Fintech: friend or foe?
Despite the 2008 global recession and slowing population growth, the continued rise in global gross domestic product paints a profitable picture for fintech start-ups. According to a study by the Center for Financial Inclusion, global GDP is predicted to reach $85 trillion by 2020 – a four-fold increase over four decades. This rise in real incomes across all regions of the developing world will translate into greater demand for financial services.
Many of today’s banks and other financial organisations are still stuck in post-crisis mode, grappling with current and pending regulatory changes, bloated business models and shrinking profit margins. As such, investing in new technologies to better meet their business and customer needs has been very low (or non-existent) on the priority list. This complacency has opened the door for innovative thinkers to come through with better, faster solutions that address most organisations’ legacy technologies and complex processes.
Leveraging open source software, mobile, cloud and digital technologies, these new competitors are providing intuitive apps and tools, streamlined processes and a fresh approach to a usually monotonous services industry, and in the process, they are changing the game and turning the financial services world upside down.
From payments to wealth management, from peer-to-peer lending to insurance, emerging fintech initiatives threaten to grab $4.7 trillion in revenue and $470 billion in profits from traditional Wall Street firms. Moreover, with heavy financial backing – $12 billion in fintech investments in 2014, up from $4 billion the prior year – this digital evolution can no longer be ignored.
While open source software, an agile delivery process, cloud technology and mobile computing form the foundation of the fintech sector, its explosive growth has been driven by significant changes within the financial services industry. As a result, most established organisations have been either too busy (particularly with regulatory changes), too cash strapped, too inflexible or just unable to address changes on their own. Seeing an industry ripe with opportunity, innovative start-ups have quickly stepped in to fill the void. Here are five main issues that have helped fuel the fintech evolution:
Eye not on the ball: changing regulatory landscape
Stringent regulatory changes over the last few years have increased reporting, transparency requirements and costs for all capital market participants. Many firms invested heavily in their legacy systems to meet requirements, but did little to streamline their processes or improve their analytical capabilities.
Given the industry’s shortcomings, new technologies have emerged to focus on institutional-only problems. Examples include Algomi, which leverages social concepts to ease bond trading, and Tradier, which provides full-fledged brokerage services as APIs.
No money: shrinking budgets and margins
In response to a wave of new regulations, most organisations made significant investments in their legacy systems and point solutions to achieve compliance. With rising cost pressures and shrinking profit margins, companies know they need newer and less costly delivery models but most have little to invest in new technology initiatives.
Fintech companies, unencumbered by complex systems and processes, are looking at all areas of finance for opportunities to simplify and successfully improve margins. For example, Roostify is tackling the mortgage business by taking the traditionally complex process of buying a home and turning it into a streamlined, instant online process. Their cloud-based service helps lenders process loans faster and reduces risk, while improving the homebuyer’s experience.
Falling behind: shifting customer preferences
Mobile technology and social media, rising customer experience and service expectations as well as lower switching costs for customers to take their business elsewhere have dramatically changed the competitive landscape for banks and other financial services companies. Strongly held by legacy systems and rigid business models, many organisations are finding it nearly impossible to deliver sophisticated, technology driven solutions to meet their customers’ changing preferences. Fintech start-ups have quickly stepped in.
One such area is wealth management. Here, roboadvisors Wealthfront and Betterment are attracting young investors interested in financial advice yet seeking simplicity and speed. Betterment now manages $2.2 billion for 85,000 clients, while its rival Wealthfront has amassed $2.3 billion in 27,000 accounts.
Everywhere access: growing use of mobile
Cisco Systems predicts the number of mobile users will rise to 4.9 billion in 2018 from 4.1 billion in 2013 as consumers in emerging markets come online. This continued growth in mobile users is fueling a wave of new mobile technologies, many focused on financial services, including mobile banking, payments, location-based commerce and personal financial management.
According to CEB TowerGroup, bank investments in mobile banking technologies are expected to increase at an annualised rate of 13.4% through 2017.6 While customer demands have forced most banks to develop mobile banking apps, other financial service sectors have been slower to develop mobile-specific solutions.
Predictive intelligence: increasing role of analytics
Today, companies need forward-looking, predictive insights to help shape their business decisions. This is a significant challenge for many financial services organisations that operate with siloed databases and systems. fintech companies, built from the ground up with a focus on data, are able to combine their internal data with external information, such as social media, demographics and big data, to quickly determine which efforts are most profitable, evaluate their risk exposure, streamline processes and analyse future margins. This type of fast analytical power enables fintechs to quickly improve and enhance their products, provide highly personalised offerings and strengthen their competitive positions.
As technology advances at an ever-increasing rate, customers, partners and employees of the financial services industry are demanding more in terms of exceptional service (e.g., faster access to information, personalised products, quicker response rates and transaction speeds, enhanced analytics and real-time decision support systems) and they are not willing to wait. Meeting these demands with five-year implementation plans is no longer feasible. In this age of digital transformation, agile organisations that can quickly integrate and drive innovation into the business will succeed.
Determining the right path for your organisation
Faced with a new brand of competitors, financial services organisations should quickly determine if and how these new initiatives map to their existing businesses, and whether they pose a significant opportunity or threat. The diagram above highlights one suggested path to determine how best to integrate a fintech initiative into an organisation.
Step 1: Determine the impact of the initiative on your current market.
The first step is to define the fintech initiative’s core value proposition and what impact it currently has on your market. The goal is to determine whether an initiative will be of value to your customers (opportunity), is irrelevant at this time (no impact) or provides significant value to your customers to the detriment of your business (threat). Some areas to investigate are included in the following chart.
If this initial assessment shows no impact, organisations should take a “wait and watch” position as the market and technology continue to evolve. If the initiative is clearly a threat or presents an opportunity to the business, management should move quickly to determine the best course of action (engage or defend). First, however, a company must determine how valuable the technology will be to its own business.
Step 2: Determine the value of the initiative to your business
The more areas of the business an initiative can bring value to, the higher its overall value will be. Some areas to consider are included in the chart above.
If an organisation determines the technology will offer little or no value, it may decide on a “wait and see” strategy in order to preserve resources or eliminate the risk of potentially harming the business. A company may also opt to divest the product, service or business segment under attack and focus on opportunities that are more profitable. Additionally, an organisation may decide to take defensive measures and leverage its established brand and competitive position to fend off the new competitor.
Step 3: Determine your organisation’s level of readiness and select a course of action.
If the value is deemed moderate to high, the business should consider the best course of action to “engage.” This should be determined by evaluating a number of readiness factors, such as budget, culture, experience and desired time to market. These factors can assist an organisation in deciding whether a strategic partnership, investing in or acquiring an established fintech or building the capabilities in-house is the best engagement model. For some organisations, a combination of the various approaches (e.g., partner and invest) will be most viable.
The options in terms of the chosen engagement model include:
- Partner The least risky and expensive option to add value is to partner with an established player or innovative start-up. A strategic partnership can strengthen a company’s competitive position and reduce the time needed to develop and bring to market new products or services. For example, the UK’s Santander Bank has partnered with peer-to-peer lender Funding Circle to grow its small business loan business. Santander refers rejected business loan applicants to Funding Circle for assistance. In return, Funding Circle directs businesses to Santander when they require traditional banking services such as a relationship manager, international banking and cash management.
- Invest Some organisations may prefer to have a bigger stake in a fintech initiative, particularly if the value to its market is high and time to market is critical, in which case it may directly invest in or form a dedicated VC arm to fund promising technology. Goldman Sachs has made significant investments into payment platforms Square and Revolution Money; payments security firm Bluefin Payments; and bill presentment and payment start-up Billtrust.
- Acquire For many established financial players, legacy technology and lack of an innovative culture are huge barriers to making an in-house innovation lab successful. For these organisations, the best option for gaining new technology and innovative processes is to acquire an existing fintech. This approach can often be less risky if the technology is already established, and can add immediate value to the business in terms of revenue and customers. Additionally, buying new intellectual property, products or services may be more cost effective than developing in-house.Earlier this year, DH Corp of Toronto acquired Fundtech for $1.25 billion. Fundtech’s transaction banking software will help DH expand its service offerings to global financial institutions and large US banks. Last year, BBVA acquired the start-up Simple, a Portland-based bank that operates entirely online, for $117 million.
- Build While a more expensive approach, the build option enables a business to develop innovations from the ground up and enhance existing ideas already in the market. This is just what Charles Schwab did earlier this year. The launch of its Intelligent Portfolios platform seeks to capture a piece of the rapidly growing robo-advisory market. According to an A.T. Kearney report, robo-advisors will manage 5.6% of Americans’ investment assets totalling about $2 trillion by 2020.
Others are establishing innovation labs to discover and build their own fintech innovations. Capital One has three Digital Innovation Labs in the US tasked with advancing its enterprise-wide digital agenda. Its team of entrepreneurs focuses on building products and experiences for Capital One customers.
When a company lacks specific capabilities, it can partner with a service provider that offers a blend of technology, digital and finance expertise, providing innovative insights and helping to accelerate the project.
Today’s digital technology can bring both great opportunities and daunting challenges to the financial services industry. New business models have already proven they can reduce costs, create efficiencies and improve the customer/client experience. Banks and other financial services organisations can no longer avoid embracing fintech initiatives. Stepping into this emerging world does not need to feel threatening, overwhelming or impossible. By using a pragmatic approach, as well as seeking strategic guidance from consultants who understand the fintech space, organisations can quickly understand what they are up against and determine the best approach for future success.
Sean O’Donnell is a director of technology at Sapient Global Markets, based in London. His background is in designing, building and running financial trading platforms, particularly in FX, CFDs, metals and some money markets for tier one, tier two and large broker clients.