In less than a decade, the smartphone has become essential to our daily lives. Perhaps ironically, its primary function of allowing us to make a call at almost any time and anywhere has been superseded by a dizzying array of other activities it facilitates, including banking. The convenience and accessibility with the smartphone and subsequent digital devices, e.g., tablet, wearables, etc., has changed things radically for financial institutions (FIs). Today, consumers determine how, when and where they will access financial services. To say this change has complicated things for banks and credit unions is an understatement.
The pace of the digital revolution has put many FIs and some of the vendors that supply them with solutions in a position of continually playing “catch up” with these consumer expectations. New, smaller, early-stage FinTech companies have appeared on the scene with solutions that allow banks and credit unions to lower cost and increase their responsiveness to the rapidly changing digital landscape. Many FIs are now partnering with these companies, and this presents some challenges when it comes to vendor contract management.
Some of these challenges are obvious. Because these FinTechs have been operating a short time, there is a limited amount of data available to judge their ongoing viability. This creates a valid cause for concern for FIs relying on the technology these upstarts offer. To navigate this challenge and others that will undoubtedly emerge, FIs will need to be creative in how they evaluate their options when considering a replacement for their online and mobile systems.
Why Traditional Approaches Do Not Apply
Most decision makers at FIs understand price is not the only variable to consider when assessing a vendor contract. This is particularly true when considering a relationship with one of the newer FinTech providers. Many of these FinTechs not only provide a technology platform that allows FIs to be more responsive to the needs of their digital customers and members, but they also feature newer technology that can reduce the complexity and cost many FIs face in their online and mobile IT infrastructures. This may mean, in some cases, that the value proposition of these less-established providers will be more compelling than many of the incumbents who maybe slow and inflexible.
When assessing the financial health of FinTechs, a different set of metrics other than those used with an established provider of other services is required. These considerations are not significantly different from those used by the venture capitalists that are investors in many of these FinTechs. The basic difference between this approach and the more traditional forms of due diligence is a matter of direction. Traditional due diligence practices evaluate a vendor’s viability by reviewing its financial performance in recent years. When assessing the viability of a FinTech, the evaluation is much more difficult as it must be based on their future performance. The nature of this approach is not attractive to many FIs because of its implied risk, but there are ways to mitigate that risk to a degree during the due diligence process.
Balance Sheet, References, Source Code
There is one metric used in the traditional approach of evaluating a vendor’s stability that is also an important part of considering a FinTech provider as a vendor, which is the balance sheet. There should be no expectation that the balance sheet of a FinTech will rival those of the more established providers. However, cash is still king, so FinTechs with balance sheets that demonstrate a healthy amount of cash on hand should be candidates for further consideration.
It is not uncommon for references to be a part of vetting any new vendor. When considering a FinTech provider, this type of qualitative information may be more heavily weighted given the lack of quantitative data that would usually be part of the equation. Obviously, some of the same guidelines apply when considering references for FinTechs as are used in considering references for established companies. However, the weighting applied to the data gathered may be different with a FinTech provider. For example, the FinTech may not have developed a large customer base. If an institution can be found that is a legitimate peer, the input offered may be especially valuable in understanding how the FinTech operates. In addition, references that provide a well-rounded view of the FinTech provider’s strengths and weaknesses should receive additional focus. Software vendors, like financial institutions, are not perfect. Give a FinTech provider extra points if a reference provided shares the good, the bad and the ugly about them.
Early in the process, discuss with the FinTech any measures for containing risks that are considered non-negotiable. It is not uncommon for an FI to want the FinTech to agree to “out clauses” related to critical delivery dates. If the FinTech fails to meet the date, the FI has the option of walking away from the relationship. Out clauses may even involve deliverables associated with other FIs, especially if the FinTech has a limited number of customers “live.” Another measure being taken to address the risk of working with a FinTech company provides the FI with the source code for the FinTech’s solution in the event of default of the contract.
The Landscape is Changing
There are already many signs that indicate more and more FIs believe the risk of doing nothing in the face of the digital tsunami created by consumers is far greater than the risk involved in working with FinTechs. This being the case, it is reasonable to expect that FIs will be working with FinTechs more often over time even in segments of the market where little precedent exists for doing so. One such market segment is composed of smaller credit unions and banks. Typically, many of these institutions have relied on their core banking vendors to provide many of the additional products they need, such as online and mobile banking. Recently, some of these institutions have shown a willingness to break with this approach to respond to the competitive pressure in their markets.
There are other areas in the financial services landscape where history is likely to repeat itself. The large, established and publicly-trade technology providers in the industry have grown primarily by acquisition. In many cases, those acquisitions were meant to provide much needed innovation to the dated solution sets these companies had to offer the market. Over a period of several years, there were many such acquisitions and much talk by these larger providers becoming “one stop” shops, which would reduce the overhead involved in managing relationships with multiple providers. Over the last few years, things have been quieter, and the acquisitions have been fewer. Look for that to change as these same organizations once again seek to protect their franchise by acquiring another generation of innovative companies.For the time being, banks and credit unions will be try to do the same – protect their franchise – by partnering more often with FinTechs. Because the stakes are high when it comes to responding to the demands of the digital consumer, the risk of doing business with these younger companies with limited track records will be offset by the risk of falling behind in the race to attract and retain these customers. To increase their chances of success, leading FIs are already coming up with approaches for doing business with FinTechs that are very different from those used with traditional vendors.