Small Fintech Players- Friends Or Foes?

Summary

• Fintech boom is here to stay.
• Key trends of fintech include P2P, DLT, invisible payments and robo-advisory.
• All core banking businesses have been disrupted and need to adapt very quickly in order to survive.

“The reasonable man adapts himself to the world; the unreasonable one persists in trying to adapt the world to himself. Therefore, all progress depends on the unreasonable man.”- George Bernard Shaw

George Bernard Shaw was onto something when he said that. In the financial services sector, which now also includes the fintech companies, the “unreasonable man” is most certainly the fintech companies.

Tracing the steps of the fintech journey post-2008:

In order to fully appreciate the explosion of fintech and how it quickly became the “unreasonable man”, let me take you back to the Global Financial Crisis (GFC) of 2008. Not only did the GFC lead to catastrophic events such as failure of key businesses, then-unprecedented unemployment rates and a prolonged downturn in economic activity, it also served as a catalyst to the growth of the fintech sector.

The immediate aftermath of the GFC led to:

1. Growing mistrust of global financial institutions
2. Post-crisis regulatory reforms which led to a financing gap as more capital had to be held against loan portfolios
3. Reduction in the ability to take risks and low interest rates also led to margin pressure. The financial institutions then started downsizing mid/back office operations and started exploring ways in which technology can be used to reduce costs
4. New generation of highly qualified fresh graduates facing a difficult job market[1]

Combine this with the technological innovation of 2000s (such as camera phones, bluetooths, iPhones and cloud computing just to name a few) and an explosion in the smart phones/ internet penetration rates, you get a unique cocktail that kickstarted the current fintech revolution.

In the beginning, many financial industry executives were consumed by the threat that these non-traditional financial technology companies posed. Many fintechs were heralded as disruptive competitors that could overturn the industry’s existing business models and grab significant market share, perhaps even driving some well-known players into irrelevance.[2]

We have since moved on and entered a new chapter in the evolution of the financial technology sector. The financial institutions are now more accepting and are seeking more opportunities to team with these emerging technology companies in order to gain access to new markets and products, greater efficiencies, or just to introduce more innovation. At the same time, many fintechs themselves have sought to join hands with large financial players to expand into markets, gain industry and regulatory knowledge or simply to cash out.

Exhibit 1[3]- Explosion of fintech deals since 2013

In the remainder of this article, I will be discussing:

• Key trends in the fintech sector
• Impact on core banking businesses
• Multiple pathways for achieving fintech deals
• Promising fintech players globally that provide banks with collaboration opportunities

Key trends in fintech sector

Both the financial services firms and investors are keen for deals in various areas of fintech, as players try to come to terms with new and evolving technological capabilities and react to changing consumer and infrastructure dynamics. Although there are a number of exciting technologies that have taken the fintech space by storm, I will center around peer-to-peer (P2P), blockchain and distributed ledger technology (DLT), invisible payment services and robo-advisory in this article.

P2P’s growth prospects continue to thrive, especially in this era of low interest rates and demographical shifts. According to research from Liberum, people lending money via P2P platforms can gain returns in excess of 5 per cent per year as compared with the average base rate of 0.25 per cent.[4] Additionally, as developed countries experience an aging population, consumers are increasingly looking for investment products that generate higher returns than traditional savings accounts offered by banks. At the same time, millennials, which are about one-third of the global population[5] are having a profound impact on the consumer loan market due to their unique requirements. They are seeking credit to finance major purchases and refinance their student debt. They are also hungry for a simplified, streamlined lending process and peer-to-peer is filling that unmet need.

Blockchain and Distributed Ledger Technology (DLT), is still being viewed with caution but it holds great promise for banks. Blockchain technology records data by saving it in an open-access database maintained across thousands of computers and it has the potential to significantly enhance the security and speed of transmission of financial data. This is already attracting a lot of attention from major firms such as Standard Chartered investing in distributed ledger specialist Ripple in September 2016 and Santander also collaborating with Ripple to launch the first blockchain-based money transfer service in 2018.[6]

Tech company R3 CEV, meanwhile, has also secured deals with over 50 of the world’s leading financial institutions to join a consortium tasked with investigating possible applications of DLT. R3 has already gained some noteworthy experience in this area by already working with 11 global institutions on experimenting the exchange of tokens across a private network without the need for a third party verifying the transaction.

Invisible payment services, meanwhile, remains a hotspot too, albeit a maturing one. With the increasing need for a convenient and efficient mechanism to reduce the time spent in completing transactions[7], invisible payments take physical payment methods such as cash and cards completely out of the equation. PayPal and Alipay are billion-dollar public companies; tech giants Apple and Google have also moved into this space using their technology platforms; and there is still a lively ecosystem of smaller players, such as iZettle and Stripe, that are doing well.

This is tempting investors, with private equity firm TCV injecting US$180 million into cross-border payments company Payoneer. Payment applications like Payoneer are providing consumers with multi-bank access through a single platform. Credit and equity funding are also being raised using digital P2P platforms and crowdfunding. There is huge scope for future deal-making across all of these areas, as institutions move to buy in technology and understand evolving market trends.

The financial services industry needs to take a page out of Uber’s and Deliveroo’s playbook, who have driven the wider application of such payments in order to stay up-to-date with changing consumer trends.

Robo-advisory services are on the rise. According to Deloitte, there are around 100 robo-advisors in 15 countries around the world. According to McKinsey, there are 42 million households globally which represent about $66 billion in annual revenues. These households are prime candidates for robo-advisory:

Exhibit 2- Estimated market size of virtual advisory[8]

Robo-advisory accounts are designed to automatically rebalance allocations among asset classes when pre-determined thresholds are hit. The performance of robo-advisory accounts has not yet been tested in a full market cycle but recent market volatility has revealed their effectiveness.

Impact on core banking businesses

Retail banking

Payments are a key revenue stream for retail banking. Not only are they important in anchoring client relationships but they are also critical for cross-selling as banks can use the payments data to cross-sell a range of products such as loans, savings accounts, mortgages and credit cards.[9]

Exhibit 3- Invisible payments and opportunities for cross-selling[10]

Currently, the banks seem to be in a reactive mode and are behind when it comes to innovation in the payments space. Only a handful of banks have shown any progress in this area. One such banks is BBVA which has essentially transformed mobile payments in the countries it operates it.

[11]

Exhibit 4- BBVA digital payment footprint[12]

The cross-selling model can also be further refined by the data and predictive analytics capabilities that come with fintech innovation.

Improving this digital experience both in terms of payments and better product predictions will lead to more satisfied customers.

Investment banking

The fintechs have been able to disintermediate traditional players in the retail financial services space but the rules of the game will be different when it comes to Investment Banking. This is due to the high barriers to entry which limits the possibility of fintechs to grab the market share of investment banks. Collaboration, and not competition is the way forward here.

All internal and external stakeholders such as shareholders, customers and regulators are exerting pressure on firms to reduce their structural costs. A part of this cost base is “sticky” such as the costs related to the implementation of regulatory compliance measures. However, there is still room for further cost-cutting. The most likely scenario in this situation is that firms will experience a squeeze[13] in which the assets under management (AUM) will increase but the margins will continue to shrink.

The middle and back office costs will be the first to be slashed using process automation techniques. Typically, costs can be reduced by 50% to 70% for high-frequency tasks (one-third of the cost of an offshore FTE) such as those performed in Research and Advisory teams. Process automation will also lead to increased productivity (automated solutions can work 24/7). The firms of the future will essentially create value from harnessing large amounts of data.

Distributed ledgers will also cause firms to rethink their business models. These ledgers also have the potential to reduce costs and transaction times while improving data security, control and auditability.[14] Firms are increasingly looking into DLT technology and how it can be leveraged for trading financial instruments. As well as optimizing existing trading processes, tokenization is another emerging theme. Instruments that can be tokenized can potentially be securitized and therefore also collateralized.

Asset Managment (AM) & Private Banking (PB)

I believe the impact of fintech on both AM and PB will be quite similar albeit with a few subtle differences.

First, let’s have a look at the common aspects.

Currently, the fee structure of AMs and PBs is very high. This is one of the reasons why these sub-segments are the most profitable in the banking industry.[15] As predictive data analytics and process automation become the norm, there will be a significant reduction in manpower which will drive down costs. Far more people will be able to access these services as the fee structure becomes more favorable.

Firms would also be able to harness these digital technologies and come up with new offering and products so that they are able to meaningfully differentiate from the competitors which would again benefit the customers.

Robo-advisory has also started to create a mark. Financial services firms such as J.P. Morgan, Charles Schwab and BlackRock have already started rolling out robo-advisory services and the results have been quite good. Customers and particularly the millennials are very receptive to the offering. Not only is it the requirement of the customer from an efficiency perspective, this also results in cost reductions which will be a prominent theme in the future.

The area that distinguishes the future private banking business from the asset manager is the importance of the human element in PB. This becomes even more important the wealthier the client. High-net worth and ultra-high network client relationship managers will hold on to their jobs as no machine has been able to replicate the human touch- at least for now!

Multiple pathways for achieving fintech deals

Investing in fintech by utilizing separate corporate venturing arms or bespoke fintech funds continues to be a valuable tool for exploring the market and buying in technology. Much of BBVA’s activity in this area, for example, conducted by its corporate venturing arm, BBVA Investments.

Similarly, Santander also announced in mid-2016 that the bank would double its investment in InnoVentures, its London-based fintech venture fund, to US$200 million. This fund specializes in taking minority stakes in upcoming and promising fintech startups with an aim of integrating new technology into Santander’s banking processes. American banks such as Citigroup, Goldman Sachs and J.P. Morgan also have venture investment capital investment arms.[16]

Banks form these kinds of strategic partnerships with the start-ups to use their technology, and much like venture capital does, they profit in the future if these investments take off.

Several banks such as Citi and J.P.Morgan have supported incubators and accelerators by providing mentoring, office space and access to other resources. An incubator model is a good way to see what is going on and build relationships. An established bank can guide a startup through development and if a product gains traction, the bank will have a good understanding of how to fit the technology into its business.

Another option for banks is direct equity investment. Rules such as the US Bank Holding Act and the Volcker Rule that were put in place after the GFC, placed restrictions on the size and the nature of equity investments that banks can make. These rules prohibited the total equity investment to a maximum of 5 per cent of a non-bank subsidiary and also restrict investments in covered funds, making it difficult to dip into fintech in this way. Last week, it was announced that the regulators plan to roll back post-financial crisis restrictions, including the Volcker Rule.[17] More to come on this so watch this space.

With so many approaches available, it’s important to recognize that there is no one way to explore opportunities in the fintech space. Institutions are starting to recognize this and are taking a multi-pronged approach to maximize their chances of success.

Fintech players globally that provide banks with collaboration opportunities

Theme	Potential fintech investments	Value Proposition	Key Resources	Risks	Revenue streams
P2P	Viainvest	1.) Delivering credit to those who had no access2.) Provides instant eligibility for financial products3.) End-to-end paperless transactions4.) Low interest rates	1.) Proprietary and non-proprietary technology2.) Existing business network	1.) Biggest risk as a nano-finance/P2P venture is bad debts	1.) Processing fee charged per loan transaction2.) Loan fees charged on every loan
	Lendity
	Oxygen
	Kasahat
	Bank Bazaar
	Paisabazaar
	Agora
	Bucksapp
	Pipe
DLT	ZeFi	Future general-purpose technology applicable to all walks of life. There is a tremendous potential to make customer experiences both memorable and efficient	Enhancement of post-trade services, compliance processes, trade finance, FX transfers etc. by supporting digital currency transactions	1.) Governance and regulation of DLT networks in securities markets is a key concern2.) Banks will need to get rid of legacy systems in order to incorporate DLT tech	Subscription fees for usage of lending, payment, insurance and trading platforms
	DeFiner
	Stone Co.
	Fiserv
	Wakandi
	Inviou
	JD Digits
	Coinbase
	Bankera
Invisible payments	Grab	Cardless and cashless money transactionsDigital wallet optionsElectronic payment services	A harmonized payments platform allowing businesses of all sizes a good scalability optionImpressive growth in transaction and subscriber volume	Some consumers may have privacy concerns when sharing data online	SubscriptionsRegistrations
	Ola
	Gojek
	Klarna
	Stripe
	Afterpay
	Clik
Robo-advisory/ digital wealth management	Raisin	1.) First mover advantage- already ahead of the pack2.) Personalized experience- investors can easily invest in themes they are attracted to (e.g. ESG companies, emerging markets etc.)	1.) Knowledgeable human capital2.) Cutting-edge technology that they have used to create memorable customer experiences	Every customer is different. Robo-advisory services may be unable to capture the differences of every individual effectively.	Annual/ subscription feeInvestment fund costs
	Wealthsimple
	Robinhood
	Wahed Invest
	Folio
	Arbor
	Finanbest
	Finhay
	Forwardlane
	Multiply

Concluding thoughts

Gone are the days when fintech was just a buzzword. The wide range of technologies that are now available and their possible use means that all countries can benefit from the technological innovations in financial services. This can lead to more satisfied customers, enhanced productivity and more efficient financial institutions.

Fintech encompasses many sub-segments, such as P2P, DLT, invisible payments and robo-advisory/digital wealth management. The rules of the game have changed and the core banking businesses will have to adapt in order to stay relevant.

Financial services across the globe recognize the value that fintech can bring to their businesses. Instead of competing with each other and the nimbler fintech startups, stakeholders will have to work together on deals to ensure that the new technologies can be used across the industry.

There are many pathways available for meaningful collaboration. Minority stakes, majority stakes, direct equity investment and joint ventures are some of the options that institutions will continue to use to explore the market and staying abreast with the latest technological developments. For banks that are restricted by regulation from investing through funds, incubators and accelerators offer an effective alternative.

Technology disruption can be both a challenge and opportunity, so it’s important to have both the agility and speed to make smart technological investments, while navigating highly regulated industries such as financial services.

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[1] U.S. recovers all jobs lost in financial crisis

[2] Fintech Trends Signal Imminent Disruption

[3] Fintech Fundraising Grew Strongly in Most Major Markets in 2019, Accenture Analysis Finds

[4] https://www.lendacademy.com/wp-content/uploads/2014/03/Liberum-AltFi-Pres-11th-Mar-14.pdf

[5] https://www.bloomberg.com/news/articles/2018-08-20/gen-z-to-outnumber-millennials-within-a-year-demographic-trends#:~:text=Millennials%20are%20about%20to%20be,2001%20as%20the%20generational%20split.

[6] Everything You Ever Wanted to Know About Fintech 3.0 and its Impact on the Banking Sector | Hacker Noon

[7] https://www.pwc.in/assets/pdfs/consulting/financial-services/fintech/point-of-view/pov-downloads/invisible-payments.pdf

[8] https://www.mckinsey.com/~/media/McKinsey/Industries/Financial%20Services/Our%20Insights/The%20virtual%20financial%20advisor/The-virtual-financial-advisor.ashx

[9] https://www2.deloitte.com/content/dam/Deloitte/mt/Documents/financial-services/dt_mt_payments_disrupted.pdf

[10] https://www2.deloitte.com/content/dam/Deloitte/mt/Documents/financial-services/dt_mt_payments_disrupted.pdf

[11] Dissecting digital payments: how they are evolving around the world

[12] Dissecting digital payments: how they are evolving around the world

[13] Capital Markets Vision 2022, Accenture

[14] https://www.ey.com/Publication/vwLUAssets/EY-capital-markets-innovation-and-the-finTech-landscape/$FILE/EY-capital-markets-innovation-and-the-fintech-landscape.pdf

[15] https://financialservices.accenture.com/rs/368-RMC-681/images/accenture-capital-markets-vision-2022.pdf

[16] Wall Street banks are upping bets on their potential fintech competitors

[17] Bank Stocks Surge As Regulators Ease Volcker Rule, Morgan Stanley Jumps Over 2%