The financial services sector has undergone significant changes in recent years.
Banks used to look at technology with hostility. According to fintech and payments expert, Peter Tapling, “five years ago, if we were to have this conversation, I would have told you that the banks look at fintech as a very much us versus them – whatever they do is stuff that we could do.”
They saw fintech companies as competitors who could take business away from them. These days however, today’s financial institutions are now eager to embrace fintech. Tapling, who spent 15 years as CEO of authentication provider, Authentify, before advising a range of financial services companies, says that the industry is “shifting a lot” and integral to this mindset move is that financial institutions are ready to partner with fintech companies so they can offer new services and penetrate new markets.
Looking at the rationale behind this, Tapling talks about the difficulty around large organizations building brand new bank initiatives. To that end he mentions, “if you look at the way we do development these days, fail fast, build something small, minimum viable product, that’s not the way a big bank works.” Instead, banks look to partnerships to fill in that gap.
A Brief History of FinTech
How did fintech solutions come about? Market needs drive most innovations and introduce the need to start incorporating new tech into their internal systems.
In the US, the 2008 financial crisis triggered much-needed changes to financial systems. Lending was one financial service that customers needed but couldn’t get during that time. The economic crunch resulted in lending constrictions. There was a void in the market for consumers who needed credit but couldn’t get it.
The inaccessibility of lending led to the establishment of companies like LendingTree, Prosper, and LendingClub. They gave consumers access to money when banks tightened their policies when it came to consumer borrowing.
The rise of e-commerce was also helped by fintech development. Tapling mentions that “Paypal is a great example of [meeting the needs of the sector] in the market.”
PayPal was the first company to address problems that arose in the early days of e-commerce. The company got its start in response to a need that eBay’s platform created. People from around the world transacted through eBay but had no efficient way of sending payments. PayPal solved this problem in exchange for a small processing fee. The service provided a safe, efficient, and fast way of moving small amounts of money domestically and internationally.
While fintech filled gaps, early companies were focused on profitability without considering the risks involved. This was advantageous for consumers because they were able to get much-needed financing, but posed great risks for the fintech industry. Without proper risk valuation, they exposed themselves to losses that resulted in the failure of many companies in the field.
Tapling expounds on this, stating that this was mutually beneficial for both – banks would go to fintech companies “[to partner and] get to the market faster” and in turn, fintechs reach out to banks for partnerships “so that they could offload some of that risk. There’s a certain book of business in that market lending space, where they don’t hold on to the loan, they originate the loan. They essentially take a finder’s fee for the loan and give it to a bank that’s going to service it, manage the risk, etc.”
Eventually, fintech companies adopted better countermeasures and become more risk-averse. They also approached banks to propose mutually beneficial partnerships. This allowed banks to enter new market segments while fintechs were able to learn and adopt better risk management systems.
So, what are some current trends in financial serices? We asked Tapling to give us a peak into the current and future landscape:
Application of Big Data in Financial Services
The use of big data, analytics, and artificial intelligence will continue to gain momentum. “Banks have never thought of the asset that they have as data,” explains Tapling. “They’ve thought of the asset that they have as money. If they had paid attention to look at all the transactions that are coming through a customer’s account, they would have a feeling for how that customer behaves.”
This created a void that was taken advantage of by a lot of companies such as Kabbage, BlueVine, and Plaid which was recently valued at over $20 billion. While banks had a sensitivity to privacy and their fiduciary responsibility, fintech companies continue to emerge that gain valuable information about consumer behaviors in exchange for access to their services. Whether a loan provider or big data application like Equifax, TransUnion, and Experian, more consumers are waiving their financial privacy. For example, Experian’s Boost product will increase a customer’s credit score if they agree to give the company access to their utility bills.
Artificial intelligence is another trend present in most fintech companies today. Mostly used in fraud management, AI can help banks find out if their customers are giving authentic personal information. Onfido and IDEMIA are two fintech companies that give banks the capability to figure out if customers’ documents are valid.
The Future of Fintech: How the Financial Services Industry is Changing
With the rise of blockchain, there’s a push for another form of lending: decentralized finance. Under this arrangement, one can borrow money from people who belong to a network to pay for assets that need to be paid in legal tender. The borrower can use cryptocurrency they own as a pledge for borrowing.
Robo-advisors, like Betterment, offering free advice will also increase in number in the future. Currently, robo-advisor makers subsidize the advice their tools give. In the future, however, these firms can make money by steering people in certain directions.
Facebook is also developing its own digital payment system originally called Libra and now called Diem. Diem seeks to support simple in-app payments within the Facebook ecosystem.
Tapling talks about Project Libra, which was originally designed to be a “global currency that attracted a ton of attention from central banks” who “[didn’t] want another central currency,” especially ones that are “privately owned.”
The project has faced hurdles as policymakers raised concerns regarding its impact. Policymakers believe it could raise major problems in the financial system, such as money laundering and competing with the US dollar and other flat currencies. Diem is gaining steam, still as an in-app payment mechanism based on distributed ledger, but with a more modest reach.
Whatever the issues with Libra/Diem, this project of Facebook accelerated interest in the creation of digital currencies by central banks. Singapore’s Project Ubin and China’s Digital Yuan are examples of these. The first central bank digital currency, the Bahamian Sand Dollar, went live late in 2020.
We can expect even more changes in the financial services sector even five years down the line. Community financial institutions will significantly reduce while the numbers of digital financial institutions are likely to explode. Community banks will only find it increasingly difficult to compete in a high-tech world.
Another future trend is instant payment schemes, supporting 24x7x365 money movement between bank accounts. These instant payment systems change the model of current batch systems – like the ACH – to real time processing of individual payment requests further accelerating the adoption of application programming interfaces (APIs) for in support of payments.
Open banking will also become common. Tapling states that “historically, banks would consume a lot of APIs, but they wouldn’t publish any information via an API. Open banking is introduces the idea of financial institutions publishing services and information via APIs.” In open banking, account holders have the discretion concerning access to their personal information. They will have the ability to choose whether they will allow third-parties to have access to their information through APIs.
The rise of open banking is good news for banks, as fintech will provide front-end applications for consumers while banks take care of back-end services.
For banks and other financial institutions to stay competitive against fintech companies in the coming years they need to have a data strategy or invest in data strategy. If they don’t start building their data capacity and develop products around data, they could lose business as a result. This can only take place through embracing new technology where possible and even building on partnerships – regardless of whichever route they take, it will always mean being able to adapt and pushing for continued innovation.
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