Fintech has taken the tech and financial services industries by storm, and is seen by many as the next wave of disruption that will change how financial services are provided and consumed. We look at what Fintech is, why it is such a disruptive force and some opportunities and challenges it presents for key market players.
Fintech is generally defined as the application of technology to the provision of financial services. It is essentially a form of disruptive innovation – in line with other great disruptive forces of the last two decades including those that have impacted the telecoms and media industries – but applied to the financial services industry.
Disruptive innovations such as Fintech are primarily about two things: (a) creating efficiency; and (b) reacting to changing consumer behaviour or (for the most significant disruptors) changing consumer behaviour.
Those who introduce disruptive innovation often do so by designing a good or service for a specific set of consumers in an existing market (eg people with smartphones or those who expect faster service) – either because those consumers are demanding a more efficient good or service or because the disruptor believes that consumers will use a more efficient good or service. This provides an element of choice for consumers to depart from using the existing technology available to them. The more effective the disruption, the more consumers depart from the existing technology creating a market that previously did not exist and eroding the previous market.
Disruptive innovation is not a new concept. Indeed, it has been a hallmark of technological advancement throughout history, but it seems to be coming thicker and faster in recent years. A significant driver for this is the advent of the Internet which allows for faster and more efficient communications and exchanges of data.
This is no different in the realm of Fintech. There are a number of early examples of Fintech. Western Union started to provide money transfer services by way of telegraph as early as the 1870s. The first versions of the Visa and Mastercard payment networks were established in the 1950s and 1960s. All these innovations could be described as early forms of Fintech business models.
There has, however, been a significant uptick in the growth of the Fintech industry in the past several years. As with disruptive innovation generally, much of this is due to the impact of the Internet and, more recently, the penetration of smart phones and how they have changed the way that consumers expect to be able to receive goods and services. But there are other factors that have contributed to the growth of Fintech, including advancements in useful technologies like electronic finger-print identification and machine to machine communications and the accessibility of huge amounts of data and the development of sophisticated algorithms to use them. The changing landscape of the global banking industry following the financial crisis of the last decade has also been an influencing factor for Fintech.
A difficulty with the term Fintech is that it covers a large and varied range of business models, many of which did not exist even two to three years ago and many of which are yet to be developed. However, often Fintech is broken down into the types of financial services that it seeks to disrupt. Although there are other important sub-sectors (including insurance, market making and deposits), three key sub-sectors of Fintech are: payments; lending and capital raising; and advisory services.
Payments are arguably where the roots of Fintech lie, with the advent of credit and debit cards and the networks that allow people to use them arriving well before the current Fintech boom. Most of these advances, however, maintained traditional banks as the face of payments (e.g., the issuer of a credit card tends to be a bank).
In recent years, a number of business models have emerged that have threatened the prime position of banks in the payments cycle. Notably, payments systems developed by companies like Alipay and Paypal have become synonymous with online shopping. ApplePay also threatens to become a serious contender in the payments industry. These payment systems still involve banks, but are fronted by technology companies.
The development of payment technology has also created a number of interesting opportunities for business models that support payments, including around making methods of payments more secure and allowing payers to move to more convenient ways to authorise payments such as contactless payments and fingerprint verification.
The Fintech business models that may have the most potential for disruption of the payment industry are those that introduce new digital currencies (like Bitcoin). These new types of currencies (which are not underwritten by a government but rather through the application of mathematical algorithms), if they were to take off, would turn the current financial system on its head. However, so far, their adoption has been held back by the high volatility of their value and because it can be difficult for the average consumer to understand how they work and their intrinsic worth.
Lending and capital raising
Peer to peer lending is a big part of the current Fintech industry. At its heart, peer to peer lending is about sourcing a lender or a borrower directly without the need to go through an intermediary (usually a bank). Rather than going to see a bank for a loan, a consumer is able to go to an online marketplace to find one or more lenders willing to provide the funds they need.
Peer to peer lending at this stage seems most successful when targeted at smaller loans and small to medium enterprises, in large part because of the difficulty for many smaller companies to obtain smaller loans from traditional banks. Globally the US market leads the way (the Lending Club is a successful example) in peer to peer lending but there is certainly demand in the Asia region. In China only it is reported that there are over 1,500 peer to peer lending companies, including prominent examples like Lufax.
As with payments, there is an abundance of business models developing within the Fintech industry that sit at the periphery of consumer-facing lending business models. Big data and data analytics is an important one, as it has the potential to streamline background checks and figuring out what might turn into a bad debt.
An extension of peer to peer lending is the emergence of crowdfunding business models. These businesses seek to create platforms that allow entrepreneurs to raise capital, not through traditional approaches to institutional investors, but by tapping into the network of investors who use the platform. As with peer to peer lending, crowdfunding platforms currently seem to be targeted at smaller ventures which would find it cost ineffective to raise money through more traditional means.
Much has been written about the rise of artificial intelligence in recent years. From the emergence of drones and driverless cars to robots that can deliver medicine to hospital patients, the opportunities seem boundless and we are entering a period where the benefits are becoming tangible.
This is true equally in the realm of Fintech with the rise of what are being called “robo-advisors”, troops of financial advisors who are not actually people but rather are bits of software that are able to take in certain data and from this data formulate basic financial plans for consumers. Because robo-advisors are not capital intensive they can provide advice for a fraction of the price of a human financial planner.
Although the first “robo-advisers” seem to offer fairly simplistic advice only, these business models erode a key revenue stream for many of the more traditional financial services companies and it may be only a matter of time before more complicated advice can be dished out with the use of data analytics.
Fintech, start-ups and banks
Start-ups and emerging companies are widely being seen as the driving force behind the Fintech boom. As the Fintech industry grows, a number of Fintech hubs have appeared around the world. These hubs have primarily been targeted at incubating and fostering collaboration between groups of Fintech start-ups. Start-ups have asserted themselves in this role for a couple of reasons. Firstly, start-ups tend to be nimble and able to pursue innovations that a large, traditional organisation may not be willing to pursue. Secondly, the current wave of Fintech business models are technology-heavy and capital-light, an ideal combination for entrepreneurs who may have a great idea and technological knowhow but not much cash.
Because of the recent success of some emerging technology companies in the Fintech industry, some commentators are of the view that Fintech sounds the death knell for the traditional banking industry. While the new business models being developed by Fintech start-ups certainly challenge the existing revenue streams of banks and other financial service providers, they also provide opportunity for banks.
Fintech business models aim to achieve greater efficiencies in the provision of financial services, efficiencies that banks themselves can take advantage of, either through licensing-in or acquiring technology developed by successful start-ups, or by developing their own Fintech advancements internally. Many banks in the region and globally have set up their own Fintech incubators, from business units that focus on harnessing data analytics to in-house venture capital funds looking for the next Fintech breakthrough. The efficiencies created by Fintech may also lead to greater demand for the services of banks – for example, platforms that simplify the remittance of money overseas may in the end increase demand for those services.
The impact of regulation
A key challenge for emerging Fintech companies will be navigating and understanding where they fit into the existing regulatory environment.
At the core of this will be understanding how new business models are treated by existing financial regulation. Fintech business models that seek to disrupt mainstay financial services like lending and the taking of deposits will have a more obvious nexus to existing regulation. However, Fintech business models that are at the periphery of these services, such as new payment networks and security technologies, will also need to consider how they fit into this regulated environment. While Asian financial regulators have expressed their desire to encourage innovation in financial services and broadly seem to support Fintech, regulators will be keen to prevent a new financial crisis caused by a failure to properly regulate new types of financial services particularly where they facilitate the unsecured exchange of large amounts of capital.
Given the reliance on a lot of Fintech business models on data analytics, Fintech companies need to be aware of the myriad of new laws relating to privacy and data protection that have emerged in Asia in the last five years or so. Another related and growing area of regulation is cybersecurity. Regulators (particularly financial regulators) are putting in place tougher regulation around the IT risk management requirements for banks, and the outsourcing of business functions by banks. These laws will be relevant to many Fintech business models, as will be the reputational risks associated with cyber breaches (evidenced by a number of recent, high-profile cases).
To add to this complexity, Fintech companies with aspirations in the Asia region will need to deal with the fact that each Asian jurisdiction is approaching these issues in a slightly different way, and at a different pace of policy engagement. In some emerging markets in Asia, it is not an easy task to determine how new business models like e-payments or digital currencies fit into the existing law – early engagement with the regulator is often necessary, both to understand existing licensing requirements but also to help shape the view that regulators may take on new business models.
Fintech, although not a new concept, is quickly becoming an important industry, globally as well as in the Asia region. There are great opportunities for start-up and emerging companies who are able to innovate and create new business models while navigating the regulatory challenges that they will undoubtedly face. And, while Fintech presents challenges to traditional banks, there are certainly benefits for existing market players who can harness the efficiencies created by some of the new Fintech business models that are emerging in this latest wave of disruption.