I recently had the pleasure of sitting down with Jason Henrichs, CEO of Alloy Labs, at SXSW for a wide-ranging discussion on all things fintech and financial services.

While our conversation covered many topics, from the value of conferences like SXSW to the importance of restoring consumer trust in the financial system, one topic really stood out to me:

Will fintech and legacy banking one day merge?

At this point in the evolution of financial services, we seem to have a blend of the two. Fintech cannot exist without legacy banking, and legacy banking cannot exist without fintech. But will the two eventually merge into a single, unified entity?

For traditional financial institutions like banks—slow adopters by necessity with a tendency to focus on safety and security—the power to accelerate innovation through fintech partnerships is clear. But at what cost to operational efficiency? 

Meanwhile, for fintechs that have built a reputation for agility and disruption, merging or partnering with a legacy bank offers access to a vast customer base and established infrastructure, but could it stifle their innovative spirit?

Over the last 30 years (especially the last 10 as CEO of CSTMR), I have seen both evolve, and I believe the potential unification of these two industries presents all stakeholders, especially consumers, with dramatic upside. In today’s article, I want to briefly explore this union, examining how we got here and what the future holds. 

Historical Context

Fintech and legacy banking have become increasingly intertwined over the past decade, with the relationship between these two sectors evolving from one of competition to collaboration.

The “why” is multifaceted, but a good first step is to provide some historical context.

Since the Medici family established one of the first banks in Florence, Italy, legacy banks have dominated the financial services industry, operating with established processes, extensive networks, and robust regulatory frameworks. However, the financial crisis of 2008 exposed significant weaknesses in the traditional banking system, leading to an economic crisis, a loss of trust, and opening the door for innovation at a time when consumer preferences were evolving.

Fintech companies emerged in response to these gaps, aiming to offer more innovative, transparent, and customer-focused products and services. 

Companies like PayPal revolutionized payments, while, more recently, others like Robinhood democratized investing. Over the past decade, fintech has grown from a niche vertical within financial services to a major force, challenging traditional banks to innovate or risk disappearing.

The data shows that the global fintech market is booming, with the market size expected to grow to USD 1.5 trillion in annual revenue by 2030. 

As McKinsey highlighted in a recent report, “…revenues in the fintech industry are expected to grow almost three times faster than those in the traditional banking sector between 2023 and 2028.”

Add to this the fact that the number of fintech startups globally has also skyrocketed (the Americas alone saw a 13% increase YoY), and it’s easy to understand the impact and disruptive potential of this industry. 

While many factors are at play, it is worth highlighting the role of digital transformation in setting the stage for the relationship we see today between fintech and legacy banking. 

Digital Transformation: Paving the Way for Fintech

While the notion of “digital transformation” may seem like old news in 2024, this movement was/is a paradigm shift that fundamentally laid the groundwork for the current era of financial innovation.

Long before fintech startups like PayPal became household names, banks were already embarking on a journey to digitize their operations, albeit at a slower pace. This early phase of digital transformation wasn’t solely about launching online banking and mobile apps–it embodied a significant change in perspective and attitude, with banks recognizing the need to adapt to a rapidly changing market.

In the early 2000s, banks began investing in “digital” banking platforms, allowing customers to check balances, transfer funds, and pay bills electronically. This marked a significant departure from the traditional brick-and-mortar, branch-centric model, offering convenience and accessibility to customers who demanded online solutions.

The adoption of mobile banking followed suit, further empowering customers to manage their finances on the go. 

However, this initial wave of digital transformation was largely focused on replicating existing services in a digital format (e.g., check your balance at the bank vs. check your balance on your computer). It lacked the disruptive nature that would later characterize the rise of fintech.

Nevertheless, the seeds of change had been sown, and it was simply a matter of nurturing them to grow–easier said than done. Although banks have gradually become more comfortable with digital technologies, recent McKinsey data from 2023 shows that only 30% of digital banking transformation initiatives are successful. 

This statistic underscores a crucial point: despite the priority placed on digital transformation, it has rarely achieved the desired success in traditional banking.

Digital transformation as we know it has fallen short, but the fintech/banking merger takes us a step closer to realizing its original purpose. Banks are no longer just digitizing existing services, they are leveraging fintech to serve consumers and businesses better while also driving enterprise value creation and resilience.  

COVID-19 and the Agility Imperative

The COVID-19 pandemic exposed a glaring weakness in traditional banking: a lack of agility and resilience. 

The Paycheck Protection Program (PPP) is a prime example. 

The sudden influx of loan applications overwhelmed many traditional banks, whose outdated systems struggled to handle the volume and complexity of the program at scale. Meanwhile, those fintechs and banks that leveraged agile financial technology were able to process applications quickly and efficiently, capturing a significant market share.

A recent working paper from the Federal Reserve Bank of Philadelphia highlights this fact, noting that banks that partnered with fintech organizations during the pandemic were “… able to reach a wider pool of borrowers who were previously outside of their branch network while retaining the ability to lend to borrowers who were within their network.”

While just one example of many from that period, the pandemic clearly served as a wake-up call for legacy banks. It highlighted the need not only to digitize but also to become truly agile–able to respond to market shifts, regulatory changes, and customer demands with speed and flexibility.

This agility imperative extends beyond COVID-19. 

In today’s post-pandemic world, one of geopolitical instability, rampant inflation, and rising interest rates, financial services providers must constantly innovate to stay relevant. Consumer preferences can change overnight, new technologies emerge at breakneck speed, and economic conditions can fluctuate unexpectedly. The ability to pivot quickly and offer new products and services on demand is crucial for survival and growth.

Fintechs, by their very nature, are built for agility. 

They prioritize rapid experimentation, data-driven decision-making, and continuous improvement. Legacy banks, on the other hand, are often burdened by bureaucracy, outdated technology, and risk-averse cultures that can hinder agility.

However, the pandemic demonstrated that even large, established banks can become more agile when the stakes are high. 

Embedded Finance: The Next Frontier 

As traditional banks and fintechs continue to collaborate and merge, a new frontier is emerging: embedded finance. 

This innovative model seamlessly integrates financial services into non-financial products and platforms, with an eye to improving the customer/user experience.

Often labeled a “fintech trend,” embedded finance goes far beyond fintech and financial services.

Imagine buying a car and securing a loan directly through the dealership’s website, or paying for groceries and splitting the bill with friends through a messaging app. We can do these things already, and this point highlights the power of embedded finance–it eliminates the need to navigate separate platforms, making financial services more accessible, convenient, and intuitive.

Calling this innovation the “next frontier” isn’t hyperbole–the market is projected to grow from $54 billion in 2022 to a remarkable $248 billion by 2032.

This growth is being driven by two main factors: API innovation and (surprise!) evolving consumer preferences.

For the former, APIs via what PwC calls “fintech enablers” are driving the seamless integration of financial services into non-financial platforms, creating new possibilities for collaboration and innovation.

With respect to the latter, consumers increasingly expect financial services to be embedded into their everyday experiences, rather than being a separate, siloed activity.

Embedded finance represents a significant opportunity for both banks and fintechs.

Banks can leverage their infrastructure and regulatory expertise to provide a foundation to the underlying financial services, while fintechs can focus on developing innovative user experiences and integrating these services into platforms both new and old.

Embedded finance is a natural extension of the unification of banking and fintech. It represents the next stage in the evolution of financial services, where financial products and experiences become a part of our daily lives.

Banking and Fintech: The Future Is Now

The journey we’ve just traced, from the early days of digital transformation to the pandemic-accelerated agility imperative and the rise of embedded finance, reveals a financial services landscape in perpetual motion.

In my opinion, the evidence is clear–fintech and traditional banking are not merely coexisting. They are co-evolving, their destinies increasingly intertwined. 

As “financial services” continues to weave itself into the very fabric of our daily lives, the distinction between traditional banking and fintech will continue to blur. The future of finance is not about one replacing the other, but about a dynamic fusion of their strengths, creating a more inclusive, efficient, and accessible financial ecosystem.

To learn more about the trends and happenings of fintech and financial services, check out CSTMR’s Mighty Finsights Podcast.