Fintech, open banking and beyond

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Financial technologies have been around for a while.

Credit cards emerged in the 1950s, the 1970s witnessed the first electronic stock trades and, in the 1990s and after, the internet and ecommerce boom (and bust) shaped even greater changes. During this half a century, the banking sector took full advantage of new technologies to grow the number of bank branches from 18,000 to over 82,000 in the USA, taking this as just one metric of the technological impact.

Today startups present new ways of processing payments, raising funds and borrowing money. Yet, for the first time, the services offered are not an enhancement of traditional banking services but can efficiently replace them, threatening the main financial institutions. In 2017, the total transaction value in the fintech market amounted to $3,300,958m, with the “digital payments” segment accounting for most of it.

The growth in transaction value is a direct result of the sharp increase of the number of fintech startups: from 1,000 in 2006 to 8,000 in 2016, raising a total of $78.6bn, according to BCG.

Why?

According to SparkLabs Global Ventures, three key factors have led to the emergence of fintech startups:

  1. Decreased credibility of traditional finance institutions after the 2008 crisis. Moreover, since the proven success of several fintech startups, governments are now loosening regulations to encourage startups to enter the marketplace.
  2. Technologies such as IoT, cloud computing, AI and blockchain, coupled with widespread smartphone adoption, enable startups to create radically different services that are better and easier to access.
  3. Changing attitudes to technology, money and security. Most consumers are now familiar with technology and some of them even prefer to interact with a screen rather than bank employees.

The big players

PayPal ($80.16bn market cap) became the iconic success story in the industry with its IPO in 2002. Some of us might be less familiar with other public fintech companies like Square ($12.69bn market cap), which provides hardware and software to facilitate electronic payment or Envestnet ($2.34bn market cap), which gives financial advisors an overview of their clients’ financial health to better advise them.

But an IPO isn’t necessarily a benchmark of impact as this Business Insider report shows. Many fintech startups have not IPO-ed yet. Ant Financial, valued $60bn, is an online payment provider running Alipay, China's biggest mobile payment network with 450 million users and 16mn daily transactions. Lufax, which operates in the peer-to-peer lending area, is valued at $18.5bn and has already financed 20,000 loans worth a total of $2.5bn.

Other fintech startups are having a significant proliferation in their markets, such as challenger bank Monzo (£65mn) and its striking orange cards now commonplace in many wallets, and Funding Circle (£1bn+), which is the UK’s largest peer-to-peer lending service.

Investment trends

While total investment in European fintech startups fell by 25% from 2015 to 2016, funds raised in 2017 have already hit a record high and could break the $2bn milestone by the end of the year, according to CB Insights. With already $12.2bn raised in Q3 2017, global VC investment in fintech startups is expected to reach an all-time high for 2017. Asia currently accounts for 41% of the global funding. At the current run rate, Asia deals to VC-backed fintech companies in 2017 are on pace to rise 29% from 2016.

More recently, research from London & Partners showed that London’s fintech firms are set for a record year of investment, shrugging off Brexit fears.

While the vast majority of banking executives are well-aware of the fintech startups and the threat they represent to the traditional banking industry, a consumer survey conducted by Statista shows that the majority of consumers surveyed have never heard about fintechs. This is likely to change with the PSD2 regulation (Revised Payment Service Directive) coming into play early 2018. The new European regulation will oblige banks to provide third-party providers with their customers’ accounts through open APIs. This paradigm is called open banking.

Open banking

Open banking will revolutionise the payments value chain by enabling third-parties to build services on top of banks’ data and infrastructure. In the near future, you may be using Facebook or Google to pay your bills and making P2P transfers while your money is still safe in your bank account.

The PSD2 regulation does not come without concerns. Today, if your data is misused or shared inappropriately you know where to go to get it sorted, since only your bank has access to it. But in the future, with hundreds of third parties that have access to your customer data, this is going to be a real challenge.

The new EU directive could contradict another regulation, the General Data Protection Regulation (GDPR) which also becomes into play early 2018 and aims to empower citizens inside the EU to better control their personal data.

Fintegration

These new regulations are another good excuse for banks to cooperate with fintechs, almost as persuasive as the $470bn in profit that startups could potentially take away from them, according to Goldman Sachs research (2015). It proves convincing as traditional banks are pouring money into fintechs in the hope of combining the respective strengths of both models, merging the agile service of fintech with the stability and security of traditional banking.

Termed ‘fintegration’, the co-operative trend has led to the emergence of a new category of startups acting as a bridge between fintechs and banks. TrueLayer, Plaid and Finicity are all API platforms that offer developers an easy way to access the bank data they need to build new financial apps and services, helping startups and banks alike to drive innovation in financial services.

Final word

Banks have been around for 600 years and have already faced disruption more than once. Years ago, telephone banking had mistakenly sounded the death knell, pretty much like the advent of internet banking did in 2000. Still, banks survived and adapted to changes. Today, the cycle is repeating itself - banks are facing an onslaught of new technologies, from massive smartphone adoption to blockchain.

Some of their services are at risk; P2P payment processing, which currently takes them days, can be handled by any blockchain fintech in a matter of seconds. And some are not; financial advisory services to large corporations, risk management, require a great level of expertise that is unlikely to be replaced by a chatbot any time soon.

The relationship between fintech firms and financial institutions may certainly look to be a complicated one, but just like any great relationship, leveraging each other’s core capabilities would reap great dividends for all stakeholders involved, including the most important one - the customer.