Advanced Capital Markets - Assignment Group 7

1st Year Business Administration

Advanced Capital Markets

WHERE IS THE BANKING

SECTOR GOING?
The FinTechs’ and BigTechs’ arrival

Aleandri Gioia
Minciuna Florina Madalina
Olivotti Francesca
Perotti Chiara
Priolo Alessandro
1 Sola Alessandro
Tanaselea Isabela
Advanced Capital Markets - Assignment Group 7

INDEX

Introduction ............................................................................................................... 3

How FinTech firms are challenging banks ............................................................. 4

How BigTech firms are challenging banks ............................................................. 6

How banks are responding to these challenges .................................................... 8

Possible future outcomes ...................................................................................... 10

Conclusions ............................................................................................................. 12

Bibliography ............................................................................................................ 13

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Advanced Capital Markets - Assignment Group 7

Introduction
This paper tries to highlight the key issues that the present financial service industry is facing
as a result of FinTechs and BigTechs, based on an exhaustive examination of studies covering
the interactions between the retail banking system and Tech newcomers.

More precisely, FinTech businesses and conventional banks reflect two distinct realities in the
administration of key financial services activities. Traditional banks have a lengthy history of
operations, giving them a competitive advantage in terms of know-how and competence,
whereas FinTech start-ups primarily focus on AI and IT services. The emergence of Fintech
accelerates the trend of democratisation of financial services, which are becoming more
accessible to people all over the world. However, the most uncertainty stems from the bank's
rigorous regulatory framework, which acts as a safeguard for clients but creates issues in the
exposure to increased risk-taking and changes implementation.

BigTechs, instead, are currently one step away from entering the retail banking sector. When
and if this occurs, their primary skills will create issues for the banking industry and could
possibly outperform it. Among other advantages, they have huge installed customer bases,
solid reputations, captivating brands, significant earnings, and unlimited access to financial
markets. They can benefit from their improved knowledge of customer preferences, habits,
and behaviours.

If they join as lending institutions, they may exploit banks' market share. This may prompt
institutions to regulate them in a diverse range of areas, including requiring forced data sharing
or providing more privacy protection, as to restrict their gathering of information. To prevent
potential monopolisation or unfair competition, regulators might additionally limit their power
through antitrust law.

In a medium-term horizon, banks are likely to preserve their dominant position. The
importance of the current function that banks play in the economy cannot be overstated. They
do occupy a position of influence, mostly because of the respect they have traditionally
attained and the stringent regulations they are required to comply with. This would happen
because BigTechs would probably be subjected to a strong bank-like regulation, preventing
them from taking control of the banks’ market share. On the other hand, FinTechs can hardly
be profitable individually and are likely to remain as a bank satellite.

The primary goal is to create a future ecosystem that includes all these participants in order
to increase efficiency and prevent financial instability for all parties involved.

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How FinTech firms are challenging banks

In the last decades, the growing development of Fintech has been one of the most impacting
phenomena driving changes in the financial sector.

FinTech, following the definition given by the FSB, refers to the implementation of emerging
technologies in the financial sector as a driver of innovation. Their application may result in
brand new business models, products and processes. As new services are proposed to the
market, traditional players like banks in the industry have been strongly affected and are going
through transformations.

Fintech firms and traditional banks represent two different realities in the financial industry.
The main differences rely on the management of the core activities. Traditional banks have
huge deposits and depend heavily on physical contacts with customers, while FinTech firms
mainly base their business on machine learning and IT services. This justifies their ability to
offer speed and personalization to customers thanks to their organisational structure, that is
comparatively less articulated and more agile (Brandl and Hornuf 2020). This integration of AI
into their services answers perfectly to customers’ demand for efficiency and frictionless user
experience. Nevertheless, this industry is relatively new, so it lacks experience, reputation,
and customers’ loyalty.

On the other hand, traditional banks have a long history of operations which gives them a
competitive advantage in terms of know-how and expertise. In practice, this is translated into
high customers’ retention. Historically, as it was quite complicated to process information
accurately and safely, banks had an information monopoly; however, the revolution in big data
has shuttered this power. Fintech firms, thanks to their easy accessibility to large amounts of
online data, attract mainly younger generations, while banks engage the whole population.
Among which, a privileged position is taken by the elder generation dealing with a digital
barrier.

Nevertheless, banks face difficulties in adapting to revolutionary technological developments

as their business models miss the rapidity in innovating that characterises the competitors. It
becomes harder to keep up with new market requests concerning digitalization of services,
even though there is evidence that they are increasing investments in digital banking, mobile
wallets and P2P lending, as to incorporate new technologies and attract new clients.

Banks are additionally threatened by FinTech companies because of their cost advantage. In
fact, thanks to IT they can exploit the economies of scale and deliver high quality products

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easily and fast. The benefit relies mainly on the transaction costs that appear to be more
accessible and satisfy even further customers’ needs.

A traditional bank requires relevant amounts of real estate and thousands of employees, this
does not happen in FinTech firms and customers benefit from the cost savings. This enhances
the process of democratisation of financial services that are becoming available to everyone
around the world. While financial institutions generally focus on creating more wealth using
capital coming from savings and investments, FinTech firms open up opportunities for financial
inclusion. At the same time, it is evident that banks can decrease problems arising from
asymmetric information thanks to regulation. This is done by collecting large amounts of data
and monitoring customers’ information, which permits them to exploit scale economies by re-
using their fundings repeatedly.

The creation of these new digital services has effects on distribution channels, as FinTech
firms detach themselves from vertical integration, in order to split up the banking value chain
and choose the fragment in which they want to operate. The emergence of these competitors
can crowd out the existing distribution channels of banks and reduce their incentive to
introduce other separate channels (Vendrell-Herrero et al. 2017).

Such new players are also having consequences on the business models of the traditional
companies, since they are re-bundling their offerings, splitting products and services and
mixing them with other providers to satisfy customer desires by disseminating financial
services across global society. In this dynamic and flexible environment, business models
need to be malleable as well, evolve and be modified as to rely on multiple and non-linear
models and roles in the value chain, leaving behind the traditional vertically integrated model.
Consequently, starting from the analysis of customers’ satisfaction, companies need to
develop value chains that offer growth, differentiation and flexibility to maintain a sustainable
business model in the long run.

Regulation is another big obstacle for traditional banks, with Fintech firms that are way less
constrained by the law. A Fintech faces less risks while offers are fostered, therefore it has
stronger capital and liquidity. The robust regulatory environment of banks guarantees security
for customers but difficulties in the exposure of higher risk-taking and implementation of
changes.

These factors are becoming a challenge also for regulators that are slowly adapting to
evolutionary changes in the financial ecosystem as to detect new ways for competing fairly.

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How BigTech firms are challenging banks

BigTechs can be defined as large international technology companies with high market
capitalization, well-recognized brands and established market position, which offer mainly
non-financial goods and services via digital platforms. Their business approach is built on
three interconnected components: data analytics, network impacts, and related activities
(including offering financial services).

BigTech’s platforms have significant competitive advantages that can be effectively applied to
retail banking markets. They have substantial installed customer bases, established
reputations, compelling brands, significant earnings, and unrestricted access to financial
markets, among other benefits. They can use superior knowledge on consumer preferences,
habits, and behaviour. Furthermore, these platforms may capitalise on the proliferation of large
data on individuals and businesses, as well as significant developments in artificial
intelligence, computing power, cryptography, and Internet reach (De la Mano and Padilla
2018).

BigTechs’ main skills could create challenges for the banking sector, potentially outperforming
it. Being the technological industry their main business area, BigTechs have focused on the
collection of consumers' data and achieved a supreme accuracy. This skill enabled them to
exponentially grow, creating a massive customer base, and fulfilling huge economies of scale,
scope and learning. The quantity and quality of up-to-date data they accomplish, allow them
to be more efficient, both in terms of cost-effectiveness and speed. They also benefit from a
network effect, thanks to the existence of an already established ecosystem, demonstrated by
their talent in reaching and retaining customers, as well as gaining new ones (Punzo 2018).
The high profitability attained by BigTechs, as a result of their ever-expanding size, places
them in an ideal state of financial prosperity and stability, translating into the possibility to take
on significant financial risk. The accurate profiling of the consumer base puts tech giants in a
strong competitive position, which enables them to offer tailored and, eventually, cheaper
financial instruments to their clientele. Considering the risk management ability and the users’
profiles, “BigTech’s unbundling of banking services may damage the charter value of
traditional banks if they end up being limited to offering an essential, basic facility, very much
like the utility industries of water supply, gas and electricity, while the more profitable segments
and customers instead go to Big Tech firms with few or no layers of intermediation” (De la
Mano and Padilla 2018). Connecting lenders and borrowers as intermediaries, make BigTechs
a possible dangerous rival for banks. Indeed, whether BigTech platforms function as
intermediaries or marketplaces, incumbent banks will have to fight vigorously for the credit
demand of their most loyal and valued customers: households and SMEs. They will also have

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to compete for talent, which will raise the cost of obtaining the necessary financial and
technological expertise. Moreover, the burst of COVID-19, acted as an accelerator in digital
transformation, providing a once-in-a-lifetime opportunity to switch off physical channels and
push holdouts to do more high-value, high-risk banking activity digitally (Bains, Sugimoto, and
Wilson 2022). Banks, on one hand, were forced to quickly convert almost the entirety of their
activity onto digital platforms. BigTechs, on the other hand, had the opportunity to develop
even further and increase their technical services and performances. However, even though
banks have enhanced their digitalization, they would be unable to compete on the same level
as BigTechs, owing to a lack of technological knowledge. Indeed, the tech giants could
aggressively enter the market and exploit their massive market share in the retail banking
services.

All the above premises would suggest BigTechs are ready to enter the retail banking field.
Then, why aren’t BigTechs already taking this venture worldwide? In China, the phenomenon
already exists, with the most relevant example being the Alibaba group, whose company
AntFinancial has Alipay, as a subsidiary (Stulz 2019). Instead, in Western countries, the
banking sector is heavily regulated, thus BigTechs are considering the hypothesis of entering
this market even if they are concerned that they would be obliged to follow the same rules.
Since they are currently benefiting from an uneven regulation, they could otherwise lose the
advantage of keeping lower levels of capital reserves and higher debt ratios.

At present, banks are “in a corner”, meaning that they should take a decision on their future
approach to the imminent landing of BigTechs. Hence, they need to decide on whether they
should fiercely compete or cooperate with them, also taking into account how governments
and institutions could react.

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How banks are responding to these challenges

BigTech's entry into retail banking may spark competition in the near term, which will be
welcomed given that a lack of rivalry has long been a source of anxiety in the industry.
However, it may create financial instability in the short term and perhaps lead to more
consolidated credit markets in the long run (Padilla 2020). On the other hand, FinTechs are
already reshaping consumers’ behaviour and expectations for banks and traditional financial
institutions.

When dealing with BigTechs, banks would have to transform their proprietary business into
an open platform, shared with other banks and financial intermediaries (and possibly with
players from other sectors), to benefit from the co-investments of all platform participants (De
la Mano and Padilla 2018).

Banks will have to compete fiercely downstream, especially for the demand of their most loyal
customers, but also upstream, for talent, which will drive up the cost of recruiting the necessary
financial and technological capabilities. In essence, they may have little choice but to seek
FinTech firms in order to obtain much-needed technical skills. Crucially, some incumbent
banks may be unable to compete technologically unless they partner with the BigTech
platforms. Banks may have to choose between falling behind technologically, by ceasing
engagement with tech firms and giving up some of their competitive advantages, as well as
losing some control over expenses and consumer data, if they decide to collaborate with them.

The most straightforward way to encourage market diversity and competitiveness is to make
data sharing conditional on consumer consent. Platforms of a certain size would be required
to provide others, including traditional banks, access to a fraction of their data, including
personal details, if the individual or business in question decides so (Valverde and Fernández
2020).

In addition to compulsory data sharing, antitrust law enforcement is another tool for ensuring
that banking markets remain vibrantly competitive years after the advent of BigTech platforms.
To dissuade anti-competitive behaviour, antitrust officials will need to continue monitoring
platform commercial operations. However, the success of this policy choice, may encounter
some scepticism, particularly if implemented in isolation (Padilla 2020).

Lastly, an alternative to mandatory data sharing would be to strengthen privacy protection by

restricting the capacity of giant digital platforms to gather and combine personal and
transaction data and thus, reducing their data supremacy. This may be adequate to mitigate
the above-mentioned concerns, but it may be difficult to accomplish in practice. While

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consumers worry about privacy, they appear to be accustomed to having to relinquish their
personal data in order to utilise the largest and most popular tech platforms (De la Mano and
Padilla 2018).

The presence and current growth of Fintech, on the other hand, has led banks to most notably
adopt different immediate strategies to face the challenges posed by new technology. In more
detail, banks are being forced to lower their risk levels, increase capital adequacy, and improve
the stability of their revenue pools due to the continued escalation in regulation (Buchak et al.
2018).

It is critical to emphasise that, despite their advances, FinTech firms are doing nothing
significantly different from traditional banks. This indicates that banks can respond to these
players and are actually doing it by developing themselves through digital transformations.
They form new partnerships, create new software, and improve online payments, security,
and other services.

Building a comprehensive digital banking framework from the ground up has enabled FinTech
businesses to identify and solve any operational flaws in the banking system. This has resulted
in eye-opening realisations for customers, raising their expectations of any banking
transaction. Customers' expectations of brokerage costs have shifted as a result of the rise of
digital brokerages. In more detail, they have been shown by retail foreign exchange FinTech
businesses that they do not have to pay retail FX margins and are becoming increasingly
aware that a digital-first banking experience is achievable thanks to new retail banks.

Traditional banks are practically keeping up with the technological revolution through the in-
house development and implementation of automated services. A clear example can be the
introduction of mobile banking, that satisfies the requests of the current generation to eliminate
time-consuming processes and enjoy banking services quickly. This allows users to access
their accounts without waiting lines and make payments or investments, among other things,
from the comfort of their own house. Another clear example could be the integration of AI-
powered systems and software that efficiently collect and process large amounts of data at a
high speed. Retail loan applications, for instance, are now frequently analysed using credit
scoring methods founded on extensive historical credit registry databases. This automated
solution eliminates the requirement for a local presence to issue a loan, significantly lowering
underwriting and compliance expenses for lenders, and the generated data may be used to
improve risk measurement and management even further.

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Possible future outcomes

The research showed so far demonstrates that banks and FinTech firms represent two sides
of the same coin. Sometimes they compensate each other while others compete with one
another, but what is certain, is that they benefit more from collaborating as they have
nowadays to co-exist.

Indeed, bank-FinTech alliances are the outcome of reciprocally profitable transactions

between banks and FinTechs. The objective of these partnerships is to enhance the market
value of both participants (Coase 1960; Scott et al. 2017).

FinTech, for example, can get access to a larger client base, and a greater understanding of
dealing with financial laws and develop their own digital offerings by forming an agreement
with an established player in the financial industry.

Banks, on the other hand, can achieve a competitive advantage by cooperating with FinTech
in the process of establishing a better method to deliver financial services. In some situations,
investing in a FinTech firm might grant a bank exclusive right to use a particular application or
licence, allowing it to exclude competitors at its discretion. One procedure for carrying out this
change is to delegate responsibility for the process to a designated manager. In this regard,
some banks have created the position of chief digital officer (CDO). The CDO should focus on
developing in-house digitalization competencies and innovative service initiatives and should
engage with FinTech if it is the most cost-effective alternative (Hornuf, L., Klus, M.F.,
Lohwasser, T.S. et al.,2021).

Another great example of profitable coopetition between banks and FinTech firms is
institutionalisation. That is the case of FinTech firms whose business is based on platforms
that provide users with specific types of investments. Lending crowdfunding is one of the most
innovative ways exploited by financial services. In this scenario, individuals, SMEs, non-profit
organisations, and innovative start-ups access this funding tool in order to raise funds from
individuals and finance specific projects. Among individuals and groups that take part in this
operation, also traditional banks can be found. In Italy, for instance, some banks own platforms
or take part in this financing process, by lending to support the projects proposed. This
phenomenon is rapidly spreading in the last few years as, institutional investors are
increasingly making use of alternative finance to support their clients’ investment strategies
(C. Rovera, 2016).

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In contrast, considering that BigTechs aren't yet actively competing in the market, it is unclear
what the future holds for them in the retail banking industry. The entrance of BigTechs may
thus result in several possible outcomes in the medium-term prospects.

A first scenario would depict BigTechs and banks acting as direct competitors, without the
introduction of specific regulations for the first ones. Starting from the current situation, the
marketplace will be driven to higher competition and liberalisation, also leading to possible
forms of moral hazard. Consequently, banks could either disappear, become part of BigTechs
as subsidiaries, or improve their business model strategy to such an extent to reach BigTechs’
levels. In any case, the best performing party would achieve a monopoly-like condition (Padilla
2020).

A hypothetical situation would consider the entry of BigTechs in the retail banking sector and,
simultaneously, the introduction of a partial regulation, to avoid unfair competition. The aim
would be to create a collaboration between BigTechs and the banking system. This would
imply a reduction in the costs of lending, enhancing the possibility to be financed by the
borrowers.

The last possible and most probable outcome, even according to the literature, would
contemplate the application of a strong bank-like regulation over BigTechs, preventing them
from exploiting the banks’ market share. In such a way, they avoid predatory lending methods
and are required to comply with the same fiduciary and investor protection requirements
consistently to conventional banks and other financial intermediaries. They would be able to
keep their better technological position, with some impositions on data sharing (De la Mano
and Padilla 2018).

Indeed, banks benefit from the sector’s first-mover advantage and are structured in such a
way that allows them to operate effectively, in accordance with the existing regulations. This
picture would enable some restrained partnerships between banks and tech giants.

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Conclusions
The paper proposes a conceptual framework in which technological companies and traditional
banking interact. In the industry, the general response of incumbents (banks) and new entrants
(tech businesses) will depend on how much their respective capabilities, resources, and other
assets complement or replace one another. A bank may choose to accept the entry of BigTech
and FinTech firms, if their services and activities are mostly complementary. While, when they
are interchangeable, the banking sector would try to restrain admission and compete heavily
(J. Harasim, 2021).

The new entrant can exploit non-aggressive strategies, like a promise to stay small or a
collaboration with the incumbent. Existing market participants, on the other hand, may restrict
access to their infrastructures to competitors, or employ bundling and tying tactics (OECD
2020). Since both sides' responses are dependent on the fundamental elements of the
industry (Fudenberg and Tirole 1984), they are unique to the size and positioning of each
market participant.

Nevertheless, banks are likely to maintain their hegemonic position in markets where the
traditional banking sector is well-established and has been offering affordable services to the
mass market. It is crucial to emphasise the significant role that banks currently play in the
economy. They do hold a powerful position, largely as a result of the reverence they have
gained over the years and the strong regulation they must comply with. This is essential to
maintain the market's performance since, a positive reputation is eventually translated into
higher profitability and enterprises' willingness to invest in it. On the other hand, market
transactions would be restricted if the accuracy of counterparties' information could not be
trusted.

The main point is to develop a future environment that combines all these players with the
intention of leading to efficiency gains and avoiding financial instability for every party involved.

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