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intech is defined as a technology-enabled innovation in financial services that could result in new business models, applications, processes, or products with an associated material effect on the provision of financial services.

The keywords are “innovation in financial services”. So, does the definition include the digitalization of banking services? The banking business model is relatively classic.

Even before the term fintech became popular, banks digitalized their business to provide better service to their customers. If the digitalization results in a set of new products unlike what was found in the usual banking system — for example, paying bills using internet banking, enabling their customers to make direct payments safely to other entities, providing virtual accounts for customers to receive payments from different entities — then the banks could be considered to be making fintech innovations.

So, why should banks care about the surge of new non-bank fintech companies when they can deliver their own fintech innovations? Banking is one of the most highly regulated industries. It has become very important for the economy and society in facilitating the reallocation of resources. The failure of a banking system in a country has notoriously made significant negative impacts on the economy. This is what Indonesia experienced in 1997 and the recovery took some time: until 2003.

Even the most recent global financial crisis that stemmed from the subprime mortgage problems in the United States has still left some marks on the world economy after 10 years. Because of that, banks now have to adhere to an even more stringent regulatory framework to strengthen their loss-absorbing capacity and reduce the probability of repeating the financial crisis. Loans need to have adequate collateral or guarantees of repayment, or otherwise they have to be backed up by larger capital buffers.

Long-term placement has to be matched by long-term or stable funding. Banks have to diversify their clients and maintain adequate capital buffers to face the possibility of adverse conditions in the future. Because of this, banks have limited room to expand their fintech products.

However, we know in emerging markets like Indonesia, despite the heavy regulatory framework, banks are still quite dominant in the financial system because of customer protection issues, deposit guarantees and scale of business.

Banks in Indonesia are heterogeneous. This is why some love fintech and why some may hate it. Banks with mature business setups would love fintech since they have found new opportunities to develop their products. They can also offer non-bank fintech companies mutual benefit contracts: Pool their funds in the bank and the companies would get all the virtual banking services for their customers.

The funds flow would smoothen out the bank’s liquidity management. The bank may receive some additional fee-based income from managing the fintech client’s account.

These banks can also channel their funds to finance non-bank fintech. The business relationship between banks and fintech also opens access to lists of fintech clients with high creditworthiness and this would provide opportunities for banks to gain new clients for larger loans that would potentially become good debtors.

Why may some banks hate fintech? Not all banks have enough capacity to offer the abovementioned services to fintech clients. When they cannot strike a cooperative arrangement, fintech potentially becomes a competitor for banks in gaining funding and providing financing.

Although fintech may not offer any customer protection, it offers some interesting features. Access to services is easy. In terms of funding, fintech does not check for sources of funds the way banks check for “know your customer principles”.

Non-bank fintech companies, because they are not banks and not subjected to stringent regulations, can enjoy more freedom in the financial services they offer to their clients.

Should the mature banks actually be more wary about fintech taking over the intermediation business or lose their fee-based income from payment system services? For a larger scale, banks still have more capacity to provide funds.

However, the capacity may become smaller if banks cannot reduce the interest rates of their credit and any additional fees that they usually charge to debtors.

Unless it is needed for investment financing that is usually long term and in large amounts, debtors can easily break up their need for working capital into smaller projects and ask for financing from fintech companies. This would be cheaper and easier.

The process of getting the financing is much simpler and faster because fintech companies provide more transparency for their intermediation.

Customers — debtors and investors — love fintech because of the ability to fit the desired amount, duration and target of financing with very few questions asked because everything is already laid out in the intermediation process. This is something that they may not be able to get from banks.

If there is any threat to the entire banking system, it is in the form of the loss of the segment of smaller (retail) loans and payment services. Now, banks can still capture the mortgage segment — which are smaller loans — because of their ability to commit to long-term loans.

However, this business could soon be taken over by the fintech companies with large long-term funds that have the advantage of not having to adhere to the loan-to-value regulations. The creative destruction that fintech companies deliver to the finance business is more related to the increase of speed, transparency and proliferation in intermediation processes and payment services.

Banks that cannot provide faster, more transparent and tailored financing and payment services to their clients and customers would have problems competing with fintech.
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