Financial technology startups are hot, red hot. The group raised almost $3 billion in the first quarter, according to CB Insights. And over the past 12 months, investors have poured almost $14 billion into 824 financings in the sector -- that's more deals than companies in sexier areas like cybersecurity and home automation completed.



The fintech upstarts are challenging the status quo in seemingly every aspect of the financial markets, from banking and bill paying to asset management and payments processing. They're even venturing beyond the current system into areas like digital currency Bitcoin and equity crowdfunding.



But the big banks aren't standing still. The establishment plans to spend $16.6 billion on its own set of digital initiatives this year, according to a report from IDC. So-called digital transformation spending still makes up less than one-quarter of all retail bank IT spending but is growing at about three times the rate of overall spending, IDC says.









Big banks still have nearly all the customers -- as well as their cash -- right now, but the economy is changing quickly in ways that benefit the upstarts. Increasingly, online and mobile consumers don't have the same preferences that they used to. Only 23% of U.S. adults still use physical branches as their primary means of banking, while 51% prefer online or mobile, according to a recent survey sponsored by Bank of America (BAC). And while only 5% have made mobile payments with their phone, another 29% say they are interested.

[Get the Latest Market Data and News with the Yahoo Finance App]

The many upstarts are also able to focus on improving discrete parts of the banking experience. CB Insights counts 20 different significant companies trying to crack the payments and billings niche, 16 in personal finance and almost two dozen in lending.



In many areas, the big banks may be dismissing the threat of upstarts along the lines of the classic disruption theory outlined by Harvard Professor Clayton Christensen in his book "The Innovator's Dilemma." The startup firms frequently offer limited services or primarily target customers big banks see as unprofitable. Bank execs feel safe ignoring the new competitors while they focus on retaining their current customers. But eventually, as technology improves and customer needs change, the startups become appealing to an ever-increasing portion of the market. And some bank efforts, like Barclays' new $50 wristband for making mobile payments, seem more than a little misguided.



Banks trying to catch up



Others are off to a good start, at least. Bank America claims 31 million of its customers are active online banking users and 17 million on mobile apps. Most big banks are trying to speed up change, whether by investing in improved mobile apps, better online service or even by buying whole companies. Of the 211 upstarts that "exited" the venture capital world last year, only nine made it to the stock market on their own via IPOs. The select group of winners include online lender LendingCLub (LC) and bill paying facilitator Yodlee (YDLE). The rest were acquired, frequently by the large financial institutions that dominate the current market.



For example, Simple set out to revolutionize online banking without a physical presence -- it was bought by Spanish bank BBVA (BBVA) last year for just $117 million.



And that highlights another major challenge for the startups. Simple found the current capital and regulatory requirements too steep to continue on its own. The problems Uber has experienced with taxi regulators around the globe are nothing compared to the costly and forbidding array of rules and regulations facing new financial firms.



The wild card is whether the biggest tech companies, such as Google (GOOGL) or Apple (AAPL), decide to jump into fintech. Those behemoths almost certainly have the resources and talent to navigate the regulatory thicket and Google's venture capital arm has already made numerous fintech investments. But the tech giants may not see a need to get involved more directly, at least not yet.



With the big banks and the upstarts spending like crazy to innovate, it won't be easy to figure out who's going to prevail. But with better services and cooler apps emerging almost daily, customers should be winners either way.



























