Fintech, open banking and beyond

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Financial technologies aren't new; they've been around for a while.

Credit cards came first, emerging in the 1950s. The 1970s witnessed the first electronic stock trades and, since the 1990s, the internet and e-commerce boom (and bust) have shaped even greater changes. 

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, fintech transactions amounted to $3,300,958 million, with the “digital payments” segment accounting for most of this.

The growth in transaction value comes as a direct result of the sharp increase in 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. Additionally, 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 technologies and some 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. But it's not the only one. Other names include Square ($12.69bn market cap), which provides hardware and software to facilitate electronic payment and 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. Several companies have not yet IPO-ed but are making waves in the industry. Ant Financial, valued at $60bn, is an online payment provider running Alipay, China's biggest mobile payment network with 450 million users and 16 million 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 (£65 million) 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, 2017 demonstrated that the appetite for funding in the fintech space is at an unprecedented high, and that this looks set to continue. With this shifting away from Asia, European and US fintech funding is also increasing, according to research

More recently, research from London & Partners showed that 2017 was a record year of investment, with fintech doing particularly well, 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 following implementation of the PSD2 regulation (Revised Payment Service Directive) . Banks are now obliged 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.

All of this is also taking place against a backdrop of better controls of personal data, via the General Data Protection Regulation (GDPR).

Fintegration

These new regulations are another good excuse for banks to co-operate with fintechs, almost as persuasive as the $470bn in profit that startups could potentially take away from them, according to Goldman Sachs research. Unsurprisingly, traditional institutions are engaging with fintechs in the hope of combining the respective strengths of both models - merging fintech agility 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 and risk management require a degree of expertise that is unlikely to be replaced by a chatbot anytime soon.

The relationship between fintech firms and financial institutions may certainly be complicated, but just like any great relationship, leveraging each other’s core capabilities will reap great dividends for all those involved, including the customer.