Innovation has become an indispensable prerequisite for the business world and the financial sector in particular.
In a world where technological advancements permeate our daily lives before we can even assimilate them, innovation has become an indispensable prerequisite for the business world and the financial sector in particular. In this context, thanks to the incorporation of agile methodologies, innovative solutions, and disruptive technology, fintechs have gained significant ground in recent years. In contrast, traditional large banks have failed to follow the same path despite having far more resources and a consolidated market. This situation raises a crucial question: why are fintechs outperforming banks in innovation?
In a world where technological advances burst into our daily lives before we can even assimilate them, innovation has become an indispensable prerequisite for the business world and the financial sector in particular. In this context, thanks to the incorporation of agile methodologies, innovative solutions and disruptive technology, fintechs gained a great deal of ground in recent years. In contrast, the large traditional banks did not know how to follow the same path despite having much more resources and a consolidated market.
This paradoxical situation has led me to reflect several times on why does a bank, which has thousands of technology professionals and enough capital to invest in innovation, lose in this way to a fintech? The most logical answer (although wrong) is usually: “because the people who work in a fintech are different, more creative and entrepreneurial than those who work in traditional banks”.
However, this statement ignores both logic and empirical reality: Banks as a whole have many more resources than Fintechs as a whole, so they could attract talent simply by improving their compensation. More to the point, this is what has been happening for the entire past decade, with no major impact on the relative velocities of both types of institutions.
The correct answer, in its minimalist version, is that Banks and Fintechs do not have the same starting point, do not operate under the same rules of the game and, most importantly, do not have the same objectives.
Large banks have, by definition, an infinitely more complex starting point than that of a Fintech. Without going into technical details, let’s just think about the large number of touchpoints they manage, such as physical branches, mobile branches, ATMs, sales forces and call centers and the greater diversity of products, services and segments they offer. Fintechs, on the other hand, tend to focus exclusively on the digital world, and a small number of products and segments.
This difference in initial complexity, coupled with the much higher average age of banks, generates what is called “technological entropy”, which is a tendency to disorganize their systems. A traditional bank has thousands of active software that does not communicate properly, stops working, has stability problems or becomes obsolete. It’s extraordinarily difficult to keep this legacy ecosystem operational while also innovating.
The complexity of integrating these programs is often underestimated. For example, when a bank buys from another, it inherits not only the customers, but also the systems, contracts, and software of the acquired institution. Integrating all this in a coherent way is a Dantesque and often impossible task. In a simple analogy, it’s like changing the wing of an airplane while it’s flying.
But not everything is exogenous or inevitable. Fintechs, build their own software or look for highly specialized providers, the big banks, more risk-averse, opt for reputable providers that offer a wide range of generic solutions, which are acceptable for all industries, but perfect for none. Although it may seem like a safe choice, these technologies do not fit the specific and unique needs that the financial sector demands, in addition to not having been designed taking into account the complexity of the legacy systems that these institutions have.
Another point to highlight is that of the rules of the game. Although regulation is tending towards convergence, it is still very asymmetrical in many markets. Fintechs tend to have a less strict treatment, partly for paradigmatic reasons, but often for logical reasons. For example, a Fintech financed entirely by an institutional investor can be much more flexible when lending money, since its mistake only affects its “owner”, while the bank lends money from small savers, whom the regulator can protect by limiting the laxity of credit policies.
The final point, and less commented on, is that Banks and Fintechs have very different objectives, not because the professionals who work in them are essentially different, but because their investors or owners are. 94% of the world’s banks are profitable, while only 1% of Fintechs make money. On the other hand, fintechs innovate and grow in number of customers at rates ten times higher than those of a bank.
The investor knows this reality, and when investing in a company, he tacitly declares his preference. If a bank decided to innovate and grow at a high rate while neglecting its profitability, its owner could say: if I had wanted that, I would have invested in a Fintech.
If a Fintech limited its innovation and growth and immediately focused on profitability, its owner could say: if I had wanted that, I would have invested in a bank.
Therefore, the lack of innovation of banks compared to fintechs is not due to a lack of talent or an understanding of its importance. It is largely a matter of context, complex legacy systems, conservative technology strategy, adherence to regulation, and prioritization of objectives.
