If there is one thing that the $39 billion merger between Afterpay (ASX: APT) and Square (NYSE: SQ) has brought into stark focus, it is the contrast between the established banks and the new financial players.
While banks like to pretend they are hip and getting down with the homies with the odd bit of “app-vertising’’, the reality is they are rooted in the past for many reasons.
One very important one is extensive regulation, with a massive rule book covering things such as capital ratios which are designed to stop the banks from suddenly collapsing at the first sign of financial storms.
That makes banks an incredibly safe, government-guaranteed place to store money and a good place to borrow money, assuming they will give you a loan.
Regulation makes banks annoying
However, all of those rules make banks annoyingly conservative to deal with – just ask any small business that needs to jump through lots of hoops just to get access to a meaningful line of credit, despite robust cash flow and profitability.
Banks often want security over something like property for lending while fintechs are more likely to use the latest financial technologies to streamline the lending process.
That same technology enables lenders and borrowers to be linked with smaller spreads between them, potentially reducing costs and cutting the bank’s lunch by appealing to both depositors and borrowers.
While fintechs are more likely to slowly make inroads over time into various bank markets such as credit cards, consumer lending, term deposits, mortgages and share trading, the Afterpay/Square deal shows that the day of reckoning might be much closer than expected.
Banks want fintech to be wrapped in red tape too
Commonwealth Bank (ASX: CBA) chief executive officer Matt Comyn is certainly being very aggressive in fighting to either match the new players or stymie them with the same sort of red tape that he deals with daily.
That is why he accused technology giant Apple of stifling competition through its growing market power in payments – an area the banks dominated until companies like Apple came along and quickly built up a lazy 80% coverage of the market for ‘tap and go’ payments on smartphones.
As Mr Comyn pointed out, Apple contributes nothing to the cost of payment infrastructure and is not a major corporate taxpayer in Australia but that is how fintechs and technology companies generally operate – using clever technology to make existing infrastructure work better and faster.
Pandemic speeding up digital banking
With the pandemic rapidly speeding up the adoption of digital wallets and buy now pay later (BNPL) products such as Afterpay, the threat is approaching very fast so the banks can ill afford to stand by while the technology companies embed themselves ever deeper into customer’s financial lives.
This is why the Square and Afterpay merger, which brings together a fast-growing BNPL pioneer with a growing global reach and a slower growing but more bank-lite payments system, is such an imminent threat to the banks.
After the companies merge, Square will be listed on the Australian exchange and is likely to continue to use Australia as a proving ground for new ideas so the competition will become very obvious.
Another example of the digital disruption in action is that Apple is looking at introducing BNPL style loans with its Apple Pay service – stepping squarely into an area that was part of the bank’s credit card operations.
PayPal will also be a significant player in the BNPL space.
Digital wallets becoming dominant payment solution
So Mr Comyn is right to call out any Apple system that gives it near-monopoly powers over a very popular payments system such as ‘touch and go’ matched with a digital wallet.
By his estimates, digital wallet transactions have nearly doubled their transaction numbers in the past year and are on track to become the most popular form of contactless payment by the end of the year.
Commonwealth hasn’t been standing still waiting to be smashed of course, with its own BNPL offering set to be released together with other partnerships with an online retail platform, an energy retailer and a telco firm designed to further cement customers within the CBA network.
That deal may not survive in the wake of the Square deal and has not been universally welcomed by analysts, who would rather see the banks developing relationships with customers rather than renting out their infrastructure to the fast emerging competition.