Fintech Trends Signal Imminent Disruption

Rather than an indication that a fintech bubble is forming, the sky-high investments in the sector are a sign that banks will be disrupted sooner rather than later.

Fintech investment is ballooning as companies and individual investors look to cash in on the potential for digital disruption in financial services. Last year, global investment in the sectors 12,000-plus startups tripled to $12.2 billion from $4 billion in 2013, according to Accenture. This year, the number of fintech “unicorns” valued at $1 billion or more than tripled to 36 from just 11 in 2014, according to Finovate.

This wild investment growth has some wondering if a looming bubble is forming as so much investment pours in even though operating profits for public fintech companies have declined in recent years. This is one reasonable conclusion to draw from what we’re seeing in the sector, but it’s not the only one.

It’s more likely that the tremendous growth in fintech investment is a warning bell that disruption in financial services is coming closer and closer. History suggests that Internet bubbles don’t burst until after a disruption has occurred. The dot com bubble didn’t burst until after clear cut winners from the disruption of Web 1.0 had emerged like AOL, Yahoo, and Google. The success of those companies resulted in a wild chase as investors bought into companies that had no record of generating revenues, hoping to hit on another Google or eBay.

The fintech sector hasn’t reached that late 90’s stage where big winners have already shaken out. Banking hasn’t gone through that first stage of digital transformation – we’re still waiting for the winners of digital disruption in banking to show themselves. We’re still in the early 90’s.

If you’re looking for evidence of this, look no further than the continued uncertainty among banks about how the new players in the market will impact their business. They know disruption is coming, but they’re not sure where it will come from first or how it will change the market.

Part of the reason for that uncertainty is that the potential for disruption in the industry is so vast. Financial services is such a massive industry, and it is so ripe for disruption in so many ways. The industry’s reputation never recovered from the financial crisis. Technologically, banks never caught up with the pace of change in our daily lives. They continue to build new applications atop decades-old legacy systems that have hamstrung their agility, supporting the prevalent opinion that banks are “out of touch.” So as other industries raise the bar for customer experiences, banks risk losing their customer relationships to upstart entrants.

The coming of age of millennials multiplies that risk. This is a generation that is rooted in a digital way of doing things, including their banking. It is also a generation that views banks very unfavorably, and has little use for them. As I mentioned in a previous article, they are wary of making their financial lives any more complicated after graduating laden with college debt. They value simplicity and advice on how to build their financial futures, and they want it delivered digitally, on-demand.

All of this leads to the conclusion that there’s still a great deal of room for fintech companies to grow. That goes for both kinds of fintech companies: the ones that are looking to partner with banks, and the ones that are looking to overtake them. As banks struggle to keep up with the pace of digital innovation, it will allow the fintech companies that seek to be alternative banks to take business from them. The banks will respond by buying more technology and services from the fintech companies that want to partner with them.

That room to grow means investments and valuations are going to continue to grow in fintech. And, unlike many dot com companies, those investments and valuations won’t be based on nothing but promise: most of the better-known fintech companies are generating revenues instead of dangling by the thread of their burn through rate.

As investments climb, it will make the threat of disruption more imminent for banks. Just a few years ago, bankers thought that the barriers to entry would be too high for new entrants to take business from them. That’s still true to an extent. This isn’t an industry where a small group of guys in a garage somewhere can quickly overturn the established order of things on their own. But with the sky-high investments we’re seeing in the fintech sector, it’s easier than ever for that small group of guys to get the resources they need to overturn things, and they can get those resources more quickly than ever before.

This is happening in other industries where startups are growing faster than ever and disrupting things with lightning speed. Uber still faces major legal and regulatory challenges, but it has quickly acquired the resources to face those obstacles.

This certainly sounds like a bleak picture for banks, but it isn’t. They are in a position to decide their own futures. Many banks are setting themselves up to participate in the coming disruption by investing in fintech startups through venture capital arms. They can acquire startups and integrate their talent, ideas, and technologies to further strategic goals and cater to digitally oriented customer segments better than their competitors.

Of course, the banks that are taking this proactive step tend to be the largest ones that have hundreds of millions to invest in venture capital. Smaller banks are in a more difficult position, but they could band together to form venture funds. If they acquire startups with great solutions they could white label those solutions, and then sell them to larger banks, creating a new revenue stream.

At the very least, smaller banks should create their own innovation labs to experiment with new technologies coming out of the fintech startup scene, positioning themselves to be fast-followers. There’s no reason that smaller banks have to sit it out on the sidelines, just waiting to be acquired by their larger competitors or the startup that suddenly takes off to become the Google or Amazon of fintech.

Paul Schaus is CEO & President at CCG Catalyst. Follow CCG Catalyst on Twitter and LinkedIn.