Are fintech firms friends or foes?

I just received an interesting report released in January by ClearBank and Celent, looking at how electronic money and electronic payment institutions (EMIs and EPIs) work with banks and the financial ecosystem. The findings indicate that these start-up companies fill the gaps where incumbent banks feared to tread, such as offering crypto clearing services.

John Salter, who sponsored the report, states that “the findings reinforce that, traditionally, many firms had no option but to work with or even become EMI. Incumbent banks either viewed these firms as too small or too risky to service or were unwilling to support them as they could cannibalise their own service offerings”.

The major headlines from the report include the fact that customer funds safeguarded by EMIs in the EU and the UK almost doubled in the last four years, standing at €35bn by the end of 2022.

Here’s the executive summary:

Celent kicked off this research seeking to better understand the risk posed by e-money across Europe and explore questions around how various players—fintechs, EMIs, banks—select and manage partners, such as:

• What are the key criteria when evaluating partners? Have those criteria changed in recent times?
• What is their partner selection horizon? Do players typically select partners on a short-term, medium-term, or long-term basis to start with? How often do they review partners? Do the current market conditions and potential risk of contagion change their attitudes?
• How do EMIs approach safeguarding? How do they and their customers view safeguarding—as a hurdle barrier in selection (i.e., needs to be demonstrated, but a risk tick box), or as a strategic element for them (i.e., used as part of customer value proposition)? How important is deposit insurance, such as FSCS protection?
• What are pros and cons of EMIs? How much of an issue is the inability of EMIs to offer interest-bearing accounts?

Key findings include:

• As the number of EMIs increases and individual EMIs grow larger, as a sector EMIs are becoming more systemically important, posing an increasing risk.
• Ease of integration and quality of APIs matters the most when considering technical capabilities.
• The ability to provide local IBANs (International Bank Account Numbers) and avoid a practice called “IBAN discrimination” is particularly high on the list of functional requirements of many fintechs.
• EMIs earn yield on safeguarded funds but cannot pass that back as interest to their clients. Now that interest rates are relatively high, this makes banks more attractive, particularly to those partners that want to offer savings accounts to end customers. This also has another effect: on one hand, it reduces the importance of pricing for EMIs when negotiating deals with bank partners, as the revenue from client funds outweighs the cost. On the other hand, if EMIs attempt to pass that revenue to their clients, e.g., through rebates, they risk setting a precedent and creating a race to the bottom, which might hurt when interest rates do come down.
• The relationships that fintechs and their partners strike tend to be long-term; both sides acknowledge the disruption to the business if they have to change partners. However, both sides regularly review the partners that they work with and assess whether anything has changed.
• Many fintechs and EMIs are looking to add new partners. In some cases, the intention is to enhance the product range, but often it is to provide redundancy, mitigate against potential risk, and improve resilience.
• Safeguarding is receiving increasingly more attention. In recent years, EMI clients have started to care more about how their client funds are safeguarded, forcing EMIs to improve their practices and reconsider their safeguarding partners. However, EMIs are not spoilt for choices, as not all banks offer safeguarding services.
• The degree to which FSCS (and similar) protection matters depends on the end customer and the product. If it is a consumer account, and especially, for savings accounts, it is perceived as important. However, for payments accounts that might see a large volume of transactions but relatively low balances, or for business accounts where balances regularly exceed the £85k limit, the protection scheme is much less relevant. Of course, if EMIs manage their business risks and safeguard customers’ money well—admittedly, big “if’s”—then safeguarding arguably can offer more protection as it does not have any limits.
• Finally, many providers expect the regulatory landscape in Europe to tighten in response to recent failings of market participants, and they welcome the change: “Anything that increases credibility in the industry in general is great.”

As the market continues to evolve, we expect more collaboration between EMIs and banks:

• EMIs can help align with risk appetite by insulating banks from unregulated entities. By teaming up with the EMIs, banks can deploy their advantages of a superior funding model, especially for lending, while at the same time significantly reduce their exposure to the scrutiny of onboarding and overseeing individual customers, as they ultimately belong to the EMI.
• EMIs can bring relevant technology capabilities—especially solutions that are tailored for specific industries.
• EMIs need banks for safeguarding, offering the opportunity—albeit not for all banks—to capture a share of those €35 billion deposits across the UK and EU.

We live in an age of coopetition, with the same entities competing in one area, while cooperating in another. This is true for the UK and European banks and EMIs, which can be both competitors and partners when capturing the embedded finance opportunity.

You can download the report here.