Sleeping With the Enemy
Although it may not exactly be a free-for-all, today it seems as if just about anybody can offer financial services in some form. From large retailers to car companies to technology start-ups, financial services is fair game, thanks largely to the availability of the necessary support technology. This, say experts, is a fact about which traditional banks are painfully aware.
It often is difficult to categorize these interlopers, collectively termed "nonbanks." Some of these organizations have bank charters, while others do not. For the purposes of this article, a nonbank is defined as an enterprise whose primary business is not banking and does not offer depository services.
The proliferation of nonbanks is not new. But what is important to note, however, is that what was once considered a nonbank just a few years ago—insurers and brokerages, for example—differs significantly from today's emerging crop of nonbanks, including retailers and technology companies. These new entrants bring with them a completely different mind-set and approach to financial services.
"These organizations operate as banks using nontraditional business models," comments Kathleen Khirallah, research director of retail banking with TowerGroup (Needham, Mass.). "They're not trying to go out and duplicate the model of traditional banks, like building a lot of branches. [Nonbanks] are organizations using technology to get into a business and compete effectively with minimum overhead."
But what attracts these outsiders to the financial services world?
The nature of the industry in which each nonbank is rooted can motivate each differently. Retailers and service companies, for example, can see financial services as a way to branch out and increase their offerings to its customers.
According to Richard Bradshaw, SVP of global sales with UPS Capital, the Atlanta-based financial services arm of the shipping giant, increasing UPS' reach to clients was a major factor for his company's foray into financial services. UPS Capital offers, among other things, SBA loans, export/import bank services, transportation insurance and leasing. Entering financial services "can provide diversification of companies' own income strength," Bradshaw explains. "The more solutions UPS offers clients, the more inclined they are to stay with us. We offer transportation, logistics and financial services—it's a business solution."
Financial services are simply a logical value-add to customers, according to Dan Shannon, SVP and general manager of consulting and professional services with Metavante (Milwaukee). "[Nonbanks] are trying to better service their clients," he says. "It's a value-add and differentiator for tighter customer relationships."
Furthermore, comments TowerGroup's Khirallah, many retailers already are engaged in financial services anyway. "Retailers already have some limited experience in financial services through their store credit cards and realize underwriting credit creates some customer loyalty," she says.
In addition to retailers expanding into financial services are the pure technology plays, such as PayPal or Debitman. These companies originated to fill a perceived gap in financial services. "The genesis of PayPal was that it was a group of technology people with no payments experience who saw a way to transfer funds outside the existing system," explains Stuart Weiner, VP and director of payments system research with the Federal Reserve Bank of Kansas City.
Amanda Pires, a spokeswoman for PayPal (San Jose, Calif.), says the company entered financial services almost unintentionally. PayPal originally was created to transmit encrypted financial messages on Palm Pilots and e-mail, she explains. But when eBay began to gain traction, PayPal hitched its wagon to the online auctioneer and payments history was made. PayPal now is owned by eBay.
"Before PayPal, the only ways to pay on eBay were bank checks and cash," Pires says. "With PayPal, sellers can turn their inventory faster."
Though some, including TowerGroup's Khirallah, say there definitely is an increase in nonbank financial services activity, others, including Terri Bradford, payments system research specialist with the Kansas City Fed, believe it is more a matter of the increased visibility today of ventures like PayPal. "Part of it is [nonbanks] are becoming more prominent on the front end, and so this heightens our awareness of what they've always done on the back end," she states.
Technology Powers the Competition
Either way, it is becoming easier to enter the financial services space. "Technology has always been an equalizer for nonbanks," says Tom McAllister, financial services industry principal with SAP (Newtown Square, Pa.). "We finally have enough power to drive massive 360-degree systems because the right software and hardware is there to enable interplay between channels. Anyone coming into the market today can buy these systems."
According to Adam Dener, a partner with New York-based consultancy Capco, it is a combination of the right tools and services that is speeding the nonbank trend along. "The proliferation of technology and outsourcing makes the cost of entry [into financial services] relatively low versus 20 years ago," he says. "There are plenty of potential providers who would help others enter financial services. Also, the scope of technology that's available today has created a dynamic such that the cost of entry is lower. This is not a particularly comforting environment for the incumbents because they still have to finance their old investments."
Banks have heard long enough about how their complex, sometimes antiquated core systems are holding them back from reaching their optimal operating potential. However, the issue once again rears its head as it relates to nonbanks.
When companies such as UPS or Wal-Mart come on the financial services scene, they bring with them a vast amount of experience with massive distribution and inventory systems. These are things "you don't find associated with the typical bank," remarks Genie Driskill, COO of Atlanta-based Synergistics Research.
"Retail banking is a distribution game," says Capco's Dener. "The models for best practices in distribution are companies like Wal-Mart and the niche retailers."
Further, nonbanks enter the fray with a clean slate, technologically speaking. According to TowerGroup's Khirallah, it is not so much a matter of nonbanks bringing new technology to financial services; it is that they bring more modern versions of older technology to the table. "Retailers don't build their [financial] systems from scratch," she explains. "Nonbanks are more apt to go to an outside service provider for help with their financial services ventures. They're starting with a greenfield so they don't have to deal with as much of the IT complexity as [traditional banks]."
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