With the recent news of Mastercard’s creation of Accelerate, an initiative to drive the fintech industry’s growth, it’s time to take a new look at why banks and other large financial institutions should do more to support fintechs.
With the creation of the Financial Conduct Authority’s Innovate program in 2014, the regulatory environment has been more friendly towards fintechs in the U.K. than in the U.S., but that’s now beginning to change. With the FCA’s recently announced collaboration with the U.S. Commodity Futures Trading Commission, the U.S. will enjoy a new regulatory sandbox environment for fintech providers, to the benefit of some U.S. customers. (Of the traditional federal banking regulators, none has moved quite so far ahead publicly as has the commission.)
Banks have been mentoring startups, hosting innovation labs, and investing in young companies, but that isn’t enough. Financial institutions in both the U.S. and the U.K. have missed out on huge opportunities by insufficiently supporting fintech innovators.
One classic example of a missed opportunity can be seen in the 2014 launch of Plastc—a fintech startup that promised a single smart card that could store information for up to 20 different debit or credit cards.
Plastc filed for bankruptcy in 2017, after acquiring more than $9 million in pre-orders from 80,000 backers, but failing to secure its latest round of funding. Plastc failed to reach its potential, in part because the startup lacked the managerial experience to allocate its resources effectively—this amounted to an expensive failure and thousands of angry customers.
Similar fates befell Dealstruck, an online lender; BTCjam, a peer-to-peer marketplace that was launched to borrow and lend using Bitcoin; Coinprism, an online wallet service; Snapcard, a bitcoin wallet service; and others.
A number of factors are behind this lack of support, but they mostly boil down to one form or another of short-term vision. It could be that banks allocate abundant start-up funds, but less capital for the funding required to scale.
Alternately, the fintech could have been underfunded in the first place. And when infusions of capital are required, many players underestimate the time needed for the second-round raise, or the lag between intent to fund and the arrival of funds. You can almost always count on it taking longer than the estimated time to secure later-stage funding, and the start-up is almost always going to need more capital investment.
It’s up to financial institutions to fill this gap because they have the balance sheet strength to operate in this space. Early stakes are small. They can increase equity stakes as part of second-round financing, which is our own preferred approach.
But there’s more to it than cash. Financial institutions can also provide the fintech with access to a customer base, enabling it to scale with low acquisition costs while simultaneously broadening and improving the product—this is what we have done with hi-tech Lifetime Mortgages, which became a $1.35 billion business in its first year.
Fintechs bring banks innovation
The stakes are high for banks. Remember, it’s the new players that are meeting previously unidentified consumer needs and defining the new customer experience.
Banks need to stick their necks out and start engaging with these disruptors as partners. Harking back to famous cases like Kodak, money spent defending analog technology didn’t save the company. But ten digital partnerships, with, say, two successes, might have given the company a way forward, and things would look very different today.
Part of the problem is that there is not yet an ecosystem in place where the gains from one successful venture capital investment can be easily recycled into the next. By this, I mean that Silicon Valley for tech or Boston for life sciences hasn’t really got a specifically fintech equivalent yet.
Footloose institutional money could back start-ups in scaling-up mode in particular, for example through a “fund of funds” model.
If necessary, government might play a role in creating institutional structures for this to happen in the early stages. British Business Bank, a government-owned business development bank, exemplifies this model and, following the U.K. Treasury’s Patient Capital Review, is looking at how to support innovative firms access to the financing they need. Another option might be an extended regulatory “sandbox” for testing new products in a safer environment.
Perils of fintech startups
But, by and large, the lack of this level of support has meant that even decent startups hit a “valley of death” when they fail to get funding for the next phase of their growth.
Exacerbating the problem is how entrepreneurs in both countries have a propensity to create companies with a view to sell them to tech giants for relatively small change. This mentality signals a deep fear of failure and a need to fly under the radar. While they may be innovative, these startups may become too focused on avoiding the regulatory minefield.
In response to these issues, real support starts with providing more critical startup or scale-up funding. Banks should take patient equity stakes to help keep startups running. This can include mentoring entrepreneurs so that they learn to work ethically within and outside regulatory confines to avoid the sort of unintended consequences that Facebook has been recently facing.
Financial firms can also form more fintech partnerships that make innovative products and services available to banking customers.
My company, Legal & General, has already made 120 investments in digitally-oriented businesses. Fintechs help us think beyond our own limits as financial institutions, while we can ground them in the realities of financial services.
For example, we are investors in Salary Finance, which enables employers to step in with short-term loans to employees, displacing the hugely expensive payday and doorstep lenders. Salary Finance has 500,000 people signed up. We also have a partnership with Slice, providing household insurance for Airbnb renters.
Startups offer the chance to connect the world and help deliver financial services that can drive widespread growth and prosperity—creating millions of jobs and building stronger, fairer, and faster financial services. Let’s help them do so.
It will only help us maintain our financial leadership.
About the author
Nigel Wilson was appointed Group Chief Executive of Legal & General in 2012, having joined as Group Chief Financial Officer in 2009. He won the “Most Admired Leader” award at Britain's Most Admired Companies Awards 2017, for Management Today. In 2015-2016 Wilson was a member of the Prime Minister’s Business Advisory Group. He can be reached at [email protected]