Choose your language:
The experts and the titans in the financial services industry still don’t know what to call them. The marketplace in North America and Europe is still a bit leery about them. But everyone from China to venture capitalists have found themselves embracing the so-called “nonbanks.”
There is no doubt that nonbanks—untraditional startups and digital-based businesses that are disrupting old financial sector models—are shaking up the industry. As a post-recession regulatory climate continues to place pressure on large banks like Bank of America, Citibank and Wells Fargo, nonbanks have been able to circumvent federal mandates like the Dodd-Frank Wall Street Reform law.
As a result, an entirely new world of banking is sprouting up. Some observers are calling it “shadow banking,” a sort of ominous reference to a parallel universe of nonbanks that are innovation and subversion rolled into one. While it might sound trivial, it’s not: shadow banks are commanding $3.2 trillion in the U.S. economy and over $15 trillion worldwide. In China alone, the shadow banking system has assets worth nearly $5 trillion, according to The Economist. The Chinese and other BRIC emerging economies like India are supporting that, with regulators described as either turning a blind eye to some of the activity or encouraging shadow bank growth.
That’s making some people, including traditional bankers and regulators in North America and Europe, very uneasy. JPMorgan Chase CEO Jamie Dimon says shadows banks keep him “up at night.” Federal Reserve Governor Daniel Tarullo says the regulators are watching “risky” activity closely, while Bank of England Deputy Governor Jon Cunliffe is struggling to keep an open mind and “not start with the presumption that it should be regulated.” Australia’s Commonwealth Bank wants regulators to shut down the shadow banks and public support to prop up the startups—therein lies a distinction.
Nonbanks are definitely disruptive, but not in the way shadow banks are unpredictable and potentially destructive. Commonwealth’s call to support startups makes a bit of sense in that respect. It could also be one reason why Gartner’s Kristin Moyer dedicated recent research notes to nonbanks rather than reference shadow banks at all since nonbanks is where the action is—and not just for nonbanks, either. If traditional or “retail” banks are patient, as Moyer suggests, expected disruptions and failures in the nonbank space may serve as a savior for the regular banks.
“This, combined with some of the challenging financials nonbank startups face, lead us to believe that 75 percent of current nonbanks will be acquired at a discounted price or go out of business [by 2016],” predicts Moyer. “The high acquisition and failure rate will primarily come from nonbanks that are not part of larger core businesses, caused by a lack of financial resources. While many nonbanks are receiving substantial venture capital and investor support at the moment, this is unlikely to be sustained indefinitely, if previous technology investment bubbles are a guide.”
That level of disruption offers an opportunity for traditional banks to refresh themselves in the wake of regulatory schisms. The innovations from the nonbanks can be absorbed by larger traditional banks, along with the talent developing the latest in banking technology. Not only could that be useful in helping expand market share, but banks could benefit from enhanced compliance abilities as they navigate through a complex regulation maze in the U.S. and Europe.
“Digital firms and nonbank startups are not always subject to the same regulations as banks and are, therefore, able to innovate more rapidly and aggressively,” adds Moyer. “The time, cost and additional risks that banks face from regulatory overhead make it extremely challenging for CIOs to use APIs to enable needs-based services/data and openness.”
Hence, larger banks are looking hungrily towards the day when they can acquire the much smaller nonbanks or simply pluck up their talent as nonbanks close. As an Accenture report observes, “global investment in financial services technology (“fintech”) ventures has tripled to nearly $3 billion [since 2008]. The dramatic changes underway in financial services, driven by new digital technology, regulations, consumer behavior and the need to reduce costs, mean this trend is set to continue, with global investment on track to grow to up to $8 billion by 2018.”
In addition, the various digital ecosystems—from third-party developers to what Moyer calls “frictionless” configurations—evolving from those nonbanks may end up playing a big role for banking. That will become a bigger part of the way banks will execute. For vendors, this presents an opportunity to present talent ecosystems, especially for small to midsize banks that don’t have the resources to outright acquire a nonbank.
The devolution of nonbanks will occur once there are signs of the market correcting what some observers see as a bubble and venture capitalists begin to draw back on funding. The opportunities for vendors will occur as the investment cools off and the acquisitions start to happen.
Charles Ellison is a senior analyst relations strategist for TEKsystems. He keeps close tabs on changes and public policy shaping the innovation space. He is also a former congressional staffer, senior aide to state and local elected officials and an expert advocacy strategist. You can reach him with questions and comments @twoARguys via Twitter.