Why and How Banks Collaborate with Digital and FinTech Companies

The antagonism between tech companies and banks in the payments market is turning toward alliance. Digital giants and fintech startups supposedly poised to gobble up bank customers and the defensive banks commonly considered blind and slow are finally seeing the mutual benefit of collaboration. Although warnings for banks to go digital and mobile are still dire, and predictions that banks will have their lunch snatched by the tech companies may still be gleeful, attitudes are starting to shift.

The Sibos 2014 conference, sponsored by SWIFT, the Brussels-based international bank messaging network, and held this week in Boston, provided numerous examples of changing attitudes. The smart technology companies, financial technology startups, and global banks are collaborating.

Digital Currency Opens Eyes

It has not been uncommon for fintech start-ups to take a total disruptive attitude toward banks and the established financial system. The inventors and early, early adopters of the Bitcoin show one extreme. Cryptocurrency refers to any number of digital schemes for securely representing and storing some means of value. The Bitcoin cryptocurrency was designed as an open and democratic alternative to established, government-controlled currencies—with no need for existing banks, for that matter.

Bankers, for their part, have expressed more than a little resentment over the regulatory burden they face that their nonbank competitors can ignore, blissfully developing products for consumers without the need to spend the time on compliance and regulatory concerns. The playing field is not level, and banks have a high hill to climb.

“To the Bitcoin people, the world is a happy place with no regulations and money is just flowing,” one banker at SIBOS said. “Then they get hit with sanctions and see what happens.”

What’s changing is the realization by the smart fintech firms and banks see that they need one another to thrive, if not survive. Apple, one of the long-held bank killers, and its entrance into payments with Apple Pay is held as a prime example of cooperation.

More surprising is the reception that digital currencies received at Sibos. The SWIFT-sponsored Innotribe innovation initiatives spent all day Monday on Bitcoin specifically and cyptocurrencies in general. They were the most attended sessions of the conference that day, a first for an Innotribe session. Throughout the rest of the conference, the line on Bitcoin went something like this: It may not be the form digital currencies take, but it shows that cryptocurrencies are here to stay.

Apple Pay: Bridging the Gap

This would have been unthinkable four years ago. So would one of the digital giants (Apple, Google, and Amazon) plotting to disintermediate banks from the payments system completely partnering with the enemy. “When you see large US banks working with Apple to bring a product to market, you see that we can all play a role in the ecosystem,” said Vineet Malhotra, managing director, Canadian Imperial Bank of Commerce (CIBC).

(For the record, “disintermediation” refers to cutting out the middleman, a major internet “disruption” strategy: think Uber in the transportation-for-hire business. Banks have been afraid of disintermediation for a long time. I first heard the term in the 1980s, when corporations started lending money directly to one another using commercial paper. Banks certainly were not disintermediated from money and capital markets then, and there are few if any futures in which they are disintermediated from payments, though there certainly are futures in which they lose customer control.)

Indeed, Apple Pay was held at Sibos as the prime example of collaboration with a digital company and one that serves the interests of both, as well as the customers. “Apple Pay is a collaboration between a digital corporation, banks, card networks, and merchants, all moving the market forward,” said Michael Fiore, SVP and Group of Head Personal Payments and Mobile Money at MasterCard.

Fear and Innovation

The fact is, digital companies are more aware of where customers spend their time and create better customer experiences for them on mobile devices. Square and Amazon found a market for micro credit-card payments on mobiles and used new risk models. “If they stayed with legacy technology to manage risks with those micro payments, the market would not exist,” he said.

Banks may then become more like infrastructure providers—with the primary infrastructure being customer accounts. “At the end of the day, Apple Pay is about leveraging existing infrastructure and the existing demand-deposit accounts (DDAs) of bank existing customers,” said Paul Simpson, global head of equity asset services at Bank of America Merrill Lynch.

Large banks do not execute quickly and are not nimble. Everyone agrees with that. Today’s hottest technical talent likely does not have large banks on the list of desired programmers. “We have to have partnerships to innovate in this space,” said Emma Loftus, managing director and USD Clearing product executive at J.P.Morgan.

It’s also about fear on the part of the banks. The smart fintech companies are realizing that they need partnerships to succeed as well. “These firms have really neat software, but they are data starved. They don’t have the data sets,” said Jack Klinck, EVP and head of global strategy and new ventures, State Street, a strategy and analytics firm in securities trading and clearing. “That’s our advantage. Without the data they aren’t going to get anywhere.”

Fintech startups are also realizing that it is beneficial to collaborate with banks. Ripple Labs created an open-source protocol for realtime, cross-border, cross-currency settlement. Ripple enables organizations and individuals to transfer funds, airline miles, or other representations of value over the internet.

One of the firm’s target markets is small banks that want to offer international payments less expensively. They could use Ripple to transfer money without paying the high correspondent banking fees, a cost that gets passed on to businesses and consumers and makes payments more expensive.

It makes more sense to build on existing institutions than to try and create an alternative to banks. “If it’s billed as an alternative outside the existing banking infrastructure, it’s too small and niche,” said Chris Larsen, Ripple CEO.

Several of the finalists in the Innotribe Startup Challenge competition have similar views and actively sought bank partners as part of their contest pitch presentations. The winner of the startup category, Epiphyte Corp., presented its cBridge product, which allows banks to bridge between existing systems and new protocols like Ripple.

Another finalist, Standard Treasury, offers a service that makes it easier for banks to connect to their customers using application programming interfaces (APIs), which Standard Treasury will create and support. The startup seeks to make legacy bank systems compatible with today’s digital technologies.

Security, Safety, and Regulation Rule

In the end, the large banks see their role in emerging digital financial markets as proving their unique experience in complex global financial markets. Banks should refocus on strengthening relationships with and services to their corporate customers without the endless discussions of technologies. “We can collaborate with vendors who can understand corporate requirements,” says Charles-Henry Dubarry de Lassale, head of Corporate Innovation & Solutions, Global Payments and Cash Management, HSBC.

Banks know regulation and how to work with regulators. The large ones know how to run low-margin services at scale. They know how to operate globally. They understand security and operate highly secure networks, something merchants have an awfully difficult time doing these days. And they still appear to have consumer trust.

As Dominic Broom, who heads treasury services sales for BNY Mellon put it in analyzing the bank’s latest payment study, “Our business has been based for hundreds of years on trust. I trust that currency has value and is going through a pipeline that’s secure and safe. That pipeline trust and security has enormous value, and I don’t see it being replaced by other market participants.”