Bulging bank tech debt: The tipping point for business payment innovation

There are now hundreds of global fintech companies having raised tens of billions in venture capital.  

The theory is that a modern, technology-led solution can provide value at a lower cost than heavily-regulated incumbents. Some succeed, while others start fast only to flame out or struggle to find a viable exit.

At a time when fintech startups are raising more cash than ever before, are they pointed at the right problems?

To identify the right opportunity in fintech, we need to look at one sector with successful challengers and the other with less successful challengers to incumbents.

Consumer payments 

Consumer payments have had a series of technology catalysts. The internet prompted globalization and removed the physical constraints of purchasing goods from any merchant at any time. Then the smartphone boosted non-bank payments and the app economy, removing friction from purchases. Technological advancements such as cloud and machine learning have improved the digital experience. 

Square and Adyen are successful examples of venture-backed companies who create real value for their clients. They are profitable, have differentiated value propositions from their competition, and provide best-in-class user experiences.

In comparison to these challengers, we have seen large consolidation among the biggest incumbents – Fiserv acquired First Data, FIS acquired Worldpay, and Global Payments acquired TSYS.  The common denominator of these deals is “technical debt”.  

Technical debt has been built up over decades through a lack of investment in integration and modernization. Consolidating ‘tech debt’ in a larger organization affords greater economies of scale to justify the necessary investments and modernize legacy systems.

The consolidation in consumer payments stems from the success of technology-enabled challengers. The likes of Square and Adyen continue to grow and innovate, driven by their ability to evolve and thus provide value to clients. Their wins destabilize the primacy of incumbents, who are faced with resolving their tech debt in these new mega-organizations. 

The lesson from consumer payments is simple: new actors can create huge value if they help solve problems, many quite modern problems.  

The challengers have succeeded in consumer payments. 

Business payments

Historically, a “business payment” was more likely a single $1bn payment that could only be tracked by picking up the phone to one of the banks on either side – a slow analogue process. A modern business payment looks more like a million separate $1,000 payments to different parts of the world. Manual tracking is ill-suited for this scale of low-value payments. 

Moreover, the ‘payee’ looks different from before, they may be unbanked, live in an emerging market without a stable currency, and may prefer funds split across multiple payment types and across multiple currencies. The result is that corporates and their banks do not have the services they need to enjoy the same efficiencies brought to consumer payments. 

The main problem is that 95% of business payments are supported by banks. 

The former cash cow for traditional business payments, FX margins, is running dry as spreads compress and customers get more sophisticated and have access to interbank rates. 

Banks’ tech debt has soared – it dwarfs even the tech debt mentioned above in large consumer payment firms. 

We’ve reached a tipping point and now is the right time for a true business payments challenger. The sheer amount of regulatory and compliance faced by banks is also at an all-time high. While that was previously a moat for fintechs, the tide has turned towards finding a fix for consumer payments’ bigger brother. The market is begging for new thinking: even with FX margins shrinking, the already large business payments market continues to grow globally, with regions like Asia growing over 8 per cent annually according to McKinsey.  

Such concentration remained with the banks because fintech firms previously struggled to go ‘upmarket’. The principal moat encountered was the daunting task of meeting or beating basic bank-grade requirements to get in the door (think of these as security, scalability and compliance).  

This flies in the face of the startup mantra of “move and break things”.  

Fintechs have not often enough prioritized the back-office, security, compliance and other high-level needs that corporates require. Consumer payments were lower hanging fruit. 

Ultimately, to operate in business payments, a fintech must engender trust: a corporate treasurer has to make a risk-based call to trust a start-up over its incumbent chartered financial institution.  

What was previously a very high barrier to entry, has now become the catalyst for challengers. 

An opportunity for a fintech that can legitimately address the legacy issues and prove the lesson of consumer payments: solving the basic modern problems with new technology, like tracking a payment without having to pick up the phone. 

It’s the fintech opportunity that is hiding in plain sight.