Why are banks, wealth managers and family offices putting their own capital into new fintech businesses instead, in some cases, of making the innovations directly themselves? FWR takes a look at the rationale.

As banks, wealth managers and other financial players try to surf AI and other technology waves, a question that arises is whether it is easier to finance R&D in-house or fund an external venture instead.

The topic arose again in early September this year when Luminary, which calls itself an “AI-native wealth transfer and administration platform,” raised $22 million in Series A funding that drew participation from the likes of BNY, the FinTech Innovation Fund of Rockefeller Capital Management, Focus Financial Partners, family offices, and others. That funding round was led by Ten Coves Capital. 

Luminary says it turns estate documents into structured, source-verified data powering workflows for financial advisors, trust companies, law firms and accounting firms. This might be the kind of business that established firms could have built themselves, but as the example shows, it might make more sense to leave this role to a new firm and try to profit if it succeeds and take a controlled hit if it doesn't.

“For a wealthy family, there's no more important task than planning for their future. That goes well beyond distributing assets. It reaches charitable giving and what the next generation cares about. Luminary gives families and their advisors a powerful way to do that work together. That's why I invested,” Rudy Adolf, founder and former CEO of Focus Financial Partners, told Family Wealth Report. Adolf has invested in Luminary at Focus, and individually through his family office.

“People say general-purpose agents will commoditize application software. But Luminary is different because it isn't built on an LLM [large language model]. It's built on proprietary, structured data that captures every entity, asset, relationship, distribution term and fiduciary power in an estate, audited for completeness and tied back to the source documents. A smarter model can't copy that,” he said. 

A clear trend
There appears to be a clear trend of startups being where the action is for fintech innovation, rather than from established players, Arvind Purushotham, head of Citi Ventures, told FWR.

“There’s little R&D in financial services that goes on in large financial services. A lot of that innovation is in the startup world,” he said in a call. “This [investing in firms] gives us on-the-ground intel that can be very helpful. We have got insights that we would otherwise not have.”

Purushotham’s own career is testament to the durability of this approach. He has been at Citi Ventures for more than 15 years and was part of the founding team. With a background in the US and Silicon Valley venture capital sector, technology is a big part of his background. Purushotham has worked in the technology sector as a semi-conductor engineer. Before Citi Ventures, he worked at VC firm Menlo Ventures. 

Today, Citi Ventures has more than 100 businesses in its portfolio. One segment of this is fintech businesses. It recently sold an anti-fraud tech business to VISA, for example. 

In fact, Purushotham and his colleagues meet hundreds of startups a year that are looking for capital. 

Taking this approach is useful both for seeding potential fintech “winners” but it also keeps banks at the leading edge of innovation and in touch with what their peers are up to. 

“We understand business models even better and see what our peers are doing…we become partners in these businesses,” he said. Importantly, investee companies don’t need to be clients of Citi, he said.

FWR asked BNY about this approach to “outsourcing innovation.”

“We are focused on identifying emerging technologies that can help address real challenges across financial services,” Marianna Lopert-Schaye, global head of strategic partnerships, investments and innovation at BNY, said. Asked about the specific Luminary business, she said it “brings a distinctive approach to wealth transfer and estate planning, an area of wealth tech where modern infrastructure can help advisors better serve high net worth clients.”  

If you can’t beat ‘em, join ‘em
It may be that part of the reason for investing into external firms is a defensive one. Fintechs pose a competitive challenge to incumbent banks, particularly as the latter labor under legacy technology and costs. Seeding fintechs that can also be later absorbed or used by the investing bank looks like a smart move.

A paper presented to the FDIC Bank Research Conference 2024, by academics from Duke University and University of Connecticut, entitled From Competitors To Partners: Banks' Venture Investments In Fintech, found that the percentage of banks investing in fintech surged from around 20 per cent in 2001 to more than 70 per cent in 2022; five banks made such investment before 2011, and 24 banks did so in 2022. Fintech deals involving banks reached 66 in 2022, rising from only five before 2014. 

Readers will recall the flurry of interest around “robo advisors” more than a decade ago, and the AI trend in some ways continues in this vein. For example, Goldman Sachs and JP Morgan were co-investors in Motif, an early robo-advisor. As that example showed, however, these ventures don’t necessarily work out as predicted: Motif closed in the spring of 2020. (Charles Schwab later acquired Motif’s intellectual property, including its technology platform, algorithms, and source code.)

Turning to another bank, in 2020 UBS set aside “hundreds of millions of dollars” of its own money (Forbes, May 26, 2020) for a corporate venture fund. In Japan, Mizuho put money into a local robo advisor, WealthNavi. Just over a decade ago, UBS Wealth Management Americas and tech company SigFig formed a “strategic alliance” to develop digital technology for UBS WMA, its financial advisors and their clients. 

Prove, a North American tech company, said in a January 31, 2022 article on its website that the amounts that banks and fellow financial firms are putting into fintechs has continued to grow. 

“Most leading banks with vast AuM have realized that investing in fintech is the future, another reason why fintech startup valuations are so high,” it said. “Investors will gauge how well these investments are received by incumbents, and this will lead to more investments from venture funds or other banks that will open their own venture funds. In contrast, older financial institutions are developing labs and accelerators to leverage emerging technologies in order to foster innovation. By partnering with fintechs, they gain expertise in fields outside of their areas of specialization." 

Among examples of more recent deals, Capitolis, a fintech that says it unlocks balance sheet constraints and cuts capital market risks, said in October that it had completed $220 million of financing. The round was led by Citi. Bank of America, Nomura and Tradeweb Markets came in as new strategic investors. Barclays, BNP Paribas, JP Morgan, State Street and UBS also took part. In another case, Quantifind, a US regtech providing AI-powered risk intelligence for financial crime and national security work, raised a $200 million growth investment led by Summit Partners. Existing backers Citi Ventures, S&P Global, Deloitte and Stephens Group also took part. 

Possible downsides?
There is some suggestion that banks’ investment in fintech firms might dent returns over time, even though bank executives will nevertheless think the expense is worthwhile if they gain intellectual property and other benefits. According to a March 2022 research paper (source: Science Direct), “Bank equity investments in fintech firms generate statistically significant negative abnormal stock market returns (CARs ranging from -0.21 per cent to -1.05 per cent), driven by integration costs, technological redundancies, and higher risk-taking,” it said. (“CAR” is “cumulative abnormal return.) 

Whatever the figures say, the focus on AI and the large amounts of capital required to drive it will likely continue to encourage some banks to finance fintech startups.

At Citi Ventures, Purushotham said there have not been many exits from its wealthtech portfolio because many of the relevant companies are among its more recent investments. 

“Some of our current portfolio companies operating within that are relevant to wealth management and private banking are Wealth.com, Jump, Conquest Financial, and iCapital, to name a few,” he said. 

Innovation role
Purushotham said he thinks of Citi Ventures’ innovation approach includes three areas: to invest in firms that are developing differentiated solutions and introduce them to business leaders inside the bank for possible commercial use; second, convening meetings between founders and Citi leaders to discuss trends, and third, to educate Citi employees about opportunities and advancements that new technology gives rise to.

Clearly, AI is ever present in today’s discussions. 

“Generally speaking, nearly every startup we speak to has an element of AI integrated into their product, in a lot of ways. AI nativity is becoming “table stakes” for companies really seeking to drive innovation, particularly in financial services,” Purushotham said. “There are so many areas of financial services that can be augmented by AI, from automating meeting notes and actioning follow-up items between advisors and their clients through agentic workflows, or KYC processes that can be streamlined in a safe, compliant way with AI. Given our position investing on behalf of Citi, we’ll continue to look at those startups that are developing the future of finance, which in many cases may involve an element of AI workflows,” he added.

In certain cases, a fintech is steered at an established trend such as intergenerational wealth transfer, for example via the Luminary venture.

"Scaling wealth transfer services starts with data that can serve as a single source of truth for advisors and the families they serve. We're proud to back Luminary as it delivers a platform that helps advisors bring a new standard of care to their clients," Steve Piaker, founder and managing partner of Ten Coves Capital, said. 

Luminary’s platform supports client assets totaling more than $500 billion; clients include Caprock, IEQ Capital and Wealth Enhancement Group, as well as tax advisory practices, AM Law 100 legal practices and trust companies.