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Business Commentary Is fintech a disruptor or enabler for Canada’s big banks?

Michael R. King is co-director, Scotiabank Digital Banking Lab at Ivey Business School, Western University

According to the search tool Factiva, the term "fintech" appeared close to 90,000 times in the global print media this year versus fewer than 300 in 2007, with many more references on social media. Its usage has actually declined since 2014, suggesting the fintech hype may have peaked.

An influential study by Citigroup reported that fintech investments topped $19-billion (U.S.) in 2015, a tenfold increase from 2010. The consultancy McKinsey & Co. is reportedly tracking more than 2,000 fintech startups, with the global estimate around 12,000. The numbers in Canada are sketchy, but reported to be around 250 and growing. Fintech startups are typically classified by their main business, such as payments (e.g., digital wallets, cryptocurrencies), financing (e.g., peer-to-peer lending, crowdfunding), investments (e.g., robo-advisers), insurance (e.g., insurtech) and infrastructure (e.g., blockchain).

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The question facing Canada's banks is whether fintech is a disruptor or an enabler for their industry?

The early view appeared to be that fintech startups would disrupt incumbent banks and steal their customers, similar to Airbnb and Uber. But the emerging consensus is that banks and fintech startups will inevitably collaborate, combining their respective strengths to deliver a superior customer experience. Not everyone agrees, of course, but the tide of opinion has clearly changed.

My personal view is that fintech presents both an opportunity and a threat to incumbent banks. Fintech is a cost disruptor, a revenue enabler and a revenue disruptor.

Consider this problem: All Big Six Canadian banks have published targets for return on equity of 15 per cent to 20 per cent, while growing earnings by 5 per cent to 10 per cent a year.

The problem is that Canada's gross domestic product (GDP) is expected to grow below 2 per cent on average, limiting room to grow traditional banking. At the same time, regulators are requiring higher bank capital levels, and a myriad of fintech startups are targeting the most lucrative pieces of the banks' value chain.

How can banks achieve high profitability in a low-growth, high-capital, increasingly competitive world? There are several possibilities, with fintech playing a central role in each.

First, banks can use fintech to disrupt their costs, increasing their efficiency by lowering overhead and other noninterest expenses. By moving customers online to a digital offering, the banks can reduce the number of branches while making staff more productive. The banks are looking at various "pain-points" experienced by their customers and striving to provide a better experience. Rather than having to queue at a branch to deposit a cheque, customers can deposit it using their phone. It won't be long before we handle all of our routine banking tasks online. Instead of going to a branch to see a banker, mobile bankers may one day come to us to provide a product or service.

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Second, banks can use partnerships with fintech startups to increase revenues by targeting new customer segments and expanding into foreign markets. As pointed out by Mike Gardner in The Globe last month, the biggest threat to banks is their legacy computer systems, which are costly to maintain and present operational risks. Fintech startups have built user-friendly apps from scratch using the latest design thinking and technology. These applications are attractive to customers and represent a source of competitive advantage.

But the costs for startups to acquire customers and build scale present a huge barrier to entry.

And small teams of entrepreneurs and coders may lack the expertise in regulatory compliance and risk management required to compete longer term. Partnering with an incumbent bank can be a win-win for startups, as seen in the case of small-business lender Kabbage with Scotiabank and private lender Borrowell with CIBC. Not only can these partnerships be used to serve the home market, they can be rolled out in foreign markets to compete cost-effectively abroad.

Third, banks can use fintech to enable revenue growth in higher margin, less capital-intensive businesses such as wealth management and insurance. By launching fintech applications such as robo-advisers and InsurTech, the banks can scale these businesses more rapidly while providing services to clients that were uneconomic when they involved a high level of customer service.

The catch is that bank revenues may suffer in the short run. For example, the launch of BMO's low-fee robo-adviser, SmartFolio, may cannibalize some of BMO's existing wealth management revenues. But longer term it is better for BMO to keep this revenue in-house than to lose it to fintech startups such as WealthSimple or Nest. And providing a lower cost, passive offering will make increasing sense as Canadians focus on how much they are paying for investment advice.

Of course, fintech can be a revenue disruptor, allowing new entrants to disrupt the Canadian banks.

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But the threat is not likely to come from startups. Instead it will be social media companies, cable and telephone providers, and foreign banks looking to move into Canada's lucrative market. This risk can be seen most clearly by looking at the Chinese social networking giants Alibaba and Tencent, who have launched super-apps providing many banking services, spun-off payment companies, set up online banks and jointly funded an online insurance company. No doubt Facebook and Google are watching closely, as are foreign banks.

With these external disruptors, it is time for the Canadian government to take a leadership role and champion a national fintech strategy, similar to the United Kingdom, Australia, Hong Kong and Singapore.

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