Unbundling of the Banks in Europe

Published on
March 19, 2015
Toby Coppel
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Unbundling of the Banks in Europe

Who will disrupt banking? We've all heard about the opportunity from a breakdown in trust after the financial crisis, but little about who will replace the full service financial institutions in retail and investment banking. Since the birth of the internet, only a handful of US companies such as Etrade, Lending Tree, and Bankrate have successfully built new mass consumer financial services brands and they were all launched in the late '90s.

There is a hidden, but seismic and structural shift underway. As a new generation of best-of-breed services such as Lending Club take on the banks, customers are willing to be promiscuous, to be tempted by new products rather than switch to new full service brands. Alexander Pease from USV has a nice schematic of this startup activity in the US.

The opportunity is there thanks to technology and the banking crisis of 2008-09. As they clean up their act, banks are less willing to take risks or to invest in consumer-focused innovation, focusing instead on deleveraging their balance sheets. Trust in the old institutions is low, meaning customers facing ever stricter lending criteria at their bank are more willing to try upstart services to borrow, such as UK-based Zopa, the original pioneer and Europe's largest P2P lending marketplace; and Funding Circle (UK), which has attracted thousands of small businesses to their low-cost, easy-to-use loan marketplace. Both have funded $1 billion in loans to date.

Historically, trust underpinned loyalty, meaning consumers and small businesses had relationships with a small number of financial services brands. The new promiscuity means a willingness to choose best-in-classproducts; previously, they would single source through their main bank because their salary was paid into a current account with that institution.

Big retail banks offer a diverse portfolio of products and services. In theory they leverage knowledge of a customer across those products, but in practice very little of that customer data is used to drive more intelligent and customised recommendations and usage.

Consider the fate of newspapers. They used to bundle an array of products (news, classifieds, movie listings, retail advertising) but their monopoly in distributing that bundle was eliminated by the internet. In the age of the smartphone, banks' distribution advantage is also no longer an asset-in fact, it is likely to be a liability, a high cost structure that will prevent them from competing effectively with new entrants. For example, Lending Club's operating expenses are approximately 1.7% of an average loan compared to 5.3% at a high street bank. Algorithms and software are replacing people across a range of financial services - inside retail banks (bank tellers, personal and business loan underwriters) and other financial institutions (wealth management advisors, mutual fund portfolio managers, hedge fund traders). Tom Loverro has some great slides on this.

A multitude of European startups are attacking the traditional banking providers with innovative products offering superior customer experiences at a fraction of the bank's charges. TransferWise has campaigned on the basis of the outrageous and hidden fees charged by the banks for international money transfers (as much as 5%), while offering their own mobile-first, easy-to-use service for only 0.5%. The banks cannot compete with TransferWise given their cost structure and their once-lucrative profits in this area will erode to nothing over time - one less source of support for their local branch networks and bloated IT / management structures, and one less subsidy for their least profitable products.

In Europe, the regulatory environment is arguably more friendly for new entrants than in the US, and there are startups successfully attacking the banks at scale in lending (Funding Circle, Pret d'Union, Ratesetter, Zopa) and international FX transfers (TransferWise, World Remit). Other areas that provide sizeable profits to the banks are in the early phase of startup development, such as equity financing (Angellist, Crowdcube, OurCrowd,Seedrs), mortgages, payments (Adyen, iZettle, SumUp, Tipalti), personal financial management (e.g. Tink), pension and savings (e.g. Nutmeg,SavingGlobal), working capital finance (e.g. MarketInvoice, Novicap), and even core banking (current accounts e.g. Number26, Holvi).

Meanwhile, don't forget the blockchain-based software and applications under construction by a new cohort of startups to revolutionise the global payments system and back- and middle-offices of the banking industry (e.g.Blockstream*, Blockchain*, and Eris Industries).

We are excited that the next 10 years will see tremendous value creation by startups competing with traditional banks and their expensive branch-networks, staffed by humans, not algorithms. It will likely take place product-by-product rather than through the rise of a "new bank". If you are working on a new startup in Europe with a killer product that competes with one provided by a bank or traditional financial institution, we would love to hear from you - please get in touch.