Introduction 

 

• FinTech is a huge buzz word out in the world at the moment, and whilst a large number of people can tell you what it is, Financial Technology, far fewer really understand how FinTech is disrupting the Financial Services market and just how much the market could be transformed within such a short period of time.
• The aim of this piece is three-fold; (1) provide you with a brief but detailed overview of what FinTech really is and why we should all be keeping an eye on it (2) explain why FinTech has the big banks so scared and what they need to do about it (3) highlight two of the most important concepts: PSD2 and blockchain & wider cryptocurrencies, and why I think they will revolutionise the way we bank and spend on goods and services.
• Over the next few months on my website I will share some of my favourite FinTech companies which I think will change the Financial Services market significantly in the next 3 – 5 years, so watch this space.
• Even if you don’t see yourself as a ‘techy’ person I’ve tried to make this post easy to follow. It is millennials who will be most impacted by the technologies I’m discussing and as the famous proverb states, it’s better the devil you know than the devil you don’t.

 

Overview of Fin Tech

 

• FinTech is already big, but it’s exponentially growing. According to Accenture, in 2014 global investment in Fintech ventures tripled to $12.21 billion (http://www.fintechinnovationlablondon.co.uk/media/730274/Accenture-The-Future-of-Fintech-and-Banking-digitallydisrupted-or-reima-.pdf). Therefore FinTech is the next (or according to some people already) big technological disrupter, in the same bracket as the ‘Sharing Economy’.
• At a fundamental level FinTech is using Technology, usually software or ‘digital’, to provide Financial Services. Often one of the biggest unique selling points (USPs) of these companies is that they are able to provide Financial Services products through technology in a far simpler way to customers and at much lower cost than incumbent, often large multinational, companies.
• FinTech Companies are often start-ups wanting to do a similar thing to what Uber has done in the taxi market to the Financial Services market. But you don’t have to be a small start-up to be involved in FinTech, it’s also something large banks have started waking up to in recent years.

 

Risks to Big Banks and Optimal Responses

 

• Big banks are comparatively easy prey. Firstly, no-one likes them. Following the Financial Crisis of 2008 many wouldn’t believe that trustworthiness in the banking industry could get any worse, but it has. In 2008, Edelman’s Trust Barometer stood at 56% for banks and financial services sectors. Five years later (after Libor Rigging, PPI etc.) in Europe the levels are almost laughable, less than 25% of UK and Ireland respondents trust banks (http://www.bankrate.com/financing/banking/are-banks-trustworthy/#ixzz4BxGa9XcN). What this means is that customers are very responsive to disruption in the market and are pretty much willing more challenger banks and FinTech Companies to come in and level the playing field.
• Secondly big banks are massive, and it is incredibly difficult to turn a tanker, they are too slow at responding to the lean start-ups. Thirdly, they have become too comfortable and the regulator helps them. Challenger banks have to hold greater capital and it took Metro Bank years for its license to be granted by the FCA,  and it was the first high-street bank to be granted such a licence for over 150 years. Finally, large banks have a considerable legacy infrastructure estate, which makes adapting to new technologies more costly and more time consuming given the extra cost and effort associated with the integration and testing.
• Openness, collaboration and investment are the key themes that emerge for the big banks if they are to benefit from the disruption starting to take hold within the Financial Services world. Those are the three ways that the big banks should look to address the four key risks the banks face.

 

 

 

PSD2

• The first important concept related to FinTech that I want to focus on now is PSD2. PSD2 is a European regulation that obliges banks to create Application Programming Interfaces (APIs) that will allow third parties access to bank services.
• To provide some more detail and history, PSD2 stands for Payment Services Directive 2 and is the successor to the PSD1 which came into effect in 2007.
• Why does it matter? PSD2 has been introduced primarily for 2 reasons; (1) to ensure a high level of customer protection; (2) to increase competitiveness within the payment space, helping to break up the monopoly that a small number of large multi-national banks currently have and as a result drive down prices and increase transparency for the customer.
• So what? The impact of PSD2 is that, with the correct permissions, non- traditional banking institutions will be able to access account information and take/give payments directly, without the need to use intermediaries such as WorldPay or Visa. If you’re still not sure what this means let me use an everyday example.
  • Currently —- If I were to buy a product off Amazon (the merchant) today, Amazon would have an acquirer e.g. World Pay, who would then contact the card scheme, i.e. Visa, to pull the payment from your bank.  As you can see there are a lot of players involved with the one transaction.
  • Once PSD2 is introduced — You are on the Amazon App, looking for your first sofa (a search I recently did) once you’ve filled your basket you get a choice of accounts from which to pay from; debit card, credit card (nothing new yet) but also a short loan or a combination of all three. Before making the purchase – within the same Amazon App – you can check all your account balances from different banks, before deciding which one to use to make the payment.

• The transaction goes from a ‘pull’ from the merchant, to a ‘push’ on the customer’s behalf.  This will allow third party payment initiatives and account access services using APIs to get pushes from the customer, dissolving the acquirers and so called ‘middle men’.
• If my explanation has not been sufficient and you’re still rather confused, then I suggest checking out http://starlingbank.co.uk/explaining-psd2/ they’ve done an excellent job of explaining everything, including some  excellent diagrams.
• Now you’ve got an idea about what exactly PSD2 is, and how in theory it will help the FinTech Industry revolutionise legacy financial payment methods, I want to highlight the key positives and negatives of the new legislation:
•  Positives
  • Consumers – Now have the ability to consolidate multiple accounts into one, with continued protection under their product T&Cs
  • Consumers – Gone will be the days of checking your balance on a clunky banking App, you’ll be able to use the most convenient (and best quality) interface to check bank account details
  • Consumers – Greater integration of banks with the merchant, this makes things not only more convenient but also practical and helps accountability
  • Merchants – Reduced costs compared to card interchange
  • Merchants – Immediate settlement into merchants account
  • Merchants – Even greater direct relationship with customer
  • Banks – Suddenly have the ability to position themselves as merchants, not just banks.

 

• Negative
  • Consumers – Lack of clarity of responsibility between PISPs (merchants) and ASPSPs (banks) in the event of loss
  • Merchants – Cost and effort associated with the creation of Application Interfaces
  • Banks – Significant costs to change systems
  • Banks – Loss of screen time in front of the consumer

 

Blockchain

• The first important thing to remember is that blockchain and Bitcoin are not the same thing, although very commonly mixed up or used interchangeably.
• Blockchain is the technology protocol that underpins the distributed architecture of the Bitcoin cryptocurrency, therefore blockchain is the fundamental technology of digital currency, whereas Bitcoin the highest profile company in the digital currency market.
• Blockchains are distributed ledgers that enable the irrefutable and secure movement of value between parties who didn’t know or trust each other.
• A Block is composed of a group of transactions over a specific time frame; multiple blocks linked together make up a blockchain. Another thing that you should never forget about blockchain is that it is a ledger record of the transfer of Bitcoins between or among people or entities.
• Now I’ve covered the basics of what blockchain is I want to focus on why it’s important and how it can be used:
  • It’s opening up the market – currently only significant intermediaries are able to handle financial assets, such as banks, government and technology companies, what blockchain does is allows financial assets to be moved by individuals through mass collaboration and clever architecture. With blockchain you simply need a computer, internet connectivity, and client software and your good to go.
  • Real time capability – as highlighted in the section on PSD2, there is currently a lag in the system due to the number of parties involved in transactions. Blockchain will allow payments to be made and validated instantly, to get assets moving faster and better reflect the fast paced world in which we now live.
  • Enhanced security – Cards and accounts at the moment are too vulnerable to fraud, in the UK alone fraud costs £193bn a year (https://next.ft.com/content/fbb5c2e8-21ad-11e6-9d4d-c11776a5124d).  Blockchain architecture makes use of algorithms that record transactions in a reliable way, without divulging any personal information, making it almost completely immune to fraud.
  • Prevent double spending – One of the major problems with online shopping now is the risk of double paying. If your internet connection gets interpreted mid-transaction you don’t know if the transaction completed and end up paying twice. The amount of effort required to sort that out is significant. Blockchain technology removes the risk of double charging. Once a transaction is processed and enters the block it cannot be processed again, it is not physically possible to do so.
  • Low transaction costs – Everyone can get on-board with a money saving innovation, and cryptocurrencies absolutely provide this. This is achieved by removing the costs associated with third party intermediaries as well as the overhead costs for exchanging assets, when code is king manual effort is removed, reducing costs.
  • Decentralised verification – The decentralised nature of cryptocurrencies is a big selling point of those who de-trust the state and are afraid of Big Brother knowing everything you do and every move you make, both physically and online. Blockchain removes the need for a central authority (such as a Central Bank or clearinghouse), because the authentication is built into the software and visible to all powers.
  • Reading the above benefits of blockchain and cryptocurrencies hopefully conveys just how massive an impact they could have on the current market. And the incumbents are scared, so scared in fact that they’ve started teaming up in an attempt to get back ahead of the curve. More than 45 leading banks, including Credit Suisse, RBC and UBS, have joined the R3CEV Consortium to develop blockchain infrastructure for banking http://www.huffingtonpost.com/don-tapscott/how-will-blockchain-chang_b_9998348.html.
  • Whilst the potential benefits are massive, it is important to highlight that it’s still early days for cryptocurrencies, and it’s not yet obvious how they’ll be adopted long term into the financial services industry. However, the future is coming, and if established players want to remain strong in the market they have to engage with this revolutionary approach to finance, and ensure the technical specialists and developers with the most knowledge and experience are working with them, not against them.
  • I suggest you also take this as an early(ish) heads up and start doing your own research, as being an early adapter could save you a lot of money, frustration and effort.

Conclusion 

 

• FinTech is already large and has started gaining traction in mainstream media and thinking, but it is still growing massively and rapidly so now is the time to get ahead of the curve in understanding. Personally it is an area of real interest for me, both in terms of career and personally, as I am one of the millions of customers who gets highly frustrated by the current high street banks.
• I have purposefully not mentioned the impact on Brexit on the industry, and this is because I’ve articulated my view in another post on this blog, check it out here: http://jablifestyle.net/2016/07/02/investing-advice-for-millennials-post-brexit/. The conclusions I come to at a macro investing level hold true for FinTech, the short term is unknown and uncertain however the long term trend remains the same, FinTech will be massive and cause great disruption in the market.
• Big banks are at an important junction, if they are unable to adapt to the new technologies disrupting the financials services markets they will be left behind, the barriers to entry are being lowered by technology (cryptocurrencies) and regulators (PSD2) and the industry has been resting on its laurels for too long. If they are unable to pivot and reach to the challenge with will lose considerable market share in the next 3 to 10 years.
• I hope you’ve enjoyed this intro to FinTech and it has sparked an interest, over the next few months I will be sharing some of my favourite FinTech software, products and companies which I think will change the Financial Services market significantly in the next 3 – 5 years, so watch this space, and if you’ve got any which you’re currently loving, please reach out!

 

 

Photo Credit: Tech in Asia