There are startups that want to destroy banks and startups that want banks to buy their software. Luckily for the banks, there are many more of the latter than the former.

Ben Savage, partner at the Los Angeles-based Clocktower Technology Ventures, told Bank Innovation that the flourishing fintech ecosystem holds both risks and opportunities for banks, but highlighted a specific threat: fintechs that target specific niches.

The overall landscape for fintech companies is positive. Savage noted that in 2018 Money20/20 boasted more growth equity players than in past years. The takeaway? “At the later end of the life cycle for fintech there is greater demand and tons of capital,” Savage said.

As for the earlier stage companies, Savage said, “It felt to us for a while two years ago there were acres of whitespace — there’s a lot less of it today. Our job is more difficult as a seed-stage investor — you have to pick the smartest ideas. Two years ago there were fewer people chasing them, but now you need to see founders and business models working on the 2.0, 3.0, 4.0 version of ideas that haven’t broken through. You’re more likely to see a refinement than a breakthrough.”

He also described how regional banks may be the best place to look for innovation these days. “Regional banks are a pocket of innovation because they know their customers better, arguably than the money center banks, and the innovation starts at, ‘What does my customer need?'”

Regional players may also be more attractive for bank-fintech partnerships. “It’s idiosyncratic at each institution but what we’re finding is larger, slower-moving banks have struggled for any number of reasons… it’s hard to line up all the different operators who have high impact and day jobs. And most require buy-in from different parts of the bank, and typically inside banks there are competing interests. But smaller banks are starting to do interesting things — what we’re finding is banks I’d never even heard of doing the most interesting things. They say, ‘If we’re going to compete with larger banks who have more tech resources, we’re going to have to do it by partnering with fintech.'”

Build It, Buy It
Despite innovation bubbling at smaller institutions, banks have been slower to embrace investment in fintech than some other spaces, Savage said. “Broadly, in insurance, you saw every incumbent company set up a strategic venture arm because they realized how far behind they were relative to the early wave of fintech attacking it… They proved to be more nimble than banks, due to more flexible balance sheets, and the Volcker Rule.”

Venture capital has also driven up the price for fintech startups so that it is expensive for banks to buy companies outright. This has led to the launch of investment platforms because the startups are too far out of reach to buy. Also because of the Volcker Rule, Savage said, banks cannot invest in funds.

Savage pointed out fintech hasn’t seen a significant exit in some time.

“Fintech founders want to partner with people who understand financial services,” Savage said, “and there’s still a shortage of investors focused on financial innovation who really get financial services.”

Some industry watchers have commented that no fintech has built anything a bank couldn’t build itself. Savage dismissed this idea. “That’s a naive stance to take,” he said. “There is a large pile of software companies whose customers are banks, so it’s not true, because banks don’t build all the technology in the house. In fact, banks are the largest consumers of technology in aggregate outside the technology sector itself, and banks have proven to be great customers of technology over time.”

As for the year ahead, Savage pointed to one coming trend that should give banks pause. “Taking fintech solutions and applying them to affinity-based markets, like a vertical strategy for the life sciences, or that really meets the needs of first responders or schoolteachers — these affinity-based platforms, if they can efficiently build technology and unlock economically viable business models that weren’t previously viable — this should scare incumbents. Most fintech so far has not been scary for incumbents. But if a new player says, ‘I’m going to target this niche cheaply and deliver a resonant customer experience,’ that could be death by a thousand cuts for an incumbent and people are figuring out this is a risk.”