Once reserved for ambitious start-ups and industry-leading tech operators, financial technology ( fintech) has since 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 grown by more than 160% since February 2013, and by some 30% over 2017.
Fintech is rapidly advancing across an array of global hubs. While the fintech concept was pioneered in developed markets, the fluidity of international capital and the borderless nature of technology adoption means that emerging markets are fast catching up. As competition mounts between regulatory jurisdictions, the coming years are likely to see fintech innovations generated across a widening geographical 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 difficulties in maintaining market share. Regulators, meanwhile, are being compelled to adopt a flexible stance with regard to fintech activity in order 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 the sector real possibilities for growth. The uptake of fintech by the world’s banks, however, is likely to follow an unpredictable trajectory.
Convergence
One of the most interesting facets of today’s fintech industry is the convergence of a large number of actors that both collude 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 their younger 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%, but even in less established financial markets this cooperative trend is also gaining momentum. For example, in South Africa and Indonesia the rate was 64% and 55%, respectively. Moreover, in all of the 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, however, does not mean that the era of usefully disruptive competition is over. New fintech players are entering the complex financial services ecosystem, and some of them are adopting a more confrontational stance when it comes to client acquisition. These players include ICT and 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 becoming concerned about the risk these newcomers pose to their business models. Some 80% of the respondents in PwC’s survey stated that they feared losing business to innovators, particularly in the areas of payments, fund transfer and personal finance.
Technology Tree
As well as competing with a diversifying field of fintech participants, banks and other financial institutions also face the challenge of keeping pace with the expanding selection of fintech products and services in the market. For banks, lending and payments related products have been the entry point to the fintech arena, with this category of business being the main growth driver of the segment. The Fintech100 list for 2017 – which is a collaborative effort between H2 Ventures and KPMG that aims to analyse and assess the global fintech landscape – found that 32 of the top 100 fintech companies were lending operations, while 21 were based upon new payments technology. Together, these two areas made up the single-biggest category, which is a status they are likely to retain given the lucrative returns available if they continue disrupting the world’s lending market.
In terms of underlying technology, effective data use forms the basis of business models for the majority of fintech firms. Manipulating and analysing large data sets is likely to continue to form the foundation of future fintech development for the time being. In the 2017 PwC survey some 74% of the large financial firms interviewed stated that data analytics will be the “most relevant” technology that they planned to invest in over the following 12 months. Recently, however, artificial intelligence (AI) has begun to emerge as the most interesting area as far as some banks are concerned. According to PwC, recent advances in AI have propelled the technology to the top of the development list for financial services, with start-ups that apply AI receiving an average funding of $1bn over 2016 and 2017. In the banking sector AI technology has a broad range of potential applications, including contract intelligence, which is used to analyse contracts and extract important data points; lending opportunity engines, which search for and select clients most suitable for credit extension; robo-advisors, used to provide council for various investment activities; and virtual assistants, which can communicate with customers to help them with various banking tasks, such as retrieving account information and resetting passwords.
Digital Services
Mobile fintech is another valued interest 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 larger institutions across global markets 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 even 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 necessary partnerships to do so.
Digital security is another area in the fintech universe that is receiving high levels of investment. Since high-profile data breaches have the potential to damage reputations and incur monetary losses, banks and other financial institutions are spending three times more than non-financial organisations on cybersecurity, according to a recent report by Kaspersky Lab. As technology evolves and is found to be applicable across a wider range of activities, the interface between the traditional banking sector and the disruptive fintech industry is becoming an ever more complex one.
Friend Or Foe
The increasing diversity of fintech technologies has implications for banking sectors across the globe. Over recent years they have developed so rapidly that banks have found it difficult to decide whether they are a threat to business or a potential means to increased profitability. In some markets, the challenge to banking incumbents is an unambiguous one, with fintech companies obtaining banking licences themselves and competing head-to-head with established lenders. After a decade that saw hardly any new banking licences issued in the US, 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 from Warburg Pincus, applied for a national bank charter of its own in July 2017, having already formed its banking product through a partnership with the Bancorp Bank. Its business model is similar to that of traditional institutions, being 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 eschewing 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 business activities outside of banking. On the other side of the Atlantic, Sweden’s Klarna, one of Europe’s most highly valued fintech start-ups, obtained its banking licence in June 2017. Its approval by Sweden’s Financial Supervisory Authority allows the company to offer retail banking services, including credit card provision, across the EU.
Traditional banks have been quick to answer this rising 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.
Outsourcing
Where the creation of new institutions through partnerships is not the preferred option, banks are joining forces with fintech firms to enhance their digital offerings under their existing brands. In doing so, they aim to establish proprietary digital infrastructure that is capable of competing with the more digitally nimble newcomers. These arrangements frequently cross national – and even continental – borders. In October 2013, for example, Canada’s Scotiabank announced its freshly inked agreement with one of Latin America’s most prominent start-up accelerators, NXTP Labs, to provide the bank access to promising fintech developments emerging from Mexico, Colombia, Chile and Peru.
Bank Islam Malaysia has formed a strategic partnership with Cognizant, one of the main professional service companies in the US, to build a new digital platform that will enable the bank to boost its exposure to small and medium-sized enterprises and Malaysia’s rural, underbanked population. Forming partnerships with fintech firms has proved particularly popular in emerging markets that are already saturated with modestly capitalised lenders, as regulators in these environments tend to be less willing to issue new licences.
In more developed markets, however, some traditional lenders have taken a step further, establishing standalone digital banks to compete with this new breed of competitor. Santander Group in Spain, for example, launched Openbank as the nation’s first completely digital banking institution in June 2017. The bank has also grouped all its mobile services – including brokerage, personal financial management, card control and payments – into a single mobile app, which it advertised as a “virtual branch”, offering on-call access and a team of personal account managers.
Whether digital financial services are implemented via partnerships or from within banks’ existing infrastructure, the potential for fintech firms 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: 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,” Abubakar Jimoh, CEO of Nigeria’s Coronation Merchant Bank, told OBG.
Regulation
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 taking an accommodative approach to tech firms operating within their financial sectors. The disruptive power of tech-based products and services has also 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 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 also raised a number of concerns on the part of regulators, especially regarding consumer protection and market stability. Determining regulations for volatile start-ups and advanced technologies is a complex undertaking, and the prudential mandates of regulators mean that 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 threatens to deny the market of its possible advantages.
Therefore, many regulators have become cautiously creative in their 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 regulating 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 list of previously agreed set of 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. Tests so far have included cross-border and domestic payments solutions based on blockchain technology, consumer-orientated 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 a number more have been established since then. The European Banking Federation has also proposed that a fintech sandbox be created for the whole of Europe, as this would allow companies to trial their products on a cross-border basis.
While traditional fintech hubs, notably the US and the UK, continue to dominate the industry for the time being, the regulatory sandbox concept empowers developing hubs to establish themselves on equal regulatory terms. As a result, emerging markets are becoming more prominent in the global arena, a trend likely to become more pronounced in the years ahead.
Middle East & North Africa
The MENA area is an early adopter of the new regulatory model. Abu Dhabi was the first to launch a regulatory sandbox in the region, accepting its 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 endeavours. Meanwhile in Jordan, the AhliSandbox has been developed as a proprietary facility by Jordan Ahli Bank.
The MENA region demonstrates, however, that a sandbox is not necessarily essential to fintech success. Along with the UAE and Jordan, Lebanon and Egypt – neither of which have established sandboxes – account for 75% of start-ups in the MENA region in 2015. Egypt’s giant consumer base makes it an attractive market compared to the high-net-worth but relatively small markets of its Gulf neighbours. As such, recent years have seen a steady stream of fintech accelerators established in the country. The most recent of them, Fekretak Sherketak, was launched in late 2017 by the Egyptian Ministry of Investment and International Cooperation, EFG Hermes and the UN Development Programme.
Blockchain
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 appears set to become a key concern for the banking sector. While in 2017 only 20% of financial institutions that responded to the PwC survey identified blockchain as an area in which they planned to make significant investments over the coming year, around 50% of larger fintech firms expressed their intention to do so.
Given the ability of fintech companies to drive market changes, this suggests that momentum will continue to build in the blockchain concept, whether banks desire it or not, but how problematic this development may be for traditional lenders remains to be seen. “Mobile banking and cryptocurrencies, especially blockchain technologies, will certainly be a disruptive force in the market. However, how that disruption will actually occur is still largely unknown. It is also clear that, despite any substantial market changes that may accompany cryptocurrencies and blockchain technology, banks have existed for centuries now and have faced even more disruptive technological processes,” Karen Darbasie, group CEO, First Citizens Trinidad and Tobago, told OBG. Whatever the outcome, emerging markets are well positioned to compete with more developed ones in the formulation of this new technology, 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 grasp the opportunities that these technological changes offer.
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