Fintech hurts bank profits early but delivers big gains later

Banks worldwide are racing to integrate financial technology (FinTech) as competition intensifies and customer expectations shift toward digital-first services. Yet, the profitability impact of this transformation is proving to be anything but straightforward. New research shows that the financial rewards of digital adoption often follow a two-phase pattern, with an initial period of strain before technology-driven growth takes hold.

A recent case study of China, in a paper titled "Financial Technology and Chinese Commercial Banks’ Overall Profitability: A “U-Shaped” Relationship", illustrates this phenomenon in striking detail. Drawing on data from 50 listed commercial banks over 2012–2023, the research maps a U-shaped relationship between FinTech development and overall profitability, identifying a crucial digital capability threshold that separates loss from gain.

Early digital transition: Competitive pressure erodes margins

The research shows that banks in the early stages of FinTech engagement often suffer profitability setbacks. Below the identified threshold value of 2.86 on the FinTech development scale, technological advances tend to intensify competition from non-bank players, such as third-party payment platforms, peer-to-peer lenders, and robo-advisors. These challengers disrupt traditional revenue channels, reduce fee-based income, and siphon off customer deposits through alternative financial services.

The authors argue that this initial downturn stems from the “catfish effect”, the phenomenon where digital competitors spur rapid change but place pressure on incumbents ill-prepared to match their speed or operational efficiency. Banks at this stage also face heavy upfront investments in technology infrastructure, talent acquisition, and compliance upgrades, all of which erode short-term profitability.

This dynamic explains why some previous studies have reported negative correlations between FinTech development and bank performance. Without sufficient digital maturity, the costs and market share losses associated with early adoption outweigh the efficiency gains that technology can eventually deliver.

Crossing the threshold: Technology integration spurs growth

The inflection point identified in the study marks a fundamental shift. Once banks surpass the 2.86 development threshold, profitability begins to climb sharply. At this level, financial institutions have typically invested in robust digital platforms, big data analytics, blockchain integration, and AI-powered risk management systems.

Collaboration becomes central to this recovery phase. Banks increasingly partner with FinTech companies to co-develop innovative products, streamline operations, and enhance customer experience. Rather than purely competing, the two sectors begin to complement one another, combining the regulatory advantages and customer trust of banks with the agility and technological expertise of FinTech firms.

This phase also benefits from re-intermediation, the process by which banks reassert themselves as key players in the financial value chain by offering new digital services, personalized lending, and efficient payment systems. Efficiency gains translate into lower operational costs, while advanced data analytics enable better credit risk assessment and targeted marketing, further boosting profitability.

The findings align with global trends, where institutions that successfully integrate technology into their strategic core see long-term competitive advantages in customer retention, cost control, and product diversification.

Policy and strategy: Sustaining gains in the digital era

For banks still in the early stages of FinTech adoption, policy support is vital to help them absorb initial shocks and reach the profitability threshold faster. Regulatory measures that promote innovation while safeguarding stability can ease the transition and reduce the risk of market destabilization.

For banks beyond the threshold, the priority shifts to sustaining momentum. The authors recommend embedding FinTech within long-term corporate strategies rather than treating it as an auxiliary function. This requires ongoing investment in digital infrastructure, continuous staff training, and active management of cybersecurity and data privacy risks.

Importantly, the study highlights the value of deep bank–FinTech collaboration. By aligning complementary strengths, both sides can achieve cost efficiencies, enhance service quality, and expand financial inclusion. Such partnerships can also accelerate innovation cycles, ensuring that products remain competitive in an increasingly digital marketplace.

At the policy level, the authors suggest fostering a regulatory environment that encourages open banking frameworks, supports secure data sharing, and incentivizes cross-sector cooperation. This, they argue, will not only boost the competitiveness of individual institutions but also strengthen the overall resilience of China’s banking system.