Editor’s Note: Aaron Silva is president of Paladin fs, a research firm that gathers data on core services (and other fintech products) and provides a resource for banks looking to comparison shop. Silva calls Paladin’s data a “blue book” for fintech services. This information, among other things, helps banks determine whether breaking a contract with a core provider is financially feasible, which is an increasingly common scenario, Silva told BankBeat.
Q: What are common issues banks are facing when it comes to core service providers?
Aaron Silva: They are learning the core suppliers are not financially guaranteeing any of their system’s performance. For example, if there is a failure, or something happens that causes the bank harm, they can’t go back to their contract and find a credit or some sort of benefit. They will find they have to beg for it — or sue them. Another issue we see is the bank’s rights around termination of the contract. Today these contracts are written as such that if you leave a certain service for any reason — or even a part of the service — you have to pay the entire balance of your contract, anywhere from 50 to 100 percent of it.
Q: Why do banks seek to terminate a contract?
A.S.: There are lots of reasons. For instance, if your bank is acquired and you’re two years into a five-year contract, you might have to pay the remaining contract value even though you won’t be receiving services. Let’s say you’re using a product and after a while you find it to be just terrible or not competitive and you want to go to an alternative. The vendor will likely charge you the full contract amount to leave even if it’s a poor service. In this market, because of the oligopoly, these vendors have the upper hand. And if a bank wants to do business with one of these new suppliers in fintech the big vendors have economic barriers written right into their contracts to prevent banks from trying out new products. The bank will be charged a range of fees and by the time those are added up it’s too expensive to experiment.
Q: How did the industry get to this point?
A.S.: There wasn’t always just three suppliers. The three big ones — Fiserv, FIS and Jack Henry — control 93 percent of the market now. Ten years ago they controlled about 53 percent of the market. So you have to go back even further to figure out how we got here.
The contracts they use today are literally using terminology and service standards they provided in the 1980s. Because so many bankers just signed these contracts again and again these terms became institutionalized. There wasn’t a demand to change them until recently. The people running banks are bankers, they aren’t chief information officers. They didn’t know what an IT contract is supposed to look like and they didn’t hire the people who did. And while they may have sent them out to their lawyer, their lawyers didn’t know that either.
The other contributing factor was visibility. There was no way for a bank in Florida to know what sort of contract a similarly sized bank in Iowa was signing. There was some level of ignorance and the lack of expertise over time that got us here. Lastly, there isn’t enough competition.
Q: Are banks stuck in this mold or will things change as more fintech players emerge?
A.S.: Unfortunately there is no fintech company that can come into this space and disrupt how the big core services do business. The reason no player has been able to break in comes back to the economic barriers built into the contracts.
First you have to convince a bank to risk its franchise on your new product. If you do find a banker with a risk appetite like that, you’ll probably have to buy them out of their contract to some degree. No new company coming in has the war chest to do that. It’s like an eighth grade dance. You’ve got all the girls on one side of the gym and all the boys on the other side. Everyone wants to dance but no one can really do it. These contracts last from five to 10 years, so the courage in the industry will need to increase as the time left on contracts decreases. My prediction is the role of the big three will be reduced over time as other smaller fintech companies fill in ancillary services.