Once reserved for ambitious start-ups and industry-leading operators, financial technology (fintech) has caught the attention of private sector firms and government planners alike, becoming a regular feature in budget speeches and development plans. As fintech plays a larger part in the lives of consumers, investors have come to recognise its growth potential. Tech-focused Janus Henderson Global Technology Fund, for example, has expanded by more than 160% since February 2013, and by some 30% in 2017 alone.
Fintech is rapidly advancing across global markets. While the concept was pioneered in developed countries, the fluidity of international capital and borderless nature of technology adoption means emerging markets are catching up quickly. As competition mounts between jurisdictions, the coming years are likely to see fintech innovations on a widening geographic front.
However, this will inevitably bring challenges. As large tech groups move into banking, traditional lenders will struggle to maintain market share. Meanwhile, regulators must be flexible with fintech to attract investment while also maintaining their prudential standards or risk reputational damage. With significant investment and a rapidly evolving landscape, fintech offers real growth opportunities, but its uptake by global banks is likely to follow an unpredictable trajectory.
The fintech industry has seen a convergence of actors cooperating and competing 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 notably more market cooperation. Fintech start-ups can benefit from the large customer bases of established financial institutions, which in turn are seeking innovative ways to boost productivity and gain a competitive edge, at times through partnerships with nascent fintech counterparts.
Financial institutions’ enthusiasm to work with fintech companies varies between countries, but a recent PwC survey found that at the global level, 45% of respondents had formed such partnerships in 2017, up from 32% in 2016. In Germany the level was as high as 70%. Even in less-established financial markets, this trend is gaining momentum: South Africa and Indonesia had rates of 64% and 55%, respectively. Crucially, in all 32 markets surveyed, a majority of respondents expected an increase in this type of partnership over the next three to five years.
Strengthening ties between start-ups and established institutions does not mean the era of usefully disruptive competition is over. New players are entering the ecosystem, and some – such as ICT firms, large tech companies, social media platforms, e-retailers and financial infrastructure companies – are adopting a more confrontational stance on client acquisition.
The growing diversity of fintech actors bodes well for innovation and product development; however, traditional institutions are understandably concerned about the risks 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 payments, funds transfers and personal finance.
In addition to competing with a widening field of participants, financial institutions must keep pace with the expanding selection of fintech products and services. For banks, lending- and payment-related products have been the entry point to the fintech arena, with this being the segment’s main growth driver. 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 payments. Together, these made up the single-biggest category of fintech services – a status they are likely to retain given the lucrative returns available in the 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. 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.
More recently, banks have begun to see artificial intelligence (AI) as a key area of innovation. Advances in AI have turned the technology into a top priority for financial services, with AI start-ups collectively receiving an average of $1bn in annual funding in 2016 and 2017.
In the banking sector, AI 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-advisers, used to provide counsel for various investment activities; and virtual assistants, which can support customers with various tasks, such as retrieving account information and resetting passwords.
Mobile fintech is another priority.
The cost advantages of 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. 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 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 investment. With high-profile data breaches having the potential to not only damage reputations, but also incur monetary losses, financial institutions are spending three times more than non-financial organisations on cybersecurity, according to a recent report by Kaspersky Lab, a Moscow-based multinational cybersecurity and anti-virus firm.
Friend or Foe
This increasing diversity and rapid development have made it difficult for banks to decide whether these technologies are a threat to business or a means to increase profitability. In some markets, however, the challenge to incumbents is unambiguous, with fintech firms obtaining banking licences and competing directly with established lenders. After a decade of hardly any new banking licence issuance in the US, for example, 2017 saw several fintech businesses announce plans to transform 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. It has a similar business model to traditional institutions, based on chequeing 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.
On the other side of the Atlantic, Sweden’s Klarna, one of Europe’s highest-valued fintech start-ups, obtained a banking licence in June 2017. Its approval by Sweden’s Financial Supervisory Authority allows the firm to offer retail banking services, including credit card provision, across the EU. Traditional banks have been quick to react to this trend, in part by providing the financial infrastructure that supports new digital banks, thereby retaining a stake in this rapidly evolving market.
In other circumstances, 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 to compete with more digitally nimble newcomers, frequently across national and continental boundaries. In October 2013, for example, Canada’s Scotiabank inked an agreement with one of Latin America’s most prominent accelerators, Argentina-based NXTP Labs, to gain access to fintech developments in Mexico, Colombia, Chile and Peru.
Bank Islam Malaysia has formed a strategic partnership with Cognizant, a US professional services firm, to build a new digital platform enabling the bank to boost its exposure to small and medium-sized enterprises and Malaysia’s rural, underbanked population.
Fintech partnerships have proven particularly popular in emerging markets saturated with modestly capitalised lenders, since regulators in these environments are generally less willing to issue new banking licences.
In more developed markets, some traditional lenders are going farther, establishing standalone digital banks. Spain’s Santander Group, for example, launched Openbank, the nation’s first completely digital bank, in June 2017. It has grouped its mobile services – including brokerage, personal financial management, card control and payments – into a single app, which it advertises as a virtual branch, offering personal account managers and on-call access to customers.
Financial authorities, too, are being compelled to react quickly to new technologies. In most respects, the burgeoning fintech industry is viewed by regulators as a positive development. Worldwide, the fintech segment attracted $31bn in investment in 2017, according to global consultancy KPMG, bringing the total investment since 2015 to $122bn. Governments have taken note of this magnet for domestic and foreign investment, with central banks adopting accommodative policies towards fintech firms. The disruptive power of technology has increased competition and compelled traditional institutions to improve their offerings across business lines. This has been welcomed by regulators, as it enhances consumer experience and drives growth.
Regulators are also mindful of the prestige attached to fintech, with financial jurisdictions that lack support for young tech companies and start-ups potentially perceived as second-tier investment destinations.
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 taken a creative approach to the fintech industry. For an increasing number of them, the answer to the balancing act of encouraging growth while ensuring stability lies in creating a regulatory sandbox. The concept is straightforward: a separate regulatory entity is endorsed or operated by the regulator, allowing for limited-scale testing of new products for a fixed period, during which the normal regulatory requirements are relaxed or lifted entirely. For example, a fintech company may be allowed to test a mobile payment platform on 2000 customers for three months, after which the regulator judges this performance against a previously agreed upon set of metrics. The regulator can then make a decision based on the risks and merits of the innovation.
The regulatory sandbox was pioneered by the UK’s Financial Conduct Authority in 2015, with the first fintech firms utilising the platform for trials as recently as 2016. Sandbox tests have included cross-border and domestic blockchain-based payments solutions, consumer-oriented mobile applications, securities management platforms and new lending products. By early 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, allowing companies to trial products on a cross-border basis.
The MENA region has been an early adopter of this 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 platform can then establish a commercial presence in the Abu Dhabi Global Market, the emirate’s offshore financial centre.
While emerging regulatory sandboxes are expected to fuel experimentation and innovation in MENA, the region has already made considerable progress in financial start-ups. Along with the UAE and Jordan, Lebanon and Egypt – neither of which have sandboxes – account for around 75% of start-ups in the region.
Meanwhile, in Asia, China, Singapore and Hong Kong remain the key drivers of fintech, though other large economies, such as India and South Korea, are also exploring major fintech deals. Hong Kong in particular has warmed to the sandbox concept. In the third quarter of 2017 the Hong Kong Monetary Authority upgraded its fintech sandbox, while the Securities and Futures Commission and the Insurance Authority both revealed plans to establish sandboxes of their own.
Emerging markets with large consumer bases are proving to be fertile ground for fintech activities. At the start of 2018 Indonesia had more than 150 fintech start-ups, a nearly 80% rise on 2015. In a country in which only 40% of the 250m-strong population has access to the formal financial system, banks are using fintech to broaden their customer base.
Accelerators continue to be the main drivers of fintech growth in Latin America, helping channel significant capital to the sector. According to the Latin America Private Equity and Venture Capital Association, the region’s fintech industry attracted $186m in venture capital in 2017, with more than onethird of inflows directed towards fintech start-ups.
Mexico has established itself as a centre for fintech innovation, particularly in mobile banking, which has caught the interest of banks and investment firms alike. In the second half of 2017, for example, HSBC and Ignia announced their support for Startupbootcamp FinTech Mexico City, part of an international network of fintech programmes extending to London, Amsterdam, New York, Singapore and Mumbai. While the lack of a regulatory framework is often seen as an obstacle to domestic growth, a fintech law passed by the Mexican Senate in December 2017 is set to boost the industry.
Argentina made a similar legislative advance earlier in the year when it passed the Entrepreneurs Law. The new framework replaces old procedures for applications, approvals and financing, which previously took up to one year for businesses to complete. The country is already home to many of Latin America’s most notable start-up success stories; NXTP Labs, for instance, was launched in Buenos Aires in 2011 and has grown its portfolio to include more than 150 global start-ups.