FinTech Innovation Comes in Waves

In following the modern FinTech sector for the last 6 years, the pace of innovation and change is what stands out the most. This comes before the initial point when financial technology became a concept (about 2009) and context was anchored towards digital transformation in banks. The advent and adoption of the internet was the true catalyst for the established brands and apps widely used today.

Convenience, user friendliness, access, and customer experience didn’t describe financial services at the end of the 90s. This was when the movement started — peer-to-peer (P2P) payments for consumers first launched in 1998 (by PayPal). The same product wasn’t available for small businesses, so early fintech entrepreneurs started to build for this market. Throughout the early 2000s, more services and features were slowly developed and delivered.

The last 20+ years have come in waves of innovation for FinTech. Here’s a breakdown of key trends and what’s coming up next for the industry.

#1: REPLACING legacy business models

Despite technology playing a critical role in fintech development, early advances weren’t dominated by new technology. Changes in regulation and the economy created new openings for disruption in financial services. The aftermath from the Financial Crisis (2008 - 2009) triggered shifts from legacy business models in banking, wealth management, and money movement.

Consumers and businesses had negative sentiment with established financial institutions. Many fee structures were called into question by the government and leading consumer advocacy groups. Overdrafts, monthly maintenance costs, and excess withdrawal fees from savings were charging customers more than $40 monthly. This fee income boosted income for banks at the cost of the clients they serve.

Similar fee schedules were in place with investment houses and wealth managers. Financial advisors and portfolio managers were incentivized to conduct multiple trades on behalf of customers. Certain transactions carried added commissions for these financial representatives. The combination led to a legacy model in which customer goals weren’t prioritized over business profits.

The first fintech companies focused on new models in which transaction and maintenance fees were lower than traditional options. Overdraft protection was an early product that countered the high cost of working with banks. Consumers were able to access up to $100 to cover upcoming expenses that may cause a negative balance in their deposit account. The cost was less than half of an overdraft fee. Similar changes took place with ATM withdrawals, bill payments, and transfers.

#2: Unbundling BANKING services

The launch of other smaller features (beyond overdraft protection) opened up gaps in traditional banking for fintech founders. With the emphasis on technology and lack of the overhead costs from banks, startups were able to construct new business models and products via mobile apps. Single-purpose platforms solved specific customer painpoints in a user-friendly approach. The ease of use helped early fintech companies establish trust with customers quickly, especially through a seamless onboarding process.

Less overhead and maintenance costs also meant that fintechs can reach a wider market of customers that previously couldn’t afford minimums. Many wealth management apps removed deposit requirements or annual fees. Banking apps operated without fees or transaction requirements. The combination of affordability, user experience, and an expanded market size helped fintechs have early success as banking alternatives.

‘Free checking’ was common in the industry, but banks has certain requirements for customers to get there. Direct deposit (recurring payroll deposit from employers) or minimum monthly balances were standard conditions . Some financial institutions also offered no fee accounts for a certain number of bill payments made monthly, or maintaining a mortgage or retirement account. For clients unable to meet any of these conditions, there would be a monthly fee of $5 or more.

Without transaction fees, monetization came from other sources — interchange revenue from user’s card spend (if a fintech issued a spend card), deposit interest from user balances, conversion rates from crypto or FX (in exchanging between fiat or multi-currency). Platforms able to capture spend and deposit volume emerged as early leaders.

Multiple bank accounts may not have been common in the late 2000s, but multiple fintech apps were. One for banking, one for investments, one for crypto trading, one for peer-to-peer transfers, etc. No longer were consumers or businesses anchored to one bank (or banking portal) for all their financial services needs.

#3: vertical SaaS as an entry point 

Software-as-a-Service companies established strong relationships with clients that stretched across multiple verticals — lending, insurance, healthcare, payroll, accounting, tax management, etc. Automation and workflows helped these companies gain market share from well-known enterprise software companies unable to offer the latest customized features.

New initiatives added by these vertical SaaS companies were made possible by technology in the last 15-20 years. This includes advancements with cloud technology, deeper automation, fraud detection, and underwriting enhancements (enabled through machine learning). Many institutional clients had legacy systems that were difficult to replace all at once — SaaS firms provided a path to make incremental changes over time.

Banks and credit unions have the same challenges when it comes to their core banking stack being out of date. As time went by, fully replacing bank infrastructure became a difficult, costly option (especially for small and mid-sized institutions). Working with SaaS enables these firms to plug modern technology to core processors, which was the early concept of ‘digital transformation’ back in 2010.

Many vertical SaaS companies served early-stage startups and mid-size companies in their early years. As their solutions matured, established platforms and enterprises also became clients. In addressing market opportunities and gaps from incumbent players, strong market share gains were made in the last decade.

#4: fintech as the add-on 

Having a deep connection as a software provider, these vertical SaaS market leaders started to add financial services to their suite of offerings. The most popular addition came from payments — being able to accept payments for a product, making a transfer, holding funds for a client. For software payment companies already offering merchant services (to eCommerce companies and retailers), new offerings included advances based on revenue.

The concept of embedded fintech started with these early plays. The value from including these solutions still holds true today: expansion (in product and/or market), customer ‘stickiness’ (i.e. deeper, longer client relationships), and increased revenue streams. In embedding financial services, there still needs to be a clear user painpoint being addressed — offering a ‘nice-to-have’ feature falls flat.

Enterprise and mass market brands across multiple non-software sectors (retail, travel, transportation, payroll) were the first to embed banking products. These larger companies became more sophisticated with bundling services by offering banking, credit, rewards, insurance, and benefits. The volume of their existing user base presented a lower cost of acquisition (CAC) per user in adding a new product.

For vertical SaaS companies, the dynamic is slowly changing as new players build in monetization from embedded fintech into their initial operating models — side-by-side with software services. This combined approach as a go-to-market strategy creates an opportunity to migrate an entire business relationship at once, instead of just banking or software.

The popularity and portability of APIs (application programming interfaces) is critical for embedding financial services. User-facing platforms are able to offer simple or complex products by working with banking service providers, who build and manage the required processes in the background. Bank partner workflows, regulatory requirements, user disclosures, cybersecurity, and risk controls are abstracted away.

Within fintech, companies offer platforms: the ability to connect to external bank accounts (Plaid, Yodlee, Finicity), issue spend cards to end-users (Marqeta, Lithic, HighNote), and onboard consumers and/or business clients by verifying KYC / KYB (Alloy, Persona, Incode, Trulioo, Onfido).

#5: Re-bundling by non-banks

As fintech companies matured (between 2012 - 2019), many leading brands offered secondary products and services in addition to their anchor product. With neobanks and challenger banks being so popular around the world, they were the first sector to launch a bundled banking program. The end result seemed familiar for customers — all banking needs (checking, savings, payments, card) through a single platform. The difference was that it wasn’t a direct-bank offering. Chime, MoneyLion, and SoFi were the face of this movement in the US — Revolut, Monzo, and Starling were the established brands overseas.

For smaller fintech firms looking to also bundle banking products, the option to build in-house was lengthy and expensive. APIs and stringing together vendors into one solution proved to be the path forward. The concept of ‘orchestration’ replaced program management, in which on company helped oversee and manage multiple functions in building and launching a banking program. Being able to bypass the need to ‘own’ or build from scratch, helped companies get into market faster with a sophisticated offering and compete with established players.

In the recent economic downturn, transaction activity and user volumes have subsided — making it difficult for multi-product platforms to monetize and stay afloat. This direct-to-consumer (D2C) fintech sector is starting to consolidate as companies shut down or get absorbed by competitors. New startups are no longer planning to launch bundled programs — opting for a measured path towards profitability, instead of growth. This wave towards re-bundling is coming to a standstill as new and existing firms minimize these programs.

NEW WAVES coming in fintech?

Economic conditions and a changing regulatory landscape are hindering what’s next for FinTech innovation.

A year ago, crypto platforms and products were active in the industry across startups and enterprises. Not the case anymore — regulators have influenced banks to limit involvement with custody and processing of crypto. Two leading banks for crypto companies (Silvergate and Signature Bank) shut down in recent weeks, leaving a large gap for institutions and exchanges.

Banks (especially small and regional institutions) also struggled in the last month to stem outflows of deposits. Customers were concerned about access to balances, which led to deposit runs. Silicon Valley Bank (known for serving startups and tech companies) was shut down by the FDIC and rescued last month.

If negative sentiment with the economic and regulators dissipates in the next months, we can expect movement in the following areas:

• Instant payments in the US: FedNow and real-time payments (RTP) will become new options in the next year. These account-to-account (A2A) transfers have a lower cost when compared to card processing. The switch to A2A will take time for merchants, consumers, and businesses, but discounts & incentives can help with early adoption.

• Compliance monitoring and fraud prevention: Risk mitigation and controls will have its moment in the financial services industry. Regulators are asking banks to have strict oversight policies with 3rd party fintech companies. This trickles down to fintechs having their own screening criteria, guidelines, and fraud management in place. Startups will no longer be able to rely on banks or Banking-as-a-Service to cover all compliance requirements. Vendors and orchestration platforms will be in demand going forward.

There’s a long tail of other trends just starting to emerge with artificial intelligence and blockchain, but it’s still early days to define a specific trend. Embedded banking will continue to expand into new verticals, especially healthcare, benefits, and travel.

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