FinTech in the Banking Industry

Pat Morin: Hi everyone. Thanks for tuning in to issues of interest, BNN’s podcast for the banking and financial services industry. I’m your host today, Pat Morin, principal and leader of the information systems and risk assurance practice at Baker Newman Noyes.

I’m here with Bryan Mulcahey, managing partner at FS Vector, a strategic consulting firm that delivers a range of advisory and advocacy solutions to FinTech clients. Hi Bryan.

Bryan Mulcahey: Hi Pat. Happy to be here.

Pat Morin: So Bryan, today’s conversation is a continuation of our discussion at BNN’s accounting business update back in October 2024. I’m so glad that you were able to be part of that panel and I know that FinTech is something that is on the minds of many of our banking clients.

So I’m excited to continue our conversation and touch on some areas we didn’t get a chance to cover. Bryan, can you start by specifying which type of FinTech we’re going to be talking about?

Bryan Mulcahey: So there are probably two different types of FinTechs that we talk about when we’re talking to banks about the ways that they can partner with FinTechs. The very first piece are bank techs.

So bank techs provide a solution to banks to improve their financial services or their products, their existing customer base. These could be things like digital banking solutions. It could be solutions like Intrafy to provide broker deposit solutions or enhanced FDIC coverage.

And then there’s the other set that are more of the embedded banking, FinTech type or banking as a service. So these entities have their own customers. They’ve come up with the product or service.

They work with the bank on the back end on access to the payment rails, access to custody, these funds or FDIC insurance. Some of them are leveraging the bank for issuing cards or for exemption from state licensing requirements, whether it’s state money transmitter licenses or state lending licenses.

I think most of our conversation today will focus on this latter category. It is interesting that we’ve seen a little bit of a convergence of these topics. So we’ve seen some companies, I’ll take for example Melio, which is a large invoice payments solution that has always used banks to process ACH payments, but now they actually provide that solution inside of the commercial checking accounts for some of the large banks.

We’ve seen other solutions as well that started out just leveraging banks access to payment rails or banks access to state exemptions or lack of interest rate caps. And now I’ve actually started to embed this solution directly into the bank’s checking account.

So some of these topics or even some of the FinTechs themselves have started to kind of change their business model where it used to be more always went after their own customers and now it’s they’re providing a service to the bank’s customers.

But really I think the point of this conversation or the main focus of this conversation will be on the FinTechs to have their own customer base, have their own product solution, but then partner with banks for everything that the banks are really good at.

Pat Morin: Can you expand a bit on the benefits they can provide to the banks?

Bryan Mulcahey: FinTechs are really unique advantage especially as it relates to its capital structure and the way it runs its business. So the FinTech community, the incentive structure and the reward for FinTech companies has a lot to do with customer acquisition and revenue growth.

They’re not necessarily incentivized or rewarded in terms of profitability or earnings or in the sense of like a bank, the increase in book value. Really the FinTechs are incentivized or rewarded in a merger or an IPO for high ARR or large customer acquisition or large customer base.

And so the way that they do that is a lot of them are raising money from a venture, typically the venture community, and they spend that money on customer acquisition and marketing.

So obviously that’s a huge advantage over banks. They have to be very mindful of earnings and expenses. So FinTechs often have an advantage there. They also have an advantage in the sense that most of them have been stood up from day one with a very particular idea in mind or an issue in mind that they want to solve.

There are FinTechs who their only business is some very small part of banking or a single type of customer in a single type of payment. For example, moving money from restaurants to employees to pay out their tips each night after service is over because most of the tips are on credit card now and those employees still are used to kind of divvying up the cash each night.

Right,  there’s a set of companies out there that produce a software solution to help restaurants actually sort out the tips and then pay out those tips to their employees each night.

Now they need access to the banking rails. It’s not even something that the bank would probably want to build a solution for, but they have ACH processing capabilities and deposit taking capabilities and they can offer that to these companies.

And so a lot of time when we think about these SaaS businesses or we think about these FinTech businesses, they’re really software businesses. They provide a platform to solve some particular pain point and there was some movement of money or some issuing of credit that’s happening behind the scenes.

These are rarely cases where they’re competing with banks for those customers. It’s really a whole new area of payments or whole new area of financial services that that FinTech has created by building a software solution and then providing the payment functionality or the financial services behind the scenes.

The advantages for maybe a bank that supports these types of FinTechs would be one, they don’t have the ability to go build all these different solutions in the way that the FinTech community has or the software platforms the way these FinTechs have.

And they also don’t have the ability to spend aggressively on customer acquisition. But banks have something incredibly valuable which is their charter, their risk expertise, the fact that they have some use of these deposits right there.

There is no use to a FinTech of sitting on a large deposit base unless they work with a bank who can either sweep those or loan those dollars out. There’s a natural overlap between what the FinTech is doing and what the banks can then do with those deposits or with those payments.

And so really nice kind of complement to what banking does really well.

Pat Morin: We were talking about how there’s a lot of change in this industry in particular the source of capital in the FinTech market. What is happening there and what should banks be keeping an eye out this for this year?

Bryan Mulcahey: It’s really interesting how the public markets have valued FinTech businesses and the impact that that has on banking. There are a handful or many publicly traded FinTechs companies from block to affirm.

Quite a few out there again as I mentioned, like they value the public markets or even the M & A environment. They, they value growth, they value annual recurring revenue more so than earnings in some cases.

And so there were for a couple of years the public markets were not super.

The FinTech community and exit opportunities started to dry up. Venture investing started to dry up for the FinTech space that has relaxed quite a bit. And we’re seeing a lot more investment back into the FinTech space.

And why that’s important is the money that comes from the venture community into FinTechs is used for marketing to customers, consumers, businesses. It’s used for developing new products, for standing up new companies.

And these are all opportunities for banks to support those FinTechs. In some cases, they are competitive with what a regional or community bank may be also trying to do. But in many ways, it’s complementary.

And the more money that flows into FinTech, the larger of a slice of financial services that FinTech community will absorb. And so over the past couple of years the rough percentage of FinTechs slice of all financial services volume maintained pretty consistent.

It was single digit percentages. But as more investment flows back into FinTech, we’re going to start to see that FinTechs are starting to capture a larger percentage of financial services revenue.

And I think banks should take notice of that and really think about how it either competes or partners with these FinTechs because obviously they then take a piece of that revenue that the FinTechs are generating if they’re the banks that support them.

There isn’t really the ability right now for FinTechs to acquire charters. There’s not really great novel bank charters or skinny bank charters for FinTechs to acquire. There are a few out there, but there’s not a lot.

So in the US it will continue to have this really unique ecosystem where FinTechs are required to partner with banks in order to offer their products and services. So the growing need for FinTechs to participate in that industry.

Pat Morin: The growth has been pretty remarkable. And as of late we’ve been seeing the introduction of artificial intelligence and actually that’s been in place for a while. Could you elaborate a bit on what AI means for FinTechs and what are some of the applications outside of the sexy stuff we’ve been hearing about with ChatGPT and the like?

Bryan Mulcahey: It is a really interesting area and we’ve used versions of AI or machine learning and financial services for, for a really long time. But these types of technology solutions, they’ll be adopted much quicker by the FinTech ecosystem.

Right? And whether that’s actually deploying that within their products or their customer service centers or their fraud centers, or they’re actually creating AI products and selling those AI products to the bank, the FinTech ecosystem tends to be able to develop those much quicker and implement those much quicker than banks can.

I think banks actually have a lot more room for efficiency gains by using AI than FinTechs. Like FinTechs tend to already run pretty lean. They’re running on much more modern tech solutions.

So they’ll have some efficiency pickup there and they’ll be first adopters. But banks really have a lot of room for adopting AI to improve their customer service function, their fraud mitigation function.

So on customer service, this is a really, really interesting one. Everyone says like, okay, there’s all these massive call centers. We’d love to disrupt the use of call centers, the use of live agents, but how do you do that?

And there are quite a few solutions out there that are trying to deploy AI to handle customers, inquiries, disputes. They haven’t really actually made a lot of progress. And one of the reasons is that consumers in the U.S. or customers in the U.S. still highly, highly prefer live agents and human interaction. And I do too, right? Like I’ll do everything I possibly can to try to get to live agent.

I’ll hit zero as many times as possible. I don’t even care if the IVR system can solve the issue for me. And this ultimately comes down to probably something along the lines of empathy and wanting to error one’s grievances or hear on the other side that someone is sorry for this issue.

And that’s the reality of the situation is something like 80 to 90% of people, when they call, their first goal in that call is to get to a human, just bypass all the other systems to try to get to a human.

And that’s not something that really any of these solutions have figured out yet. Hasn’t disrupted it yet, but I assume that they’ll find some ways to at least make some marginal improvement in customer service.

Other areas like fraud. The other thing to consider with fraud is fraudsters can use AI too. I watched a demo of an example of how a fraudster can change the look and text of a driver’s license to get through the average KYC process in a matter of seconds.

Pat Morin: Wow.

Bryan Mulcahey: Changing the look of the picture to match their facial recognition, changing name, address, barcode, everything in a matter of seconds. And they can do it repeatedly until it tricks the KYC provider into onboarding them and then they’re in.

And then it can commit some form of like ACH fraud or issue a card and start generating charges on somebody else’s credit report. And so it’s not just that there are good fraud AI solutions out there, it’s also that fraudsters are using this.

And so banks and FinTechs alike really need to improve their skill set here because AI also creates opportunities for fraudsters who are very good at their jobs. We know that if you Google fraud AI, you’ll see all sorts of solutions out there specifically for financial services.

Pat Morin: In addition to the bad guys using AI, those defending the banks also can use AI to bolster their tactics to protect.

Is there anything you want to add briefly that we haven’t touched on already? What should listeners walk away with today to help them at their institution going forward?

Bryan Mulcahey: Something that the bank should really consider is the opportunity over the next three, three and a half years under this administration, we’ll see far fewer enforcement actions. We’ll see a different approach to regulation and supervision of banks.

Doesn’t mean banks can go crazy and not pay attention to the risks and oversight requirements that have been laid out in prior consent orders. But we’re seeing a lot of banks come off the sideline and start having conversations at the board level or management level about their FinTech strategy.

And that’s both bank tech and embedded banking. The next three and a half, four years will we’ll probably see a lot of growth in FinTech. We’re expecting to see a lot of investment in the FinTech space.

We’ll also see some M & A, obviously in the banking space. But I think it’s a really good opportunity to refresh those conversations and make sure that you have some FinTech strategy so you’re able to compete.

This is a cycle. We’ll see a pretty sophisticated regulatory environment continue and they really understand the questions that they should be asking of banks in order to supervise those in embedded banking.

So banks still have to really focus on oversight and really focus on the risks of partnering with FinTechs. But it’s definitely an administration that is innovation focused and so definitely go back to the board, go back to management, double click on FinTech conversations and make sure you have a real strategy to compete over the next three or four years.

Pat Morin: In this episode, we have discussed how banks are leveraging FinTechs to transform their operations. We talked about the different types of FinTech as you mentioned, the bank tech FinTechs versus the embedded banking FinTechs as well as the opportunities to innovate.

Specifically, we covered the benefits such as expanding account services beyond core services through leveraged new technology, improved customer experiences through solving very specific pain points, greater financial inclusion and expanding the customer base.

We also looked at the current FinTech trends, noting how market conditions and partnership opportunities influence growth and the flexibility FinTechs have to innovate. Additionally, we explored AI applications beyond chatbots like the opportunities for increased efficiency, enhancing customer service, managing risks, and particularly detecting fraud.

Bryan it was great to chat today and continue the conversation from the A&B update. We really do appreciate the time you took to speak with us and our listeners. How can people get in touch with you because I’m sure this will just get people thinking about questions.

Bryan Mulcahey: Absolutely. Pat. Thanks for sitting down with me and thanks to all the listeners for tuning in. Yeah, you can reach out. My email is bmulcahey@fsvector.com you can also connect with me on LinkedIn.

Shoot me a message there and we’ll be happy to connect with anyone I want to discuss further.

Pat Morin: Listeners can find that contact information in the episode description. I can also be reached at pmorin@bnncpa.com and the BNN team is always monitoring and sharing updates and developments, so stay tuned for more articles, podcasts and resources from our team.

Thanks all. Goodbye.