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Bye-bye, megabank: More young adults are adopting digital banking to manage their money

FICO's report shows that Gen X, Millennial and Gen Z groups want "consumer-centric" personalized services offered by fintechs. Traditional megabanks need to develop more personalized digital offerings that create more engaging experiences.
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Written by Marc Wojno, Senior Editor on

A new report published this month by data analytics firm FICO shows that a growing percentage of younger U.S. consumers -- specifically Gen X, Millennial and Gen Z groups -- consider digital banks, such as Cash App, Chime and PayPal, as their primary checking account provider, not traditional megabanks such as Bank of America, JPMorgan Chase and Wells Fargo. The report identified five competitive threats to traditional banks and credit unions, and what those companies need to do to stay competitive: Overdraft; savings and investing; buy now, pay later (BNPL); niche neobanks; and open banking.

The report, Counterattack: Banks Field Guide to Fintech Disruption, in conjunction with research from Cornerstone Advisors, notes that although many US consumers are pleased with the quality and services of traditional banks and credit unions, the percentage of those three younger generations who chose fintechs over brick-and-mortars as their primary banks have doubled, at 12% of customers since 2020. What's more, today, only 25% of the youngest generation, Gen Z, use a megabank for their primary checking account, down from 35% in 2020. 

FICO's report stated that for Millennials and Gen X-ers, the percentages dropped by nearly half during that same period. 47% of US bank and credit union executives said fintechs are a "significant threat" in the coming decade.

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Cornerstone Advisors surveys of US-based community financial institution executives, 2020-2021

The rise of fintechs

Fintech represents "new" financial technologies, such as software algorithms, machine learning and artificial intelligence that are geared toward enhancing the use and delivery of banking and other specialized financial services, be it streamlining the mortgage process or insurance industry (insurtech), to automating investment advice to lower cost and increase accessibility (robo-advisors). Megabanks in the US are large, long-established, conservatively-operated financial institutions with hundreds (if not thousands) of brick-and-mortar branches throughout the US that emphasize "traditional" banking products, practices and security. Fintechs, on the other hand, are smaller, nimble operations tailored to specific customers' financial needs, using the latest cutting-edge technologies to provide immediate, specialized services, often with much lower fees and expenses compared to traditional banks. What's more, traditional megabanks have legacy-based infrastructures, whereas fintechs use the latest technologies.

And with $131.5 billion going toward funding fintechs globally just in 2021, traditional banks and credit unions are wringing their hands as they lose their status as the primary financial service provider to US bankers, the FICO Counterattack report said.

Much of the allure of fintech, especially for younger consumers, can be summed up in one word: personalization. As banking becomes digitally transformed from in-branch to online (thanks to the COVID-19 pandemic, which forced millions to stay at home and conduct their personal finances solely online), younger consumers want more portable and personalized services from their banks, accompanied by offers and solutions that help them build and secure their financial future.

The FICO report suggests that traditional banks must adapt to deliver better value for today's digitally adept consumers, tailoring their services to more niche customers. In fact, the report said that 56% of US banks and 69% of credit unions surveyed said they're implementing digital transformation. But are they? Nikhil Behl, chief marketing officer at FICO, told ZDNet that this isn't the case. "What stood out most from the report was that despite 56% of US banks and 69% of credit unions claiming that they have launched digital transformation strategies, only seven in 10 banks and three-quarters of credit unions said that they don't plan to replace their core systems as part of their digital transformation."

This mismatch in information ultimately underscores the fact that banks and credit unions are far from achieving digital transformation. To be clear, FICO's definition of digital transformation consists of "the rearchitecting of technology, revamping the processes and retraining of people to facilitate the delivery of digitally native financial products and experiences." It's those factors that traditional banks need to achieve to compete with fintechs effectively.

Fortunately, an entire digital transformation by traditional banks and credit unions isn't mandatory to compete effectively with fintech. How can it? "Fintech" isn't just one competing force, but rather thousands of companies competing across hundreds of products and customer segments. But FICO's research concluded that traditional banks and credit unions have the opportunity to counter the rise of fintechs in these five categories: Overdraft, savings and investing; buy now, pay later (BNPL); niche neobanks; and open banking.

Also: Buy Now, Pay Later: Flexible payments for inflationary times, or a road to debt?

How fintechs are winning over customers

Here are examples of how fintechs are making strides in these five categories, according to FICO:

  • Overdrafts: Fee-free overdraft protection is a mainstay for US neobanks. Chime, for example, offers SpotMe, which covers up to $200 overdraws on debit card purchases and/or cash withdrawals for eligible customers.
  • Saving and investing: Acorns and Stash enable consumers to automate savings or encourage them to save more money as well as invest. They combine automated savings capabilities with portfolio and fractional stock investing, emphasizing diversification and encouraging long-term investing over day trading.
  • Buy now, pay later (BPNL): This has become a popular means of purchasing products across all generations of consumers in the past few years, and the percentage of Gen Z-ers using BNPL grew from 6% in 2019 to 36% in 2021.
  • Niche neobanks: Considered the next generation of consumer-facing finance, these online-only banks are focused on specific segments of consumers that share a common set of functional and emotional needs when managing their money.
  • Open banking: This banking system is where third-party financial services providers have access and control of consumer banking and financial accounts through application programming interfaces, or APIs, to enable unique products or experiences. 66% of consumers consider being able to connect their accounts to apps as a top priority, and 69% would switch banks to do so, according to the FICO/Cornerstone Advisors report.

Also: Direct or digital banks lead the way with customer satisfaction: J.D. Power study

What traditional banks need to do

The FICO report suggests how traditional banks should respond to the five categories:

  • Overdrafts: Significantly reduce the rate of accidental overdrafts or eliminate overdraft penalization, yet keeping in mind the value that intentionally used overdraft protection can have for consumers facing cashflow imbalances.
  • Savings and investing:
    º Refine savings tools based on experience and insights: 
     Ensure their usefulness to consumers as much as possible, especially to low-income consumers.
    º Blending savings and investing into one:
     Enriching savings tools with more opportunities to earn yield, even if it's through adopting new investment asset classes such as cryptocurrencies, which banks currently are reticent to adopt.
  • Buy now, pay later (BNPL): Younger consumers have, and will, embrace BNPL. And while many of them will struggle to make payments, traditional banks should step in and help them better manage their loans.
  • Niche neobanks: Traditional banks need to find ways to reduce the time and expense of launching new products to niche customers. Once that's determined, they need to go after specific customer segments with financial needs that are unmet or inadequately addressed and build products for them.
  • Open banking: Build common standards and streamline technical integrations. To do so requires leveraging APIs and consumers' willingness to permit access to their data in order to build new products and services. What's more, traditional banks that adopt open banking practices could "build new financial management capabilities that pull data together from these disparate fintech providers and deliver unified insights to their customers that could help them protect and improve their financial health," the FICO report said.

FICO's partner, Cornerstone Advisors, adds that for traditional banks to compete effectively with fintechs, they must:

  • Build more comprehensive customer data profiles.
  • Invest in more sophisticated risk decisioning.
  • Prioritize software development agility.
  • Build for developers to assemble new products and experiences quickly and inexpensively.
  • Adopt a competitive mindset.

What does all this mean for the future of finance?

For years, many parents have lamented that their kids haven't being taught in school about the concept of personal finance. How else are they going to learn how to balance a checkbook, open a savings account or understand the concept of credit? But those days of balancing checkbooks and budgeting by hand have been replaced by fintechs that do the work and thinking, for the customer, while providing additional products and resources to manage and earn more money.

Digital banking has made it easier for young consumers to understand better, and manage, their finances. "One of the advantages of a digital environment is building a very rich experience," Behl says. "Not only can you emulate the best practices of the offline world, via tools and capabilities online, but you can make them much more personalized and robust for an individual based on their level of knowledge and sophistication."

"We've seen an acceleration of consumers -- across all age groups -- moving primarily to digital banking. As the younger generation continues to show a preference for digital options, the financial industry has evolved to cater to heightened expectations for personalized financial experiences. As traditional banks continue to expand their online banking services and fintechs grow, we are seeing them invest in resources to help empower consumers' financial literacy," Behl told ZDNet.

Despite the appeal of fintech, one thing that traditional banks have over fintechs: data… and lots of it. Behl notes that he recently spoke to a megabank that's using the wealth of data they've collected from their 12 million customers and leveraging analytics to deliver highly personalized experiences that anticipate and address each individual customer's needs. "This bank has a long history with their customers, which translates into more data than most fintechs can imagine," Behl says. "Their digital transformation and customer experience strategy takes their deep domain expertise and customer knowledge and couples it with AI and advanced analytics to engage with customers in a way that creates long term loyalty," he adds.

But as the current state of the economy threatens the prospect of continued inflation, rising interest rates and fears of a looming recession, it's important now for banks of all kinds, be it traditional to digital, to take care of their customers and provide the services they need to weather this impending economic storm. "As rising interest rates and inflation continue to increase financial anxiety, trust and customer loyalty are more important than ever," Behl says. "I expect we will see fintechs and traditional banks using data, analytics and digital decisioning technology to create those personalized experiences consumers demand."

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