Once reserved for ambitious start-ups and industry-leading tech operators, financial technology (fintech) has more recently caught the attention of major private sector firms and government planners alike, becoming a regular feature in budget speeches and strategic development plans. As fintech progressively plays a larger part in the lives of consumers, investors have quickly come to recognise its potential as a growth industry. The tech-focused Janus Henderson Global Technology Fund, for example, has expanded by more than 160% since February 2013, and grew by some 30% over the course of 2017.
Fintech is rapidly advancing across an array of global markets. While the concept was pioneered in developed countries, the fluidity of international capital and the border-less nature of technology adoption means emerging markets are catching up quickly. As competition mounts between regulatory jurisdictions, the coming years are likely to see fintech innovations across a widening geographic front.
However, the rise of fintech will inevitably be attended by unprecedented challenges. As large tech groups move into the banking arena, traditional lenders will face more difficulty maintaining market share. Regulators, meanwhile, are being compelled to adopt a flexible stance with regard to fintech activity to attract investment, but must also maintain their prudential standards, or risk reputational damage. With high levels of investment and a rapidly evolving landscape, fintech offers real possibilities for growth.
One of the most interesting facets of today’s fintech industry is the convergence of a large number of actors that both cooperate and compete to drive growth. While the early days of the fintech revolution were characterised by start-ups taking on and beating incumbents, in 2018 there is a significantly greater element of cooperation in the market. Fintech start-ups can benefit from the large customer bases of established financial institutions, while existing institutions are constantly seeking innovative ways to boost productivity and gain a competitive edge in the market, at times through partnerships with nascent fintech counterparts.
The enthusiasm of banks and other financial institutions to work with fintech companies varies widely from country to country, but a recent PwC survey found that at the global level, 45% of respondents had formed such partnerships in 2017, up from 32% the previous year. In Germany the level was as high as 70%. Even in less established financial markets, this cooperative trend is gaining momentum. For example, in South Africa and Indonesia the rate was 64% and 55%, respectively. Crucially, in all 32 markets surveyed in the report, a majority of respondents expected to see an increase in this type of partnership over the next three to five years.
The strengthening of ties between fintech start-ups and established financial institutions does not mean the era of usefully disruptive competition is over. New fintech players are entering the complex financial services ecosystem, and some are adopting a more confrontational stance when it comes to client acquisition. These players include ICT firms, large tech companies, social media platforms, e-retailers and financial infrastructure companies.
The growing diversity of fintech actors bodes well for innovation and product development; however, traditional financial institutions are understandably concerned about the risk these tech-savvy newcomers pose to their business models. Some 80% of the respondents in PwC’s survey fear losing business to innovators, particularly in the areas of payments, funds transfers and personal finance.
As well as competing with a widening field of fintech participants, banks and other financial institutions face the challenge of keeping pace with the expanding selection of fintech products and services in the market. For banks, lending- and payment-related products have been the entry point to the fintech arena, with this category of business serving as the main growth driver of the segment. The Fintech100 list for 2017 – a collaboration between H2 Ventures and KPMG to analyse and assess the international fintech landscape – found that 32 of the top-100 fintech companies were lending operations, while 21 were based on new payments technology. Together, these two areas made up the single-biggest category of fintech services – a status they are likely to retain given the lucrative returns available if they continue to disrupt the global lending market.
In terms of underlying technology, effective data use forms the basis of business models for the majority of fintech firms, and manipulating and analysing large datasets is likely to continue to form the foundation of fintech development for the time being. In the 2017 PwC survey, some 74% of the large financial firms interviewed stated that data analytics would be the “most relevant” technology they planned to invest in over the following 12 months.
Mobile fintech is another priority area for banks. The cost advantages of creating mobile apps that allow customers to manage their finances without walking into a brick-and-mortar branch are obvious, and most of the world’s largest financial institutions have developed retail-focused mobile platforms. Over recent years the field of mobile fintech has expanded from the basic functionality of the earliest portals to include mobile wallets, peer-to-peer payments and digital-only banks. The popularity of such developments among consumers has compelled traditional financial institutions to offer their customers the same services, with banks sometimes forming partnerships to do so.
As more financial services go remote, digital security is receiving greater levels of investment. With high-profile data breaches having the potential to not only damage reputations but also incur monetary losses, financial institutions are now spending three times more than non-financial organisations on cybersecurity measures, according to a recent report by Kaspersky Lab, a multinational cybersecurity and anti-virus firm headquartered in Moscow.
Friend or Foe
The increasing diversity of fintech has implications for banking sectors globally. Technologies have developed so rapidly that banks have often found it hard to decide whether they are a threat or a potential means to greater profits. In some markets, however, the challenge to banking incumbents is unambiguous, with fintech companies obtaining their own banking licences and competing head-to-head with established lenders. After a decade where few new banking licences were issued in the US, for example, 2017 saw a number of fintech companies announce their intention to transform themselves into fully fledged lending institutions.
Varo Money, founded in 2015 with $27m in capital from US-based private equity firm Warburg Pincus, applied for a national bank charter in July 2017, having already developed its banking offer through a partnership with the Bancorp Bank. Its business model is similar to that of traditional institutions, in that it is based on checking accounts, direct deposits, online bill payments and debit cards. Unlike traditional players in the US market, however, it aims to attract customers by waving overdraft fees, minimum balance fees and ATM charges.
Later in 2017 US payments processor Square signalled its intention to form an industrial loan company, which is a type of lending institution that enjoys the same privileges as traditional banks, but is also granted permission to form part of a corporation that undertakes other business activities outside of the conventional banking realm.
Traditional banks have been quick to react to this growing trend. One response has been to provide the financial infrastructure that supports the operations of new digital banks, thereby retaining a stake in this rapidly evolving area of the market. In the UAE, for example, Bank Clearly was set up in early 2017 as a digital operator offering standard retail banking services in partnership with a traditional lender.
Whether digital financial services are implemented via partnerships or within banks’ existing infrastructure, the potential for fintech firms and services to engage unbanked populations places the segment’s development high on the agenda of emerging countries.
“The greatest innovation for the banking sector can also come with enhancing inclusion,” Abubakar Jimoh, CEO of Nigeria’s Coronation Merchant Bank, told OBG. “The current number of people participating in the formal financial sector is still grossly inadequate, and that is where fintech services can play their part in the sector’s development.”
Financial authorities, too, are being compelled to react quickly to the dynamic impacts of new technologies. In most respects, the burgeoning fintech industry is viewed by regulators as a positive development. In 2015 the global fintech segment attracted over $22bn in investment, according to the Central Bank of Bahrain, a figure which is expected to grow exponentially over the coming years.
Governments across the globe have taken note of this new magnet for domestic and foreign investment, and central banks are increasingly adopting an accommodative approach to tech firms operating within their financial sectors. The disruptive power of tech-based products and services has increased levels of competition and compelled traditional institutions to improve their offerings across their business lines, ranging from retail to corporate. These moves have been widely welcomed by regulators, as they are enhancing the consumer experience and driving financial sector growth.
Regulators are also mindful of the prestige attached to the fintech concept, and the fact that financial jurisdictions that lack a thriving ecosystem for young tech companies and start-ups run the risk of appearing as second-tier destinations for capital.
Nevertheless, the growth of the global fintech industry and the absorption of its products by banks from New York to New Delhi have raised a number of concerns on the part of regulators, especially regarding consumer protection and market stability. Determining regulations for high-risk start-ups and advanced technologies is a complex undertaking, and the prudential mandate of regulators means protecting the general public and the wider financial system from technological misadventures is a primary responsibility. At the same time, an overly rigid regulatory framework makes financial innovation all but impossible, and could deny markets the possible advantages of new technology.
Many regulators have therefore employed a cautiously creative approach to the fintech industry. For an increasing number of them, the answer to the regulatory balancing act of encouraging growth while also ensuring stability lies in creating a regulatory sandbox. The concept is straightforward: a separate regulatory entity, endorsed or operated by the regulator, allows for limited-scale testing of new products for a fixed period, during which time the normal regulatory requirements are relaxed or lifted entirely. For example, a fintech company may be granted permission to test out a mobile payment platform on 2000 customers for three months, after which time the regulator will judge the product’s performance against a set of previously agreed upon metrics. The regulator is then able to make a risk-based decision regarding the merits of the innovation, and rule accordingly.
The regulatory sandbox was pioneered by the UK’s Financial Conduct Authority in 2015, with the first fintech firms beginning to utilise the platform for trials as recently as 2016. Sandbox tests have so far included cross-border and domestic payments solutions based on blockchain technology, consumer-oriented mobile applications, securities management platforms and new lending products.
By the beginning of 2017 there were sandboxes at various stages of development in the US, Singapore, Hong Kong, Malaysia, Thailand, Switzerland and the UAE, and several more have since been established. The European Banking Federation, for its part, has suggested that a fintech sandbox be created for the whole of Europe, which would allow companies to trial their products on a cross-border basis.
While traditional centres for fintech innovation – notably the US and the UK – continue to dominate the industry, the regulatory sandbox concept empowers developing financial industries to establish themselves on equal regulatory terms. As a result, emerging markets are becoming more prominent in the global arena, a trend that is likely to become more pronounced in the years ahead.
The MENA region has been an early adopter of this new regulatory model. Abu Dhabi was the first in the region to launch a regulatory sandbox, accepting the first five start-ups to its Reg Lab in 2017. Projects that emerge successfully from the new platform are then allowed to establish a commercial presence within the Abu Dhabi Global Market, the emirate’s offshore financial centre.
In June 2017 Bahrain’s regulator unveiled its first onshore sandbox, which, like its counterpart in Abu Dhabi, is available to both foreign and domestic players. Jordan, meanwhile, has taken a private sector-led approach, with the AhliSandbox developed as a proprietary facility of the country’s Ahli Bank.
While emerging regulatory sandboxes are expected to fuel further experimentation and innovation in MENA, the region has already made considerable progress in the financial start-up sphere. Along with the UAE and Jordan, Lebanon and Egypt – neither of which have established sandboxes – account for around 75% of start-ups in the region.
Egypt’s extensive consumer base, which is quickly approaching 100m, makes it and attractive destination compared to the high-net-worth but relatively small markets of the Gulf, and recent years have seen a steady stream of fintech accelerators established in the country. The most recent of these – Fekretak Sherketak, which translates to “Your Idea is Your Company” – was launched in late 2017 by Egypt’s Ministry of Investment and International Cooperation, the UN Development Programme and the Egyptian investment bank EFG Hermes.
As global fintech investment develops further, the variety of technologies with useful applications for the banking sector continues to broaden. Biometrics, identity management and public cloud infrastructure are likely to join data analytics, mobile fintech and cybersecurity as mainstays of the industry. In the shorter term, blockchain technology is a top concern for banks and brokerages, thanks to the ability of distributed ledger technology to curb the incidence of financial fraud, and reduce the cost and burden of due diligence compliance.
While only 20% of the financial institutions that responded to the PwC survey in 2017 identified blockchain as an area in which they planned to make significant investments over the coming year, around 50% of larger fintech companies expressed their intention to do so. According to the World Economic Forum, by 2025 the equivalent of 10% of the world’s GDP will be stored in blockchains or blockchain-related technology, making it a strong growth area.
“Mobile banking and cryptocurrencies – especially blockchain technologies – will certainly be a disruptive force in the market,” Karen Darbasie, group CEO of First Citizens Trinidad and Tobago, told OBG. “However, exactly how that disruption will actually occur is still largely unknown.”
Whatever the outcome, emerging markets are well positioned to compete with more developed ones in this new technological sphere, assuming regulators are willing to adopt a progressive attitude. For banks and other financial institutions, usefully disrupting their own operations and processes will become increasingly necessary if they are to benefit from the opportunities these technological changes offer.
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