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As Legacy Banks Embrace Tech, How Can Fintech Startups Compete?


Fintech startups changed the way customers and incumbents alike think about banking. As customer expectations have changed and their digital-first options have exploded, legacy banks are embracing technology, as well.

Legacy banks often have more resources to invest in new technologies than fintech startups. To stay competitive, fintech companies will need to understand legacy bank innovations and respond accordingly.


Are Legacy Banks Becoming Tech Organizations? 

In the rush toward greater efficiency and improved digital options to meet customer demand, some legacy banks are investing heavily in their own technological development.


Fixing the In-House Tech Problem

“An over reliance on legacy technology running on bank-owned computing hardware is one of the biggest things holding [banks] back from matching the agility that consumers need for digital payments and other transactions,” writes Marcus Treacher, senior vice president of customer success at Ripple.

In recognition of the challenges posed by older systems and by changing customer demands, many legacy banks are investing heavily in their own tech transformations.

Modernization efforts carried out in-house by legacy banks may focus solely on upgrading technology, or they may see IT updates as merely one aspect of a modernization plan that affects the entire organization, write Ed Quinn and Bob Hirsch at Deloitte.

Banks that take a more holistic approach to modernization can create more resilient, longer-lasting systems and processes for using them, but they also spread their resources more thinly, allowing comparable fintech companies to maintain their competitive advantages in the tech arena. Despite banks’ willingness to invest in tech, competing with digital-native fintech companies remains a challenge, write Marc van de Vleugel, Steven Breeden and Pascal Gautheron at Bain & Company.

“Successful banks today realize that they are essential technology companies operating under the rules of a banking license,” write van de Vleugel, Breeden and Gautheron. The regulatory demands placed on banks, plus the learning curve of pivoting to tech, pose challenges for legacy banks that digital-first fintech startups don’t face.


Challenges for Legacy Banks Pursuing In-House Upgrades

Legacy banks’ attention is divided when it comes to modernization because legacy banks currently face pressure to innovate from multiple sources.

The COVID-19 pandemic greatly accelerated the need for digital-first banking services, as well as the need for a tech infrastructure that could support fully remote work. The exodus to the digital realm also increased cybersecurity threats, however, write Vik Sohoni, Xavier Lhuer and Somesh Khanna at McKinsey. And, of course, fintech innovation has placed pressure on legacy banks to offer similarly convenient and efficient digital services.

Finally, legacy banks face challenges when it comes to funding technological upgrades. While these institutions have more resources overall than most fintech startups, they also have more rules and expectations regarding how they will apply those resources and to what ends. Proposed tech projects that may not show returns for years may be eschewed in favor of other projects, write Tim Adams at the Institute of International Finance and fellow researchers from IIF and Deloitte.

While some banks are addressing these challenges with in-house tech investment, others are turning to partnerships with fintech organizations that specialize in key areas.



Legacy Banks and Fintech Partnerships

Fintech companies are still the resident experts on new technologies and their applications to the financial world. Recognizing this, some legacy banks are turning to partnerships with fintech organizations to meet their own technological needs.


Community Banking and the Rise of Digital Finance

As customers seek more value from their financial relationships, financial institutions of all sizes will need to be ready to shift to digital approaches, says Vaduvur Bharghavan, CEO of Ondot Systems. For example, even small community banks and credit unions will need to offer digital card options.

Having the option to access cutting-edge digital options from a hometown bank or credit union may be key to encouraging customers to embrace digital banking. “There is a certain notion of trust and personal connection with community institutions,” says Bharghavan. “The challenge is you have to make a choice today.”

Many smaller financial institutions, however, are eager to make that choice.

“Community-focused banks and credit unions now more than ever are looking to shape the industry, rather than continually being shaped by it,” writes Mickey Goldwasser, vice president of marketing at Payrailz. Partnerships with fintech companies give these organizations the opportunity to influence the financial industry and to shape their own destinies within it, while also meeting regulatory compliance requirements and providing the service customers expect.


Addressing Customer Trust in Finance

Increasingly, consumers expect financial service they can trust, and they hesitate to work with companies that don’t inspire that trust. An Ondot Systems/Harris Poll survey, for instance, found that 69 percent of respondents believed that financial institutions are more susceptible to cybersecurity breaches than other businesses.

When it comes to trust, however, fintechs and their legacy bank partners may have an advantage over tech companies also seeking to enter the fintech space.

“With respect to trust there’s been a lot of discourse in the press with respect to how a lot of the big tech companies deal with data,” says Mark Flamme, head of digital for financial services at AlixPartners. Facebook’s challenges from legislators as the company seeks to launch its own cryptocurrency provide just one example.

Customers may feel concerned about giving their financial information to companies like Facebook, Amazon or Apple. Legacy banks, however, tend to inspire more trust, and a fintech partnering strategically with legacy banks can benefit from that trust relationship as well.



Opportunities and Challenges for Fintech Startups

Legacy banks have resources, connections and long experience from which to draw in the pursuit of technological innovation. Fintech companies, however, are not without resources of their own — and both organization types face their own challenges.

For many years, legacy banks relied on core computer systems to handle transactions and store sensitive data. While these systems tended to be highly reliable, they weren’t equipped to handle the rise of digital banking, cloud computing and APIs, write Vishal Dalal, Ondrej Dusek and Anand Mohanrangan at McKinsey.

Legacy core banking systems also pose challenges for the banks that use them. Legacy systems have often been customized multiple times, often without supporting documentation explaining the changes to the next generation of IT staff. Vendors may have gone out of business or no longer support key parts of the system. And banks find it increasingly difficult to hire IT staff with expertise in the programming languages or the hardware used to run these systems, which are becoming obsolete, Dalal, Dusek and Mohanrangan note.

Customers are increasingly enthusiastic about digital banking options. A March 2020 survey by Ondot Systems and The Harris Poll, for example, found 64 percent of U.S. banking customers would be willing to handle financial needs through a fintech company rather than a legacy bank.

Legacy banks have embraced technological change, seeking to do business more efficiently and to stay connected with customers who expect immediate, personalized digital service. Although legacy institutions often have more resources to pour into innovation, they also face certain challenges that fintech startups do not. Fintech companies that understand the tech playing field for legacy competitors can better position themselves for success.

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