A worldwide phenomenon is the emergence of Fintech Startups, which have been considered the “ultimate bak disruptor” by large companies such as JP Morgan, meaning that they manage to challenge the financial monopoly of banks.
However, a phenomenon that is occurring in the United States is the rebirth of small banks, which seem to challenge the big ones again. This event reflects the phrase: “The enemy of my enemy is my friend”.
It should be noted that the case we will explain is referring to small banks in the United States, recognizing that it serves as a case study and event of interest.
To enter into context, the financial market suffered a major breakdown and decline in the financial crisis of 2008, which exploded in the United States, challenging banks and financial institutions to solve this dilemma.
The conclusion of the same was positive considering that it managed to overcome, but it caused a disappearance of thousands of banks that could not face the strong but necessary measures, being reflected in the disappearance of almost 3000 banks in 10 years, giving that, in 2008 in United there were approximately 7000 banks, currently giving approximately 4000, according to the reports of the Federal Deposit Insurance Corporation.
In addition to the disappearance of multiple banks, the growth of large banks occurred simultaneously, gaining power and insured clients. One could say that an oligopoly with a leadership bias was generated. This means that large banks could establish certain rules implicit in the market because of their power of influence, causing the small ones to continue.
This situation occurred for several years, until in 2015 there was a historic event, Startup Fintech appear in the financial map, especially in the subject of loans. This event was reported by the data analysis consultancy, Transunion, explaining how in 2015 in the United States the amount of personal loans issued by banks and Startups were equal. In the actuality they report that the Fintech emit more loans.
However, the Fintech have a limitation that does not seem that they can solve on their own: their loans are not worth the same as the banks, the value being the rights and conditions that are associated with them. This implies that startups do not enjoy the same benefits as banks, which is why they assume a greater risk.
The reviving of small banks
Once the context is established, we can study a new financial phenomenon in the United States: small banks are allied with Fintech startups, especially those that offer banking services from mobile devices, such as transfers or requests.
The startups have the particularity that they have technology capable of competing and challenging large banks, even being these who set the pace of innovation. It is said that without the appearance of these independent companies, the current services of the banks would be stagnant and similar to those of 2010.
“A few years ago there were many comments about how the fintechs were going to destroy the banks,” said Jo Ann Barefoot, co-founder of Hummingbird Regtech and a former deputy of the Comptroller of the Currency, which regulates national banks. “There has been much more talk in recent years about the need to partner.”
The power of the alliance
This pareo occurs almost by nature, since startups have the technology and popularity that small banks need, while they own customers and legal permits.
The way it is happening is that small banks have the ability to store, manage and guarantee the money of the users. The startups have the services and the interest of people to attract new customers and compete with the big companies that invest millions of dollars in technology.
In an unexpected way, startups are managing to beat the centralization of large banks with internal support, with small banks.
“We saw Fintech coming down the pipeline, and we really adopted it as another way for us to obtain deposits,” Evolve Bank president Scot Lenoir said in a recent interview. “We decided from a strategic point of view, why not embrace that and collaborate with them?”
Risks of the Plan
Banks, fintech companies and regulators seem to be aware of certain disadvantages. Cross River Gade said that, as in any economic cycle, “there will be a crisis at some point”. The risk in that is any “contagion” and “stigma risk” becomes a focus for regulators.
“There are good actors and there are bad actors, there is a tendency to join them all,” said Gade. “We just want to make sure that regulators do not remove the carpet from under the whole world and avoid access to credit, because that is the worst thing that can happen.”
Cross River makes loans, keeps them in their books for a few days and then sells them on Wall Street. It is a similar model of origin to sale that brought down the financial industry a decade ago. But while any failure along the chain would affect the parties involved, it would not be too complicated to disconnect.
The biggest risk is that many of these fintech companies have not existed through a downward economic cycle. In many cases, these start-up companies have reached customers further down the credit curve and have found an enthusiastic group of willing borrowers and investors.
It is expected that in the United States there will be a boom of fintechs companies associated with small banks, which have the guarantees promised by the State. If the trend continues, banks like Wells Fargo or Bank of America will have to reconsider their future plans.
Also published on Medium.