For the last year or two a fairly lackluster debate has – hmm, raged isn’t the word, perhaps wafted – over the financial services industry: Will banks be displaced by fintech firms with better and easier to use technology? Or will individuals and corporations stick with nice, stable, secure banks with the huge columned headquarters downtown and slick branches in the ‘burbs?
Now Oliver Wyman, the global consultancy, has wandered into the fray to suggest, just in time for Davos, that the solution is modularity – financial services are becoming modular.
“New technology is making it easier for customers to buy from multiple product providers,” the firm announces in a whitepaper, Modular Financial Services: The New Shape of the Industry. “The number of financial products used by the average customer is increasing. We call this modular demand.”
“Modular financial services are emerging at different speeds across markets. Currently, banking in the US is more modular than in Europe and Asia. Property & casualty insurance has become more modular than life insurance. Now, the modular industry structure will go deeper and spread to new markets,” said partner Oliver Wyman and co-author, Matt Austen. “Since the crisis, most firms have focused on optimizing their existing, integrated business model. Now, the industry is going to move towards a new, modular structure.”
Admirably enough, Oliver Wyman waits until the third paragraph of its paper before introducing the terribly familiar “seamless.”
“Financial services firms are using more third party suppliers. Providers of specialist services, back office processes, and risk capital can now seamlessly plug into a supply chain. New entrants have new, focused business models. We call this modular supply.”
Although the “modular” branding may be new, the idea isn’t especially. I recently wrote about Currency Cloud and Quicken Loans’ Rocket Mortgage, which link to other partners and platforms to deliver their services. Loan companies such as Lending Club and Lenddo have tapped new sources beyond FICO for rating borrowers. They then partner with individuals, banks, foundations, hedge funds, and pensions to provide the loans.
Oliver Wyman expects that fintechs, banks, or other established financial institutions will benefit from a modular financial services model.
“Distribution will become dominated by digital ‘platforms’ that can steer demand to any supplier, allowing new product providers to proliferate. Regulatory changes, particularly around customer data, will also weaken financial firms’ hold on their customers.”
Modularizing forces are not unopposed, however.
“Large integrated financial services firms continue to enjoy advantages, including their existing customer relationships, secure at-scale operations and the fixed costs of regulatory compliance.”
In Europe and Asia, bank customers are more likely to hold most of their financial accounts – credit cards, loans, and mortgages – with one bank.
However, if they are going to compete as modular firms, financial firms will have to replace their costly, inflexible legacy infrastructure – which could cost billions and may require suspending dividends for one to three years, says Oliver Wyman, but it will allow them to develop new services.
Some new banks, like Fidor in Germany, provide services from outside providers, like Currency Cloud, through an API.
Oliver Wyman warns that in a modular architecture, no one firm owns the customer, although financial firms may no longer have much choice.
“Customer loyalty to financial institutions has been eroding since the 1990s, with the advent of monolines, direct banks, and direct insurance,” says the report, which neglected to mention one of the largest forces in the industry – online mutual fund providers that have taken hundreds of billions that might once have resided at banks. In addition to investments, and increasingly automated or hybrid automated/personal advice, firms like Charles Schwab, Fidelity, and Vanguard offer checking accounts.
A few fintech companies I have talked with in the last couple of weeks think banks have an advantage in terms of convenience and efficiency – customers would rather go to one place for a variety of financial services than use multiple providers. The Oliver Wyman report disputes this:
“The digital revolution has reinforced this trend by massively reducing search costs for customers. What once would have taken hours of phoning providers or visiting branches now takes a few moments in front of a computer or mobile phone looking at an aggregator platform or price comparison site.”
The report also looks at the importance of a large, stable deposit base, and notes that monoline credit card companies like Capital One and MBNA grew until the mid-2000s when their ability to fund lending through securitization hit a wall. Capital One acquired Hibernia National Band and North Fork Bank and MBNA was bought by Bank of America.
“Cards have thus gone full circle and are now part of integrated financial institutions.” The consultancy draws two lessons from this:
- Modularization can be cyclical rather than secular; forces that encourage it may come and go (in this case, capital market liquidity).
- Expertise is not all. The statistical marketing skill of the monolines was ultimately trumped by the greater advantage of having a large and stable source of funds from retail depositors.
The growth of online lending and uncertainty about where the Fed will take interest rates have led some observers of the online lenders to ask if they will survive a changing rate environment.
Looking ahead, Oliver Wyman expects event-based platforms that can broadly support something like buying a house from end to end; commerce platforms for both consumers and businesses with credit, cash advance, trade finance, and FX; and comprehensive personal financial management that can dynamically switch between savings and lending and keep insurance updated to cover any new purchases. The consultants also expect financial services aimed at particular business segments like property managers or importers, and expansion of affinity platforms, presumably moving beyond checks with your favorite football team.
“We believe it is realistic for new business models to capture $150-250 billion of existing revenues. Whether this accrues to new entrants will depend upon the willingness of existing providers to develop alternative models and challenger brands.”
Oliver Wyman’s managing partner for financial services, Ted Moynihan, added: “Even if we do not expect a completely modular financial services sector, the way customers buy financial services and how firms deliver them is going to be transformed.”
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