Technology is disrupting practically every aspect of our daily lives on its way to discovering the cheapest and most efficient way of getting things done. The changes are most evident in the way we buy things, the way we travel, entertain ourselves and look after our health.
Even sectors that don’t immediately catch our eye, such as factory automation and drug discovery, are increasingly investing in technology. So how can the banking system, which is the way we move our money around, be left out?
A recent report from KPMG says that based on funding for venture capital backed financial technology (fintech) companies in the first half of 2016, total funding for the year is on track to reach $14.8 billion across 820 deals. The largest number of deals in the first half was in North America although Asia also saw a good number.
Moreover, corporate investment in fintech companies is on the rise (roughly 33% in 2Q16 compared to 23% same period last year). Another study found that the funding per deal is highest in Asia at around $34.6 million, followed by America at $20.4 million and Europe at $12 million.
Why Is Fintech a Boom Market?
Consumers welcome alternative banking platforms for a number of reasons, the top ones being convenience, price and speed of completing a transaction. In fact, an Ernst & Young survey found that the number one reason for not using fintech services was not security, or trust, or lack of technical knowhow, but a lack of knowledge about the existence of such a system. A Capgemini study found that 80% of customers that used a fintech service were satisfied and would recommend it to others.
Fintech companies are really sweetening things by using sophisticated software and leveraging big data, analytics and the Internet to deliver services to customers when and how they need it. Scaling is also more efficient because they use online resources.
On the other side of the equation, banks have problems of their own that make it difficult for them to stop the onslaught by fintech companies.
The first big problem is their huge operating cost stemming from multi-layered management structures and large offices in prime locations. High overhead costs means they have a hard time competing with flexible technology companies focusing on niche areas and lower cost of operation.
The second big problem is that they are part of a highly regulated industry. While regulations are necessary, they affect the banks’ agility, innovativeness and ability to compete effectively. This has led to an industry where the major players offer more or less comparable services at more or less comparable (and high) prices.
Where Is Fintech Innovation?
Mobile and electronic payment systems are mushrooming all over the world, eating into the payments processing business that once belonged to banks. Many banks have been slow to offer mobile banking facilities while others didn’t initially consider this a major threat. But today, the ease of making and receiving payments has set the tone for far greater disruption of the banking industry:
Peer-to-Peer (P2P) Lending
Fintech companies in this area generally offer a platform that connects lenders and borrowers much the way that companies like Amazon and eBay (EBAY) connect buyers and sellers on their shopping sites. The market is huge with some regional variations. In China for instance, lenders and buyers are both individuals (the way this model was initially designed). In the U.S. however, 80% lenders are institutions that leverage the fintech company’s platform and networks to access customers (PWC report, May 2016).
The most popular P2P platform providers are currently Lending Club, Upstart, Prosper Marketplace, Funding Circle, CircleBack Lending, Sofi and Peerform. Of these, Lending Club is the largest and most established, having processed the most (loan size goes from $35K for individuals to $300K for businesses).
Upstart (founded by ex-Googlers) and Peerform (founded by Wall Street executives) offer loans on not just credit profile but also other criteria. Upstart’s annual percentage rate (APR) starts at 4.7% and is particularly popular with young professionals and college goers. Prosper’s personal loan categories are somewhat unusual: military, wedding, baby and adoption and engagement ring.
Crowd funding, as the name suggests, is a way for small companies, projects and people with ideas to raise funds from family, friends, unknown investors and/or customers. The crowd funding company provides the platform and may also check the projects’ feasibility before fielding it to prospective investors. The most popular crowd funding organizations are Kickstarter, Peerbackers, CrowdCube, Crowdfunder, Seedrs, Indiegogo, GoFundMe and Tilt.
The concept started with President Obama’s JOBS Act that sought to increase funding to small businesses. While these businesses stand to benefit from funds flow, raising funds from the public requires better record keeping, which is an added headache. Still, it has been reported in the media that globally, the concept attracted $34 billion in 2015, more than double the amount raised in 2014. Moreover, these growth rates are expected to continue.
Robot Financial Advisors
Quite simply, not all financial advice is complicated, not all of it is subjective either. So it’s possible to create bots that automate this advice on investments or management strategies based on their pre-programming. The only problem is cost: a Morningstar analyst estimates that robot-advisors need between $16 billion and $40 billion in assets under management to break even, so it’s important for this kind of fintech companies to combine with big financial institutions and banks because they are the only ones with the resources (CNBC reports).
UBS Group recently agreed to give robot company SigFig’s tools a shot by deploying its technology across all of its 7.1K employees. UBS is one of the world’s largest wealth management firms by global assets under management. Vanguard Group and Schwab also entered the robot-advice market last year. Other financial management companies are acquiring startups to bring the technology in-house, for example Jemstep by Invesco, eMoney by Fidelity Investments, LearnVest by Northwest Mutual Insurance and FutureAdvisor by BlackRock.
While crypto currencies like bitcoin have been around for a while, bitcoin exchanges have been hacked with users losing millions. But the digital currency is itself of relatively small value, with most companies interested in the underlying blockchain distributed ledger technology. Banks and technology companies like Microsoft , IBM and now even Intel are teaming up to study use cases for this technology, as it could speed up transactions and reduce fraud by improving the authentication system.
Securities trading, registration of assets and bank transfers are currently being tested. Use cases will likely continue to unfold (UBS has said it is testing 20 such use cases and incubating ones that hold greater promise).
Technology companies continue to grow into the space with startups of every hue and some big companies branching out like Alibaba’s Ant Financial and Tencent’s WeBank.
Banks are pouring money into technology across North America, Europe and Asia and collaborating with technology startups or buying them outright. JP Morgan has partnered with online lender One Deck, Goldman Sachs has bought online advisory company Honest Dollar, BNP has partnered with crowd-funding startup Smart Angels, while BBVA of Spain has bought out the Finnish start-up Holvi.
This story is just getting started.