Lets face it it won’t be long before we reach a billion dollar valuation for one or many of the digital banks. Atom bank at $150 million, Mondo bank in alpha testing at $45 million are edging towards that mark. Metro Bank, with 40 branches and no profits as yet is set to be valued for listing at circa $2.5 billion. The next headline will be – open an account with a digital bank and we will match your initial deposit. Prospective customers should prepare themselves to see a stampede for their cash, an acquisition strategy where they will be the end-beneficiaries.
In the last couple of weeks, there have been some interesting publications, albeit all mutually exclusive. Dynamic pricing in banking inspired me to think about pricing strategy for digital banks. Fintech will mostly end in tears is something we all know at the back of our heads is a possibility (as extreme as J.C. Flowers – ask those who survived the dot com bubble) and then you have the chart in 2016 Banking Trends by MX below that is certainly riveting.
Amidst all the news-making streams there are three pertinent topics that emerge for digital banks – Revenue generation (through data or pricing), customer retention (app user experience or lack of human interaction) and Valuations (if there is any way to value the right one at the right time). Digital banks are here to stay, that is indisputable but the business models and the core offering is far from defined.
Exits and exit valuations are far away so lets focus on how the digital banks will make money. The Bain report points to retail banking waking up to digital lending, what about digital banks – they are not even in ‘existence’ yet. Jim Marous points out a third of retail banking revenues at risk, so what will digital banks get? Digital banks will likely have revenue sources from data, possibly account charges and lending or mortgages. According to BCG, the retail segment will remain the dominant source of revenue for banks worldwide. Although, 2006 sounds like a distant past, 57 percent (in excess of US $1.3 trillion) of global banking revenue pool was through the retail banking divisions and mortgage lending was 56 percent of that total (Source: BCG).
The question arises will mortgage lending be the similar weighted revenue generator for digital banks. Kadhim Shubber of FT talks about Metro Bank’s weird balance sheet loan to deposit ratio of 69 percent in 2015 versus 56 percent in 2014 and investment securities as 44% of bank’s assets. So, if this is the ‘new model’ then where will the lending or mortgages come from, will it be a case where lenders or lending businesses will be separate from (traditional) digital banks? The digital banks will possibly use data to do targeted selling with a higher percentage of success rate. With PSD2 likely to come into play we may witness the advertising auction model become the holy grail of customer acquisition and data. Data protection and privacy myth in Fintech will likely be dispelled once compliance issues start cropping up and as the banks grow, says Elias Gagas of Payment Components.
Where does it leave us? APIs act as aggregators under PSD2. In essence, we can have our individual choices of digital banks, lenders, robo-advisers, payment platforms, credit card providers all under the same ‘app’. As a customer, you are not ‘sticky’ to anyone. Applications and data dictate the behaviour of service providers, relationships become critical, what a traditional bank could not do, an API, will offer a chance to achieve and offer dynamic relationship-based pricing (remember the feasibility question about dynamic pricing). These algorithms and data analysis will become the cornerstone for digital banks with low operating costs, which will be met with lower margins, the journey of customer retention will be one of behavioural prediction, enabling a service model where pattern recognition will drive profits.
For digital banks, right now, the clamour is for customers, then it will be data, followed by deposits and then maybe it will be the services that actually make money. The end-solution may be hard to predict but the ethos of any business – profitability and customer retention will drive the digital banks towards technical solutions that will move from the fringes to build the core of new banking.
The exit routes for the new wave of fintech digital banks are over the fence and the roundabout that eventually leads to an exit is also one for the future. This is the beginning of ‘life on a fintech highway’.
The next post will discuss customer experience and retention in the digital banking world.
Feature image: https://stocksnap.io