Can legacy companies adapt to this changing world… or will they be consumed by it?
You’ve probably heard the term. It’s been a buzzword for a few years now, and its prevalence beyond financial circles is only growing. Fintech. It’s not tough to break down (“financial” + “technology”), nor is its definition overly esoteric: “computer programs and other technology used to support or enable banking and financial services.” But its potential implications are dizzying, and its outer limits have yet to be defined.
According to KPMG, more than $46 billion in global funding poured into fintech companies in 2015. While that figure declined last year—the product of market uncertainties due to worldwide political instability, a slowdown in China and fluctuations in global exchange rates—venture capital investment in fintech continued to reach new heights, in parallel with the unimpeded march of technology.
Products and services that could scarcely have been imagined even a decade ago now seem inevitable—but their consequences are not. As the future becomes more and more the present, legacy companies are finding their business models disrupted, and sometimes even upended. Can they adapt to this changing world… or will they be consumed by it?
Industry at a Crossroads
A recent Forbes article by Falguni Desai, managing director of Future Asia Ventures, paints a picture of the development of fintech in the latter half of the 20th century. “The 1950s brought us credit cards to ease the burden of carrying cash,” he writes. “The 1960s brought ATMs to replace tellers and branches. In the 1970s, electronic stock trading began on exchange trading floors. The 1980s saw the rise of bank mainframe computers and more sophisticated data and record-keeping systems. In the 1990s, the Internet and e-commerce business models flourished. The result was the introduction of online stock brokerage websites aimed at retail investors, replacing the phone-driven retail stock brokering model.”
We take these innovations for granted today, but their effects can hardly be overstated. Behind the scenes, they have constructed a multi-trillion-dollar framework that allows even more revolutionary technologies to arise and flourish—and we are just beginning to see their impact on the financial services sector.
In prior stages of development, traditional firms were only bolstered by new technologies. Today, however, these firms stand at a crossroads: poised to assimilate them—or to be uprooted entirely.
Sophisticated data analytics, behavioral finance software and real-time information tools are making banks, institutional investors and other financial institutions more efficient, effective and profitable, accelerating their growth. On the consumer side, mobile wallets, digital payment apps, robo-advisors, equity crowdfunding and online lending platforms are not just enhancing traditional financial services; in some cases, they are replacing them completely.
Technology builds upon itself, as it always has. None of this would be possible without the internet as a platform and all the technologies it enhances or enables: the cloud, omnichannel services, Internet of Things, Big Data, the blockchain, artificial intelligence and more. These are the underlying technologies shaping fintech today. Let’s look at just a handful of examples—some mature and others emerging, but all with tremendously disruptive capabilities.
Peer-to-peer (P2P) lending networks allow money to flow directly from lenders to borrowers—bypassing traditional banking channels, streamlining the lending process and increasing access to smaller borrowers. With low overhead and interest rates, startups have been able to enter the market and gain ground on their more traditional rivals. According to Morgan Stanley, P2P lending companies could account for $480 billion in loans by 2020.
A recent Deloitte report, however, predicts that increased regulation and competition will squeeze these firms, suggesting it’s unlikely they will topple the big banks. Recent layoffs at Prosper—the first P2P lending company in the U.S.—as well as the volatile stock prices of Lending Club and OnDeck show support for this prediction. And with the banks awakened to the threat, some are pouring money into in-house fintech solutions, while others are co-opting the challenge by partnering with fintech startups.
Digital Payment Technologies
On the retail side, the rapid growth of e-commerce has demanded the development of new digital payments, which have quickly been adopted by consumers. Founded in 1998, PayPal was a pioneer in this space. Today, the ubiquity of smartphones has facilitated an array of “mobile wallets” and similar technologies, while the “cashless economy” is well on its way to becoming standard in countries like Sweden and Denmark.
Despite slower adoption rates, business-to-business (B2B) digital payment technologies appear to be poised for the same leap. As globalization continues to fuel growth in multicurrency, cross-border transactions, the demand for faster, more efficient transaction processing also continues to accelerate. Automated currency conversion services and improved reconciliation and accounting technologies are among the fintech innovations being applied in the B2B space.
This was one of the strongest areas of fintech investment in 2016, with companies like Betterment leading the way. Betterment automates the investing process, building and managing customized portfolios of low-cost, exchange-traded funds to optimize client returns. Software products that automate wealth management offer a seamless customer experience, with funds allocated by algorithm, and automatic tax-loss harvesting and dividend reinvestment. According to BI Intelligence, robo-advisors are expected to manage $8 trillion in global assets by 2020.
While robo-advisors are potential threats to the wealth management industry, many large firms are embracing the technology by launching their own robo-advisory products (Charles Schwab), partnering with startups (Deutsche Bank) or acquiring them outright (BlackRock). This trend will certainly continue, marrying the benefits of software automation with on-demand human expertise in more of a hybrid model.
Of course, there are some areas where automation is less likely. There will always be a place for person-to-person financial advice, for example. In addition, firms serving high-net-worth clients and other clients with complex needs are less likely to be impacted as robo-advisors become a major industry force in the coming years.
The insurance industry has traditionally been slow to embrace new technologies, but that is changing as interest in the “insurtech” space continues to rise, driven by millennials’ desire (and expectations) for speed, convenience, engagement and personalization. This term can be applied to any number of industry technologies—claim acceleration tools, risk assessment systems, automated compliance processing, etc.—and is powered by increased access to more meaningful data.
Smart-home technologies help property insurers minimize their losses and lower premiums for homeowners. Wearable biometric technologies offer an unprecedented look into an individual’s health—a significant development for health and life insurance firms. And instead of relying on basic demographic and historical information, auto insurers can now get real-time data on their policyholders’ driving habits.
The more disruptive insurtech companies are licensed to underwrite and issue their own policies. Lemonade, for example, touts a simple, quick and hassle-free experience that “reverses the traditional insurance model” by taking a flat fee and eliminating incentives to deny or delay claims. Most insurtechs, however, are partnering with traditional insurers, helping them optimize operations and reach new customers through different distribution channels. This represents a prime opportunity for the industry to reinvent itself through innovation.
Finally, we arrive at the blockchain, which first came to prominence as the fundamental technology of Bitcoin, the digital currency whose value surpassed the price of gold for the first time last month. At its core, blockchain is simply a distributed method of bookkeeping that provides a way for large groups of unrelated parties to collectively maintain a secure, reliable and transparent record of transactions without the need for a central authority—such as banks, rating agencies or government bodies—to establish trust.
“In a world without middle men, things get more efficient in unexpected ways,” writes software engineer, theorist and “resilience guru” Vinay Gupta in Harvard Business Review. “A one-percent transaction fee may not seem like much, but down a 15-step supply chain, it adds up. These kinds of little frictions add just enough drag on the global economy that we’re forced to stick with short supply chains and deals done by the container load, because it’s simply too inefficient to have more links in the supply chain and to work with smaller transactions.”
Blockchain stands to transform that framework, making many of our existing institutions—and possibly entire industries—superfluous. Besides financial services firms, which are already investing in such technologies, blockchain can be applied to any industry that relies on trusted transactions, from car sales to healthcare to energy. It has already been used to secure elections and track shipments around the world with a speed and accuracy never before possible. Among its more intriguing applications is the enabling of “smart contracts,” which both define and enforce the rules and penalties of an agreement—with huge potential ramifications for the legal, insurance and real estate industries.
While most fintech startups are focused on niche innovations in narrow areas of finance, “blockchain is fintech's real game-changer,” as a recent headline in American Banker magazine suggests. Indeed, it is a foundational platform, potentially as revolutionary as the internet itself. And though many of its applications remain theoretical, they won’t remain so for long.
Adapt or Die
Never before have so many industries seen such existential threats—and the era of hyper-disruptive innovations has only just begun. In the financial world, legacy companies are recognizing that these threats also bring opportunity—and are implementing strategies to ensure their continued relevance.
“The majority of these strategies involve some interaction with fintech firms,” suggests The Fintech Ecosystem Report, released last November by BI Intelligence. On the other hand, these fintech upstarts face significant hurdles, including customer acquisition and profitability—something traditional firms can offer in return. “As a result, many are becoming more willing to enter partnerships and adjust their business models.”
It remains to be seen whether traditional firms will swallow the fintechs, or the other way around. What is certain is that we are on the cusp of witnessing “sudden, dramatic, hard-to-predict aggregations and disaggregations of existing business models,” writes Gupta.
This is the hallmark of evolution: adapt or die. “Predicting what direction it will all take is hard,” he adds. [But] the future could indeed arrive sooner than any of us think.” iBi