This article was published in VCCircle.
Having been a user of banking technology platforms for quite a long time, I find the current euphoria around FinTech very encouraging - yet somewhat unnerving.
While at the very least Fintech is expected to have a transformational impact, at the extreme it is anticipated to be the magical potion with the potential to make revolutionary changes in the way banking is conducted and remedy the ‘ills’ that it is perceived to be plagued with.
As in most things in life, the truth is somewhere in the middle. And hence, to discover the truth and the real impact of fintech it is important to understand the key drivers behind Fintech.
Cost of intermediation is ‘perceived’ to be disproportional to the value contributed by banks
In a rather simplistic sense, banks are seen to be intermediaries who are connecting the 2 counterparties at the different ends of the transaction.
It could be customers with surplus funds to the ones with a deficit or those looking to buy foreign exchange to those seeking to sell or those considering buying companies to those looking to sell. And so on…
They are perceived to profit out of an information asymmetry. Many fintech firms are founded on the belief that with any business which seeks a rent out of an information asymmetry shall get disintermediated and hence be non-viable in the long run. They believe that there is an opportunity to connect the 2 ends of the transaction using technology and hence at a substantially lower cost.
It is also felt that due to their high cost structure, the banking system can offer many products (loans, investment products, foreign exchange conversions etc.) for certain minimum threshold amounts only. Their pricing gets skewed and unattractive for lower amounts. This introduces a certain inefficiency which can be addressed by the fintech space. Essentially, many fintech enterprises are seeking to democratize the availability of financial products by lowering the thresholds.
While all of the above arguments are partly true, what seems to have been missed out by the fintech space is the risk management activity that the banks perform on behalf of the end clients. And this could be in the form of:
Gaps and duration risk – As a simple example, the entity which is surplus (lender of funds) may not be looking to lend for the same amount and / or same time as the borrower needs.
Foreign exchange risk – the buyer and seller may not have the same amounts or the lender and the borrower may not have the surplus / deficit in the same currency.
The banks warehouse the above risks and make dissimilar transactions possible.
Credit Risk – the lender does not have the skill and / or experience to assess the repayment capability of the borrower and hence determine whether and what price to grant the loan. Banks perform an analysis of the borrowers credit worthiness and insulate the lenders from defaults of the borrowers.
Operational risk - the potential glitches in the actual execution of a transaction entails a risk whose implications could lead to a systemic risk and regulatory violations with significant financial and non-financial implications. Banks are required to employ dedicated teams which ensure that these transactions get executed smoothly as per instructions.
The cost of maintaining resources and infrastructure to managed these risks needs to be priced into the transactions. Given the embryonic nature and small size of the Fintech industry, it is felt that both the awareness and quantum of these risks may presently be limited. Hence, it in all likelihood is not be appropriately getting priced into the cost of transactions.
Regulatory risk - the intermediaries also ensure that all the transactions are as per the provisions of the prevailing regulation. Since Fintech is currently a loosely regulated space, the cost of regulation is not fully built in and this author feels that once it gets fully regulated several opportunities that are currently seen to be viable may not remain so.
Examples of Fintech enterprises based on disintermediation as the primary driver are:
Ease of service delivery due to cumbersome front ends and customer experience tools
The legacy technology platforms of most banks is an aggregation of dedicated but disparate systems. These have been plugged in together to serve specialized business requirement at that particular time. As a result, they come from different providers and many of the components of these platforms do not communicate with each other. In several cases, they also adopt different methodologies and models for evaluating the same parameters.
Since banks possess a fiduciary responsibility, they function under a strict regulatory oversight and a mountain of internal controls. They are required to adopt certain common methodologies and processes which have been envisaged keeping the larger universe in mind.
This precludes certain segments from certain products and services and also creates situations wherein the product / service front end gets complex (or even opaque) resulting into a diminished customer experience.
Many Fintech startups are dedicatedly involved in either enhancing the customer experience or making available services not available to a segment. For example, the opportunity for mobile payments / e-wallets was created because there was a segment which was not seen to be eligible for a debit or credit card or a POS terminal. However, they did possess a smartphone and hence could exchange monetary value that could be accessed through the phone.
Creating a competitive advantage through improved predictive capability of client propensity
Banks and other financial services firms possess an immense amount of data about their customers pertaining to the stage of the lifecycle, buying behavior, financial status and lifestyle etc. Assuming each of the above to be part predictors of future behavior, banks (and other financial services firms) have a very potent (though yet not fully exploited) data set to forecast future behavior of their customers.
If a customer has taken a student loan a few years bank, it can be predicted when they may be ripe for a mortgage, an insurance and a car loan. From the payment track record and the account balances the need for offering wealth management solutions can be predicted. While this is the most simplistic representation, the same logic can be extrapolated across multiple dimensions to create cross sell and upsell strategies.
With the advancement in big data analytics tools and artificial intelligence Fintech companies shall offer cutting edge behavioral analytics and decision making tools. With the customer pie not growing at the same pace as the growth aspirations of the banking sector, those with advanced analytics capabilities shall succeed at the expense of others.
Demand from customers for self-enablement - to be ‘where the customer is’
Gone are the days when the customers needed to visit bank branches to perform each of their banking transactions. While the branch visit may not become entirely extinct, it is indeed certainly becoming a rarity. And this benefits both the customer and the bank.
The cost of servicing a customer at the branch is substantially higher than outside of the branch – be it an ATM or online. Even upon incurring that cost, there is inevitably a gap in meeting customer expectations as customers seek to avail of services when they wish to while most bank branches are not available 24 by 7. In addition, each visit to the branch could entail a significant turnaround time.
As with other things like shopping (goods or services), the customer wants to decide where and when to engage in the activity of banking.
This has given rise to another opportunity for Fintech wherein they can enable the customers for self-service specifically for activities which could earlier be performed only during ‘office hours’. The introduction of technology in this space has proved to be a great win-win dispensation as banks can make their operations scalable at a substantially reduced cost while the customers enjoy the freedom to execute at a place and time where they wish to.
The online services offered by banks range from routine banking to trade execution, investments etc.
To conclude, it is this writer's view that given the infrastructure, the client base and their data along with the resources that the banks possess, they are in an enviable position to ride the Fintech bandwagon – if they chose to. It is not the time to write their epitaph!