FINTECH vs universal banks

The threats

Our significant positions in BANK OF AMERICA and CITIGROUP (20% of CAP IN) can only encourage us to analyse the potential threats from FINTECHs. Many sectors of the economy are indeed disrupted by the Internet (Media, distribution, brands, etc.). Banks seem to be resisting, but is this really the case and if so, for how long?

To understand the situation, we will take the example of the two most formidable FINTECHs, they illustrate well the problems of the whole sector.

The two largest FINTECHs in the United States are SQUARE and STRIPE. Together, these two companies are valued at more than $50 billion. Like all FINTECHs, their strong point is to rely on an unparalleled user experience (great ease of access and use with elimination of traditional frictions, real time, very clear reporting). Their operation on the cloud theoretically allows them to extend indefinitely with a low marginal cost (no branch costs, just the cloud subscription depending on the volume processed). The cloud also allows them to plug and play with other applications.

FINTECHs must have an angle of attack to win over the consumer, a precise function that differentiates them: the stronger this differentiation, the more likely they will be able to break through and consolidate their position through other adjacent services. SQUARE and STRIPE are aimed at merchants and offer them ultra-simple payment solutions. It is a quasi-virgin territory in the United States: traditional retail (90% of the total) has antique payment terminals that do not accept contactless payment. And for good reason, according to AT KEARNEY, only 3% of the cards were equipped with the contactless device in 2018.

SQUARE started with traditional commerce, offering payment terminals connected to the internet allowing mobile payments in addition to traditional card payments. The volume of payments transiting through SQUARE is increasing by 25% annually to reach 100 billion dollars today (3% of the us market). STRIPE is aimed at online merchants, the still modest but rapidly expanding share of trade. Unlike SQUARE, which responded to a local problem, offering its terminals mainly to American merchants, STRIPE does not have to adapt to a local context and can deploy its payment solution globally on any website regardless of its origin. STRIPE processes $150 billion in annual payments (10% of the total online excluding China).

A first weakness of FINTECHs, and in particular of SQUARE and STRIPE, is their differentiation into a single specific function, in this case the payment system for merchants. There is nothing to prevent a Start-up from designing an even more user-friendly payment application. Until the arrival of STRIPE, PAYPAL dominated the online payment market. PAYPAL was designed before the cloud and does not have the same integration ease as STRIPE. STRIPE is also gaining market share and already betrays a quarter of PAYPAL's volume. STRIPE may also be threatened in the future, if the application does not consolidate its advantage by extending its services, making it more difficult to abandon it in favour of an even more user-friendly competing solution.

The second, more embarrassing fragility is the dependence of these FINTECHs on VISA and MASTERCARD. The latter two companies are at the heart of all transactions and set the rules of the game through the interchange mechanism: the rate of retrocession of commissions received from merchants to card issuers. Thus SQUARE has to pay about 50% of what it charges to merchants...to card issuing banks. Consequently, SQUARE and STRIPE are dependent on the goodwill of VISA/MASTERCARD, which impose their conditions and may prevent a serious monetization of their services.

To counter this situation of weakness, FINTECHs must find another field for monetization. They can try to transform themselves into banks, using the deposits collected by their activity by making credit. They therefore have no advantage over universal banks, which do the same thing with a much higher scale effect.

The strength of universal banks is precisely the integration of complementary businesses (deposits, loans, markets, etc.) on such a scale that they make it impossible to monetize individual businesses.

Customers demand integration first and foremost. "The job to be done" according to CLAYTON CHRISTENSEN's theory is to have a trusted partner for all your financial concerns. Taken individually, the services provided by universal banks are not optimal but they are generally reassuring and that is what matters most. With individual services being modularized , banks have plenty of time to absorb the most interesting innovations or create competing solutions.

SQUARE tries to diversify into traditional banking by providing credit, but the deposit base is too small ($1.8 billion (0.1% of the amount of BANK OF AMERICA's deposits) to pose a serious threat. SQUARE must go elsewhere to monetize its outstanding user experience. A natural extension is to offer software services to merchants (accounting, inventory management, deliveries, etc.) or to start from payment to integrate another activity. Integration with payment then does not face competition from banks and allows reasonable monetization. This explains why SQUARE's share price fell when the sale of their meal delivery subsidiary CAVIAR was announced last week.

STRIPE also does not attack banks at the front, preferring to integrate additional services and gradually transform itself into a platform for services to online merchants: STRIPE thus integrates third-party applications such as SHOPIFY to create a merchant site, SAAS OPTICS to manage subscriptions, etc. The grail for a cloud software company is to move from the specific function to the platform: its competitive advantage is then much stronger. This is STRIPE's strategy: to be the "tool" platform for online merchants. This strategy moves it away from universal banking.

It can thus be seen that the large FINTECHs prefer to move away from universal banks rather than confront them. Those who choose a frontal strategy are likely to go to the wall: if they want to differentiate themselves by deposits like REVOLUT or N26, they do not have the loans for monetization and then have to subcontract the investment of their deposits to traditional banks, thus losing their advantage. If they start with credit, they lack a stable basis for refinancing and then run a crunch credit risk that is very damaging to consumer confidence. In short, it is very difficult for them to achieve "the job to be done", i.e. to be the trusted partner for all their clients' financial concerns. "The job to be done" requires integration.

It is enough for the big universal banks (BANK OF AMERICA, CITIGROUP, JP MORGAN, WELLS FARGO) to be in all the FINTECH slots, without necessarily being better to win the bid. And that's what they do:

S&P global market intelligence

The good old-fashioned cross selling banking strategy seems to be the most suitable for FINTECH threats, as it responds to the "job to be done" while improving the profitability of these banks. JP MORGAN even offered himself the luxury last month to close his FINTECH FINN, refocusing on CHASE: a whole symbol...