Fintech and the disruption of financial services

THE last few years has witnessed the propagation of a plethora of terms such as artificial intelligence (AI), big data, robo-advisory, blockchain, cryptocurrency, insuretech, investtech, cloud computing, crowdfunding and many more. All of these have been collectively called fintech, but what really is fintech? What are these technologies and how do they fit together?

In this four-part series of articles, I summarise extracts from my new book, Fintech: The New DNA of Financial Services, which provides a holistic view of all categories of fintech, and how they will progressively bundle to either disrupt incumbent processes and businesses, or where they will force the industry to become more efficient.

Most importantly, I focus on explaining concepts and terminologies in depth, while refraining from using any programming or mathematics, so that it is readable by every industry professional, student and the common man.

Fintech will bring revolutionary changes to the finance and investment industry within the next decade, on the same scale as the Internet did to the retail industry. There will be disruptors and the disrupted, startups which will become behemoths, and incumbents which will need to adapt. And a dramatic change on how all of us, as consumers, interact with the finance industry and invest our money.

Financial services as intermediaries

All parts of the financial services industry, rather than produce an independent tangible product or service, act as intermediaries or advisers to customers. They exist either because they facilitate exchange of information, or exchange of capital. The financial services industry is basically an industry of middlemen.

Technology as a tool has had three principal impacts on businesses:

This should have led to a deep restructuring of financial services a while ago. However, as financial services are deeply regulated, and segregated by countries, a dramatic change has not happened till now. Since the global financial crisis, however, financial regulation across the world has become more uniform and cross-border communication and transactions have been facilitated by the greater use of technology.

This has meant that every institution either adopts fintech to make existing process more efficient, or else newcomer startups would sufficiently improve the business model such that they are able to disrupt the incumbents. In either case, the consumer stands to benefit either due to decreased cost, or increased efficiency. The key implication is that the industry is at the stage where its business model and processes are about to undergo a step change, with the advent of fintech.

Basic skills of the fintech revolution

Fintech as a discipline relies on three basic concepts:

Data capture: Processes to capture and store data and information about every entity and person, who is or may in the future be a potential interaction of any kind, and about their minute-by-minute activities in the physical or digital world.

Data analysis: Methodologies and tools to analyse these large and growing datasets to arrive at succinct information which can drive future decisions.

Intelligence implementation: Implementation of this data-based knowledge to make existing services and activities more efficient or to create new services which do not exist today.

These concepts when applied to each financial services activity will result in the creation of new business models either within or outside the incumbent financial services institutions.

The evolution of financial services activities

Some examples of the impact of fintech on financial services processes are as follows.

Compliance processes

Every financial institution is required to have a 'Know Your Client' process to prevent money laundering, which has largely been a manual client by client process. The advent of fintech provides a tool to make this process more efficient, and has resulted in a branch of fintech called RegTech. Whether used as an in-house tool within a financial institution or as an outsourced service provided by a specialised provider, it will make the compliance process far more effective and efficient than they are today.

Transaction processing

There is a large number and variety of financial transactions performed by all types of customers across the world. While technology has been used for these processes for a long time, the invention of blockchain has the potential to completely change this landscape of how they are accounted. Even simple financial transactions such as payments at the point of purchase, money transfers between institutions and between customers and institutions, will likely change dramatically as and when blockchain gets widely implemented in the financial ecosystem.

Insurance calculations

Insurance has always relied upon estimates of risk based on long-term historical data, which are used to calculate liabilities and thus insurance premiums. With the capture of data on every aspect of the insured, risk calculations can be made more accurately, thus facilitating the transition of the insurance business from a group-based average premium calculation to a customised calculation for the risk of an individual.

Investment and risk management decisions

The collection of data on every aspect of any business and every customer leads to a wealth of information which can be utilised to make more accurate forecasts for asset prices at a higher frequency. This would then enable investment and risk management decisions with a greater depth of knowledge.

Investment solutions

Designing investment solutions for individuals and institutions has historically been done using standardised investment products without the real awareness of customer-specific liabilities. The ability to gather specific requirements of every customer will transition the investment solution framework to become liability aware and customised to the situation of every client.

Financing solutions

Every individual and institution requires financing at some point. Individuals may take a loan or a mortgage, and companies may want credit or sell their equity to the public. This funding, facilitated by the financial industry, relies on an estimation of credit-worthiness of the borrower, and the ability to source capital through their network.

Both of these aspects will be impacted by fintech. The creditworthiness can be made more accurate simply by the collection of more data about the borrower, and the source of funding can expand beyond a bank's network to be more democratic across individuals connected via platforms rather than banks.

These examples are just the tip of the iceberg. The journey to transform financial services is just beginning. It is not always easy to change incumbent processes which have been in existence for many years, and it is even more difficult to reskill people involved in those functions to adapt to the new world.

Whether an institution will adapt or not will determine if it survives in the new world with greater efficiency or gets disrupted. The same can be said for all individuals in the industry. But understanding this evolution is paramount for everyone, no matter what field you are in, and you don't need to be an expert in programming or econometrics to do so.