What VCs Know About FinTech that the Big Banks Don't

Do the big banks know how vulnerable they are? It seems like VC firms do — a number of shifts in the U.S. economy have them seeing redundancies across the industry and opportunities elsewhere, prompting them to bet millions on small yet dangerously flexible startups.Of all the fixtures in the U.S. economy, there are few that most people would see as more entrenched than the banking and finance industries. After all, once you’ve been called “too big to fail” and bailed out by the federal government just to keep you from defaulting, it’s hard to feel that your immense status is anything short of permanent.But things in the spheres of tech and politics have shifted, and a handful of bold startups thinks those changes are enough to disrupt this seemingly untouchable industry.And venture capitalists seem to agree that they’re on to something — in the U.S. alone, FinTech companies received nearly $3 billion in venture investment this year. What is it that VC firms see in these companies, and what are the chinks in the banking industry’s armor they hope to take advantage of?

What the Banks Can’t Do

With regulations from the Federal Reserve and OCC still being implemented, there are bound to be some new limitations to what banks can offer customers. While many scoff at the idea that attempts to manage the industry will have any serious effect, at the very least, these rules will make some services slower and less efficient.This opens plenty of opportunities for startups to step in and do what the banks can’t, or at least do them in a simpler, more intuitive way that doesn’t involve sidestepping dense legal frameworks.This problem is compounded by the arrival of cryptocurrencies like Bitcoin. While it’s still unclear whether the ambitious venture will really work, what’s certain is that federal agencies don’t have a consensus on how to regulate it.While national banks working strictly with national currencies work their way through a tougher legal environment, Bitcoin innovators will have virtually free rein to test its abilities and limitations without fear of reprimand.

What the Banks Can Do

But there are plenty of things these banks can do to stem the tide of FinTech beyond simply buying these startups out. One of the most essential tools of the FinTech startup is Big Data, the troves of information that innovators access to use in their algorithms.PayPal, for instance, uses information from customers’ eBay purchase histories to produce credit scores that are vastly more accurate and more quickly produced than a FICO score.Big Data isn’t something that the banks are blocked from leveraging. Instead of resting on their credibility and authority as institutions, which are quickly becoming less important to both consumers and investors (including hedge funds), these companies should be looking into how to acquire data that goes beyond their own branches.Soon, information from social media, online spending habits, and even search history could be used to offer or deny loans faster and easier.What’s most essential for banking institutions everywhere is that they wake up and realize they’re being replaced not by bigger money and more influence, but by algorithms that have proven themselves to produce better, simpler services.This isn’t a trend or the actions of a few cash-hungry industry upstarts — it’s a gradual but historical change in the way that banking is done, and history can’t be bought. If banks don’t figure out how to modernize soon, their chapter in that history could reach its conclusion.