assumption #1: Fintech is a threat to community banks. 

Banks have good reasons for identifying fintech as a threat to their competitiveness and relevance. Local and midsize banks, as a segment, have seen a decline in their market share in the last decade, suggesting that when consumers do decide to switch banks, a local bank is less likely to be the bank they choose. Larger banks adopted services attractive to digital-centric, mostly younger consumers, leaving community banks playing catch up. Consumers and small businesses have shown an openness to using nonbank financial services providers, particularly for specific services such as person-to-person payments and small to midsize loans. The new, mostly non-bank, service providers designed their innovative services for customer segments where banks had few new products and services to offer. Banks are now looking to imitate the innovators and attract or recapture customers drawn to these new services.

A defensive, market-follower strategy may be the only one available to your bank, but any investment made defensively requires a clear-eyed look at this investment versus doing nothing. Responding to a competitive threat can become a cost of doing business, effectively increasing expenses with little or no improvement to revenue. But for some, a market-follower strategy in the technology space may be a good complement to high-touch local services. Other community banks may be looking for one or more ways to distinguish their bank services from others, sending the bank on a search for more competitive differentiation through fintech solutions.

But every threat always presents an opportunity. A chartered bank has tremendous value to nonbank fintech firms, and banks of any size have the opportunity to build partnerships with nonbanks in return for fee income. They also have the ability to specialize in a particular loan or depository segment, focusing their value creating technology investments there. Sometimes, a relatively undistinguished technology offering becomes a competitive opportunity when it is communicated and delivered in a way that feels distinctive to your customers.

Key takeaway: There is no question that fintech will change the banking landscape over the coming years. If your bank believes fintech is a threat, look critically at the value of following the market versus staying the course you’re on. Listen closely to what it is your customers, and communities, want, and evaluate where you may be falling short. Critically evaluate opportunities for leveraging emerging solutions, but always stay in line with your particular strategy and goals. In other words, look for ways to translate the identified threat into a measurable opportunity. 

Assumption #2: Successful banks will be those that invest in fintech. 

While this could be easy to accept at face value, not all banks define success the same way. Bank organizational structure and strategic plans provide a window into how a bank defines success. Some structures are lean and designed for efficiency. Others focus on a portfolio of diversified business units that, taken together, provide acceptable returns over time.

Regardless, following the crowd is rarely a recipe for strategic success. Strategic success comes from making choices that fit with where the bank wants to be five or 10 years from now. The “what” and “how” of fintech investment can differ quite a bit from one bank to another. If your ambition is to double your size, the role of fintech might be quite different from a scenario in which you want to super-serve your local community and continue to be relevant there. Successful banks are those that know why they want to make any investment, including fintech. Investments in fintech may be designed to reduce costs bank-wide or provide a growth opportunity for one business line or product. A comprehensive cost benefit analysis should reveal how big an impact any individual fintech investment may have, and whether that investment fits into the existing bank business model and strategy. 

Banks that stand the test of time supplement their investments with activities that increase the likelihood of long-term value creation. The best strategies deliver value on more than one front, providing measurable benefits along with a strong message about where the bank is headed. When employees and customers know the bank cares about what matters to them, they are likely to view the bank more favorably. In the end, some investments just don’t work as expected. Also, knowing when and how to exit can make the difference between a long-term drag on earnings and a short-term experiment. 

Key takeaway: When considering an investment in fintech services, enhance your chances of success with a detailed cost-benefit analysis, supplemented with activities that make customers and employees feel enthusiastic about the bank and its mission. But always be prepared to change course if the promised value isn’t there for any given solution or provider.

Assumption #3: Fintech makes the bank more efficient and effective. 

While many times a new process or technology can lead to substantial efficiencies or capabilities, making the cost-benefit case for any operational investment is a challenge. New systems and processes promise a mix of hard and soft cost savings, but as projects proceed it is not unusual for both hard and soft savings to erode or be deferred. Plus, people are incredibly slow to change habits, and changing operational processes can sometimes look a lot like New Year's resolutions, where failure may be more common than success. Finding the perfect fintech product or partner may bring new technical capabilities, but won’t in and of itself help your employees build new, good habits. Process changes include a human element that requires time and patience. Any expected new behavior needs to be practiced and repeated until it becomes second nature.

Becoming more efficient and effective doesn’t need to turn the bank upside down. Sometimes, a few small things will have a big impact. A number of years ago there was a social sciences concept called The Broken Window Theory that suggested when you take care of little things, like broken windows, people feel more pride and have a renewed enthusiasm for their role in improving their environment. The same theory can be used when motivating bank employees to build on little improvements with responsive service and timely issue resolution. Assuming an operational improvement will provide that motivation doesn’t go far enough. Employees need to be able to contribute to engineering improvements that make their environment better. If improvements miss the mark or don’t work as expected, employees need to feel empowered to say what isn’t working. 

Key take away: Many new and emerging fintech solutions can and will bring operational efficiencies. While system capabilities are fairly easy to evaluate in terms of their potential benefit, people are the key to finding promised efficiencies. Define and monitor expected efficiencies, including those promised by vendors and those that matter most to employees. Evaluate solutions that create efficiency and capacity for the bank, but never stop engaging the people who actually make these processes happen.

Assumption #4:  Consumers care about fintech and will switch banks for it. 

Customers often report that they do not like their bank. They may cite poor problem resolution, security and data concerns, lack of certain products, or difficulty performing simple tasks. At the same time, dissatisfied customers often do not switch banks. According to the JD Power 2019 U.S. Retail Banking Satisfaction Study, only 4% of customers switched banks last year. Customer satisfaction and convenience have improved overall over the past decade, but customers still have not regained the trust and connection needed to improve bank reputations. One theory put forth suggests that bank switching is on the decline because money movement is so easy, not because banks have made banking any more convenient.

If a competitive distinction is to be found in fintech, it might be in how your bank communicates and delivers its mix of technology-based and person-to-person services. Look at your services through your customers’ eyes to see whether you are delivering value or promising something that falls short. Promising mobile services but requiring a branch visit to establish the account falls short for digital-centric customers. If services such as funds transfer, mobile deposit, and bill payment require multiple keystrokes or, even worse, several tries before the service works, it isn’t delivering on its promise. If your services do deliver as promised, use targeted communication and customer-friendly practices, like switch kits, that make the process of switching easier. 

A key part of making the “should we do it” decision for a new product or service based on a fintech-based solution is determining who will find the service attractive and whether that customer is who you want. Not all customers see value in technology-based processes, and not all customers are those your bank wants. Customers who are shopping for a new bank might be doing so simply because their existing bank isn’t responsive, and innovative products might attract unprofitable customers. If the bank goal is to capture bank switchers and feels that certain technology-based solutions will support this, the bank needs to know the value of the target market and how to become their primary bank. 

Attracting new customers without keeping them doesn’t provide long-term value. There is no question that more of the market is attracted to lower-touch, higher-tech solutions, but fintech initiatives that simply promise customer growth need to fit with the personality and strategy of the rest of the bank. It will take more than one service to entice customers to do business with a bank they perceive to be oriented toward someone older, younger, more successful, more sophisticated, or in any meaningful way, different from them. Customer surveys also provide valuable information about customers who come and stay and those who come but don’t find a home at the bank.

Key takeaway: Prior to investing in technology-based growth strategies, test assumptions around the customers the new services will attract. Build performance and risk indicators around the measurable outcomes the bank can reasonably expect, and monitor these closely. Be prepared to adapt if key assumptions prove suspect, including assumptions about what it will take to attract and keep the bank’s most valued targets. 

Assumption #5: Core technology companies have created quality fintech products and services.

Community banks don’t have the resources in-house to design, develop, and roll out complex technology-driven products and services. Small-to-midsize banks will typically rely on vendors, often their core servicing platform provider(s), for fintech services. In 2018, the top 10 banking and financial services software vendors accounted for nearly half of the global banking and financial services applications market. Companies such as Microsoft, FIS Global, FISERV, SAP, and Oracle dominate the industry. For the smallest banks, those under $1 billion dollars in assets, 90% use one to three core service providers. Banks that choose to source services from their core providers get the latest offerings and know that the services will integrate within their existing core platform. At the same time, banks that use these large technology companies may be choosing from a limited list of capabilities and services available to them, and trust (assume) that the services offered are well-designed and executed.

However, as we know, not all fintech providers are large, established firms. Some are startups or specialty providers with specific niche capabilities such as small dollar lending, alternative credit scoring, digital wallets, or asset management applications. Each of these alternative services are designed and delivered with strengths and limitations that may not be obvious or easy to discern. So, each bank has to decide whether to venture beyond the services offered through its core provider, into the murkier waters of partnering with independent, upstart companies with alternative, perhaps more distinctive products. 

When considering new services and, especially when considering new, untested providers, banks should leverage their risk management team to help evaluate their assumptions about the value and quality of those services. Start with a well-designed and effective vendor management due diligence process, which should provide a structure for critically evaluating the companies themselves. If your bank has model risk management specialists, these individuals should be engaged to assess any model or AI-driven services early in the process. Third parties can be notoriously protective in how their models and programs work, even when a bank is relying on them for critical activities. In this case, a mismatch in information and understanding can reduce the due diligence process to a “check the box” exercise that provides little choice beyond take it or leave it. However, don’t be intimidated and don’t give up easily. There has never been a better time for gathering publicly available information on product and company quality. Do your homework and ensure you know the weaknesses and limitations of what you are buying before you make the decision to move forward.

Key takeaway: Be an informed purchaser of services, especially for critical services with some technical complexity. Make sure due diligence is done by someone who is not the key advocate for purchasing a product or service. If you cannot clearly describe the limitations of any fintech partner or service, more work is needed. Use your internal risk management group and other subject matter experts to support analysis and credible challenge on your assumptions prior to making a decision. If the bank doesn’t have a risk management team, consider using qualified outside consulting resources.

Bringing it all together – Creating your bank’s fintech strategy. 

Rarely is one technology, product, service, or partnership sufficient to overturn years of depositor erosion or transform small business lending from a loss leader to a profit center. Think back to earlier transformative innovations such as ATMs. Banks struggled for years to determine whether ATM investment was a new business driver, a cost-cutting mechanism, or a cost of doing business. Banks face the same struggle today when deciding how fintechs can provide business value. 

The rise of fintech challengers may be the wakeup call small and midsize banks need. Community bank business models are being eroded on both sides of the balance sheet. Upstart players are siphoning off core depositors and specializing in various loan types, leaving banks with a less diversified base. Larger banks are reducing the number of switchers by satisfying their digital-centric customers with major improvements in in-person service, mobile banking, and ATMs. Strategic choices are critical to the long-term prospects of community banks. Fintech is a major factor in the shifting competitive landscape, and your bank needs to determine how it wants to compete. Finding the right fintech opportunity for your bank can put you on a path to growth and relevance. 

To get the most of your bank’s fintech strategy, do the following: 

  • Make sure you’ve defined, in writing, who the bank is and why it exists. This will always serve as significant context to what incremental solutions, partnerships, etc. make sense for your institution.
  • Clearly define the bank’s strategic objective(s), along with more than one way to potentially achieve the bank’s objectives. Strategy is all about choice. If there is no choice, there is no strategy. 
  • Identify your assumptions about the benefits, costs, and risks of any potential solution or partnership before moving forward. Remember, risk always lies in the assumptions.
  • When evaluating fintech options, take advantage of the skill sets in vendor management, risk management, model risk management, information security, etc. They can provide an independent view of the strengths and limitations of the services you are considering. 
  • Define key performance and risk metrics that provide the best indicators of progress and integrate KPI/KRI monitoring into established governance practices or committees. 
  • Know your options for exiting or altering the strategy if key assumptions are found to be unrealistic. Have contingency plans in place for critical strategic initiatives.

One of the promises of fintech is that it can inject new life into bank services and processes. Understanding how you assume fintech will impact your particular institution is critical. Strategic initiatives fail when assumptions don’t match reality, and fintech, for all its promise, is no different.  


DENISE RINEAR is a managing principal at Capco. She can be reached at denise.rinear@capco.com.






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