Fear of FinTech Could Hurt Your Bottom Line

Americans across the economic spectrum struggle
to manage their money. We spend too much, save too little, and wait too long to
invest. While we could all be more fiscally responsible, access to services that
facilitate sound financial decision-making is often concentrated at the top of
the economic ladder. Each rung down, those resources get a little harder to
come by, with those at the very bottom often locked out of the financial
mainstream. 

Historically, poor and minority families have gotten caught between
the rock of discriminatory practices like redlining and high-risk
lending and the hard place of debt
traps. Without access to banks, they often find themselves
subject to exorbitant fees and charges by providers of alternative
financial services, including check cashers and payday lenders. Policymakers should take steps to ensure that
all Americans – regardless of race or income – have access to secure, functional, and affordable financial
services, as these commodities are crucial to financial wellbeing and social mobility. But in
absence of policy action, the market has moved to fill this need. 

Financial
technology companies (known collectively as FinTech) are broadening access to a
range of services that they claim can help us manage our spending, save more
money, and make investments in our long-term financial security.

FinTech offers users an array of financial
services — from transactions to underwriting — that were once almost
exclusively the business of banks. Personal finance apps like Acorns, Digit, and Mint help users track their
spending and stay on budget without the assistance of a financial advisor.
Personal lending innovators like Lending Club and Prosper enable users to bypass traditional intermediaries with a
peer-to-peer lending platform. Companies like Betterment and Wealthfront that facilitate investments, financial planning, and portfolio
management have emerged as popular alternatives to traditional wealth managers.

Investors have responded favorably to FinTech
companies. Just six months into 2015, FinTech startups have raised nearly $12.4 billion from venture
investments and are on track to double their backing over the previous year. While FinTech is unlikely to replace banks altogether, and many FinTech
companies actually rely on existing bank accounts, it could sap away some the banking sector’s profitability. This has
raised concerns among traditional banks about their capacity to maintain low-margin
services in a rapidly changing marketplace without being relegated to utility status. But altering some of these services could disrupt the financial lives of lower-income households that rely on inexpensive financial products. 

Generally, banks follow a loss leader pricing
strategy: they provide certain products (checking accounts) at a cost below
their market value to stimulate the sales of more profitable products (loans)
and to attract new customers. Now FinTech companies are beginning to extract the most profitable
portions of the customer-facing banking model, leaving banks with high overhead and less
profitable products. To recoup their resulting market losses and mitigate the
threat of FinTech insurgents, traditional banks and other legacy players in the
financial sector are discussing a range of strategies, including charging more
for low-margin services, closing bank branches to cut costs, and acquiring
FinTech companies. 

The worst-case scenario for low-income families
is that FinTech’s drain on their profitability over the long-term prompts banks to abandon their loss
leader strategies. For people at the margins of the financial mainstream, the
loss leader strategy is a financial lifeline that enables them to maintain checking
and savings accounts. If banks compensate for lost revenue by raising fees and
charges on current accounts, account ownership is likely to decline. Currently,
over a quarter of American households are un- or underbanked. According to the Federal Deposit Insurance Corporation, one in three unbanked households reported high or unpredictable
account fees as a reason for not owning an account and approximately 13 percent
reported this to be the main reason. Raising the cost of owning a bank account
could drive even more people away from the banking system entirely. 

While life with banks can be rough, life without banks can be brutal. Without access to a transaction account, households often
turn to alternative financial products that charge exorbitant fees. The average
underbanked household spends a staggering $2,412 each year on interest and fees alone. For many
households, access comes down to proximity to a brick-and-mortar
branch. But as banks look to slash costs, branches are closing in droves (nearly 2,599 in 2014). Low-income and minority neighborhoods are often the first areas
targeted. Since late 2008, an astounding 93 percent of the bank branch
closings have been in ZIP Codes with below-national median household income
levels. And the rise of digital banking may contribute
further to this trend as regulators consider a new proposal
that would give banks more latitude to decide where they have physical
branches.

If the threat to their business grows, banks
could opt to use their superior resources to buy up FinTech companies. With the
five biggest banks controlling nearly $15 trillion in assets, FinTech’s
$12.4 billion in venture investments this year look like peanuts. Acquisition
was the approach Capital One took earlier this year
when it bought Level Money, an app that helps users track their spending. If
proven profitable, it’s likely that other banks will start buying up the
competition. 

While usurping the threat of FinTech by co-opting it may relieve
immediate pressure on the banks, it won’t necessarily stop them from trying to
cut costs in other ways that disproportionately impact those at the bottom rung
on the income ladder. With the last 50 years of history at our backs (or even
just the last 10), do we really want banks annexing every potential rival?

Competition is good, as is innovation,
especially if they create inroads for new and currently underserved consumers to
access and use traditional financial services. And for all their disruption, some FinTech startups have vision that traditional banks have
lacked. They see underserved consumers as an emerging market, especially in
developing countries where technological advances like mobile banking have been a key driver
of financial inclusion.

The rise of FinTech gives policymakers a good
opportunity to take stock of where we have been and where we should be going
when it comes to providing the means for low and medium-income Americans to
save for the future. As these market forces unfold, policymakers should be
designing and supporting ideas that promote more financial inclusion, whether that
means more community credit unions, subsidies and tax credits for financial
services, or a government-run option like postal banking. Regardless of the
provider, legislators need to make access to secure, functional, and affordable
financial services for all Americans a bigger priority—and FinTech’s impact on
the banking industry is bringing that need into sharper relief by the day.