Financial Technology – FinTech

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Table of Contents
  • What Is Financial Technology – FinTech?
  • Understanding FinTech
  • FinTech in Practice
  • FinTech and Bank Collaboration
  • FinTech Landscape
  • The Tech Invaders
  • Unbundling and Rebundling of Financial Services
  • FinTech Users
  • Regulation and FinTech
  • Beyond FinTech

What Is Financial Technology – FinTech?

Financial Technology, also known as FinTech, is the evolving intersection of technologies and financial services where technology plays a crucial role in improving and automating the delivery of financial services. Turning to Wikipedia, which reviewed more than 200 scientific papers, FinTech is defined as a “new financial industry that applies technology to improve financial activities.” At MEDICI, we have been tracking FinTech since 2013 on an ongoing basis. MEDICI was one of the earliest to lay down the comprehensive taxonomy for FinTech, which we will discuss later in this article.

FinTech is a broad term and has a long history. Think of credit cards in the 1950s, ATMs in 1960, electronic stock trading in the 1970s, and bank mainframes in the 1980s and so on. FinTech has been around ever since financial services came to be, just that the technology was different. Other developments that took place during this time were advancements in tools for risk management, treasury management, data analysis, trade processing, amongst others at the institutional level. We take some of these for granted now, but these were landmark victories for the industry. Mastercard, Visa, and Bloomberg were some of the original FinTechs, and these companies now fall under the large FinTech segment.

The word “FinTech” was coined in the early 1990s to define technologies that went into building the back-office of banking and finance operations. However, it wasn’t until the 2008 financial crash that the word “FinTech” picked momentum outside the finance world. This was due to VC firms investing heavily in FinTech startups that would serve as an alternative to the failed financial system.

FinTech includes a vast range of products, technologies, and business models that are enabling, enhancing, and disrupting the Financial Services industry. Financial technology not only includes FinTech startups, but also tech companies like Apple and Alibaba with products like Apple Pay and Alipay, and legacy providers like banks and insurers that are embracing new technologies.

Understanding FinTech

While FinTech initially referred to the back-end technology of banks or other financial institutions, it has grown much beyond to encompass a range of consumer-focused applications. According to EY's 2019 FinTech Adoption Index – “adoption of FinTech services has moved steadily upward, from 16% in 2015 to 33% in 2017, to 64% in 2019."

Source: EY's 2019 FinTech Adoption Index

FinTech aims to use technology and innovation business models to either improve existing financial services by enhancing capabilities, improve convenience, or lower prices and fees for consumers or create a whole new service such as peer-to-peer lending and mobile-phone payments.

FinTech is continuously evolving and encompasses a variety of financial activities like crowdfunding for raising capital for a business startup, money transfers, digital lending, investment management using robo-advisors, cryptocurrency, and many others that we will cover in this article.

Today, FinTech is a multi-billion dollar industry. Silicon Valley, London, China, and India are some of the markets that are burgeoning with FinTech startups. While the internet boom and smartphone penetration helped in FinTech adoption, some of the other technologies used include artificial intelligence & machine learning (AI/ML), blockchain, cybersecurity, big data & robotic process automation (RPA), APIs, IoT, biometrics, and cloud computing.

FinTech in Practice

There are more than 13,000 FinTech startups globally (excluding China) that are trying to provide better financial services. Let’s look at what makes these FinTech startups successful.

Some qualities set FinTech startups apart from traditional financial services. For one, FinTech plays a huge focus on customer-centricity by designing apps that place a high emphasis on user experience, simplicity, convenience, and ease-to-use. Secondly, FinTechs have tapped into an unserved/underserved segment that was traditionally ignored by large FIs such as small businesses, millennials, and low-class households. Thirdly FinTechs don't have legacy IT that slows down development and are not as heavily regulated as banks/FIs. Startups use the latest technologies, allowing them to be more innovative than incumbents. Startups are nimble and can easily pivot solutions & infrastructure as well as directly develop products/solutions for digital channels and fulfillment. 

Let’s look at a few use cases and how FinTech startups have come up with innovative solutions to create value for consumers:

  • Earlier, consumers, especially migrants working abroad, would bear a significant amount of fees in performing international money transfer using traditional banks and money transfer services. Now companies like TransferWise and InstaReM are streamlining international money transfers, disrupting the remittances sector by offering a substantial reduction in money transfer fees, greater transparency, and faster transfer.
  • Think of an alternative for a credit card, where you are not dependent on a bank to issue you a card based on your profile/credit score, which can be a big challenge for consumers with no or poor history like young consumers. Klarna, one of Europe's highest-valued FinTech companies, innovated the online shopping experience by pioneering the concept of ‘buy now, pay later.’ Klarna works as an alternative to a credit card by providing instant interest-free financing, which is typically paid off in installments, allowing consumers to try out the product. In contrast, the retailer gets paid in full. Additionally, there are also payment services like PayPal that automatically convert currencies, so a customer in America can purchase goods from a maker in Asia. 
  • Can’t get a business loan approved? Applying for business loans, especially for small businesses, can be a nightmare. The typical process requires a lot of paperwork, red tape to cut through, lengthy meetings, and weeks to get the loan approved or to learn that your loan application has been rejected. Incumbents don’t make money on small-business loans or are afraid of the risk. Instead, Kabbage, a US-based startup, got over these inefficiencies by building an automated platform that evaluated the creditworthiness in a few minutes. Kabbage uses a large set of data points to determine a customer's creditworthiness instead of relying on credit score.
  • Typically low-income families are unable to access insurance. Now companies like BIMA are bringing mobile-delivered insurance and health services such as microinsurance, personal accident & hospitalization insurance, and prepaid tele-doctor services to underserved customers in emerging markets.
  • Traditionally banks deploy hundreds of humans for anti-money laundering investigations. Now B2B companies like Ayasdi use technologies like AI/ML to decrease this investigative volume.

The next frontier of innovation in the financial services space is the rise of neobanks (also known as challenger banks) or digital banks that are transforming the banking landscape as we know it. Most of them tend not to have physical branches, with services provided online and on mobile. Neobanks are often focused on underserved/unserved segments in SME/retail. For more than 1 billion people worldwide without bank accounts, FinTech now provides an agile option to participate in financial services without the need for banks with physical locations. Neobanks offer innovative features and offerings that are different from traditional banks, including fast account opening, free debit card, instant payments, cryptocurrencies, lower costs, mobile deposits, P2P payments, mobile budgeting tools, user-friendly interfaces, etc. E.g., Nubank from Brazil, one of the highest-valued neobank globally, does not charge fees for its credit card usage. At the same time, Revolut, another European high-value company, enables consumers to hold, exchange, and transfer up to 25 currencies via the Revolut app without charging a fee.

Here is a regional breakup of neobanks globally:

Source: Neobanks – A global deep dive

FinTech and Bank Collaboration

Think of it as cable companies losing their market share to streaming companies like Netflix, Wikipedia replacing encyclopedias, and LEDs replacing incandescent light bulbs. 

FinTech companies have reached the potential to disrupt any service form the financial services value chain, and this landscape is continually evolving. The fierce fight for customer acquisition and retention have pushed the incumbents to reevaluate their strategies. But consumer trust is also at stake, and after the financial crisis, incumbents have taken several steps to safeguard that.

But banks and insurers have been quick to react, and the outcome of this disruption could be different. FIs are in the process of digital transformation to reimagine their core services & products, as well as back-end & front-end processes. Most FIs have innovation departments, and many have also launched the VC arms for investing in startups.

Instead of competing with each other, both incumbents and startups realized that the power in collaboration is far greater. FinTech startups have access to the incumbents’ customer base and years of regulatory knowledge, whereas the FIs have the opportunity to provide enhanced and new services while increasing revenue at a reduced risk and faster time-to-market. FinTech startups have seen a continued uptake in terms of investments, M&A, and deals with banks/FIs. While collaboration is on the rise, many incumbent financial institutions have developed their own comparable digital offerings to compete with this FinTech tsunami. Take, for example, DBS, one of Asia's leading banks, which launched digibank in India. In 2016, it was India’s first digital-only bank and provided a branchless experience. It offered paperless and signatureless account opening in 90 seconds, account conversation to savings account, budget optimizers, and a 27/7 virtual assistant powered by AI.

There has been a positive outlook for Bank-FinTech collaboration, and here are some samples of such partnerships and JVs:

Source: Banking on FinTech: Positive Outlook for Bank- FinTech Collaboration in 2019

FinTech Landscape

FinTech propositions, as we know them today, are either disrupted or invented. Disrupted services were existing services, such as lending, remittances, etc., that were offered by incumbents. Startups are now creating more attractive versions by making them more effective and convenient, that too at a cheaper cost. Invented services are services that did not exist before, like P2P lending, robo advisory, cryptocurrency, mobile payments, etc., which are now possible because of new business models and the latest technologies.

New entrants also include InsurTech (Insurance Technology) and RegTech (Regulatory Technology), which includes technological and business model innovations in the Insurance and Regulatory & Compliance space.

FinTech is continuously evolving and broadly comprises of these verticals:

MEDICI has been tracking over 13,000 Financial Technology startups globally (excluding China) across 18 segments. Here is a breakdown of startups across these segments as of April 2020. WealthTech, Payments, Lending, and InsurTech have the largest number of FinTech startups.

Payments, Lending, InsurTech, and Digital/Neobanking have been among the top-funded segments in FinTech so far. The year 2019 saw $45.72 billion in funding across 2262 deals.

Source: A Detailed Analysis of the Past 26 Months’ FinTech Funding Rounds

The tech invaders

Tech companies such as GAFAM and BAT (Google, Amazon, Facebook, Apple, Microsoft, Baidu, Alibaba, Tencent) are making huge dents in financial services globally. With superior technology, better customer experience, and colossal data pools, these are the new invaders that are beginning to show signs of leading the next wave of FinTech. WeChat and Amazon have seen growing traction in lending services. The Chinese Moghuls – Alibaba, Baidu, and Tencent – already have a significant head start with their FinTech initiatives.

Source: Neobanks – A global deep dive

Unbundling and rebundling of financial services

The first wave of disruption, i.e., “unbundled financial services,” commenced when startups created individual products around a piece of the banks’ value chain in specific areas such as lending, payments, investment advisory, etc. These new products were better and cheaper than the ones the incumbents offered.

This model suffered as customers wanted other products. The experience for the customer was too dispersed and suffered from a poor value proposition – going to different point solutions for various needs. The market size was limited due to monoline offerings, and competitors had started crowding the market.

What came next was the rebundling of financial services, and we’re currently witnessing this phase in financial services.

  • Incumbents: Traditional FIs are trying to create an ecosystem around them by partnering with startups to bring in efficiency, jointly launch new products, and improve customer experience, etc. The bank of the future could look like this:

Source: What Will be the Bank of the Future? 2016 View Vs. Now

  • Challenger Banks/Startups: To capture a large part of the value chain, many challenger banks (neobanks) and large startups realized they must provide a range of services for their customer needs. Some applied for their banking licenses while others partnered with sponsor banks. Learn more about how large FinTechs are rebundling and becoming banks.

FinTech Users

There are two main types of FinTech users: business users and consumers. These can be further broken down into:

  1. Consumers 
  2. B2C for small business
  3. Banks business clients 
  4. B2B for banks

Consumer adoption is increasing as smartphone penetration rises. E.g., India has consumer lending companies like money transfer services for consumers such as TransferWise or Robo-advisors like Betterment. These companies provide mostly automated financial advice and investment management to consumers and are examples of what B2C companies. B2C companies typically target millennials, small businesses, and other underserved segments that are not well served by traditional FIs. For example, consumer lending companies in India have seen good growth in their user base between 2018 and 2019.

Source: India’s FinTech User Base – Growth Story

An example of a B2B company is Stripe, which combines software and hardware to allow merchants to turn mobiles & computing devices into POS solutions. Another example is Trulioo, which provides identity verification services that allow organizations and companies to run global identity checks.

Regulation and FinTech

The financial services industry is among the most heavily regulated industries in the world. To ensure the integrity and stability of the financial system, financial institutions are subjected to certain restrictions, requirements, and guidelines. The goal is to prevent all stakeholders from risk and fraud. After the Global Financial Crisis (2007-2008), banks had to comply with hundreds of thousands of pages of compliance. The cost of compliance and unparalleled regulatory fines imposed by regulators (due to market manipulation, mis-selling, forex abuse, sanction contravention, and rogue traders/agents, etc.) has made a serious dent in banks’ profitability. Globally, banks are spending in excess of $270 billion per year on compliance and regulatory obligations, having an average of 10–15% of their staff dedicated to compliance.

Source: https://gomedici.com/uploads/RegTech-Top-21.pdf

Evolution of newer FinTech models have introduced a new level of complexity for the regulatory ecosystem – Should these news FinTechs be regulated? What framework should they be regulated under? Do they pose a risk to the financial system? And other such questions. Regulators have established FinTech sandboxes and run hackathons to evaluate the implications of the latest technologies and business models. FinTech segments, such as lending and cryptocurrency, are drawing regulators’ attention.

Dealing with regulations has always been a cumbersome task for financial institutions. RegTech, or Regulatory Technology, can play a vital role here. RegTech uses innovative technologies like AI/ML/NLP, big data analytics, RPA/IPA, cryptography, biometrics, DTL, etc., to facilitate the delivery of regulatory requirements more efficiently and effectively compared to the existing compliance capabilities. There are over 800+ RegTech startups globally.

Financial services regulators are also joining the tech bandwagon. Regulators are now dealing with massive amounts of data, different formats of reporting data that they receive from the FIs they regulate, which increases the complexities for data analysis. This makes a great case for supervisory technology (SupTech) adoption. Supervisory technology (SupTech) is the use of innovative technology by supervisory agencies to support supervision.

While regulators are adopting the latest technologies themselves, they are also rolling out new regulations to transform the banking landscape and create a level playing field for new entrants. Two new European regulations, PSD2 (Revised Payment Services Directive) and Open Banking, mandate banks to create open APIs to enable authorized third parties to use bank-held customer data (based on customer consent) to create a whole new world of possible innovations to give consumers a greater choice for their financial services need. This will break banks’ monopoly on customer data and give consumers a greater choice on their own data. Another recent EU regulation that gives greater control to consumers is the General Data Protection Regulation, which is a framework for collecting and using personal data.

Beyond FinTech

FinTech not just touches the financial services industry, but every business the financial services industry deals with (pretty much all of them). As incumbents are grappling with what the next wave of financial services will look like, they are also eyeing startups that are ‘Beyond FinTech’ those which focus on making an impact in the movement of goods/services across vital economic sectors (agriculture/health/real estate/energy among others). “Beyond FinTech” refers to a variety of areas including but is not limited to AgriTech, PropTech, HealthTech, CleanTech, EdTech, and others.

A lot of companies today are becoming FinTech companies. This is being done for various reasons like customer engagement, monetization, etc. The availability of financial infrastructure APIs today makes this possible such that companies like Grab, Swiggy, or Ola can launch their own wallets, lending, credit cards, and insurance products.