An article originally published on TechPulp.net / on
FinTech promises to disrupt banking but faces unique challenges. From a complex regulatory environment to an extremely cautious user base, mobile banks and investment apps have their work cut out.
Emerging technologies have dramatically changed the mechanics of basic banking functions like loans, payments, cheque-cashing and savings. In FinTech (short for Financial Technologies), small companies are — for the first time in decades — able to go toe-to-toe with banks, offering innovative and white-glove services.
Traditional vs. online banks
The IT infrastructure that subtends established banks is old — 1980s old, if not older — and this scaffolding has remained unchanged since its initial release. Why? Because regulation makes it exceedingly risky (read: lawsuit-risky) to innovate. The latest and arguably most consequential bout of ossification came in 2008 when the fallout from the subprime crisis imposed numerous new regulatory requirements and hiked up the maximum fines that could be levied in the event of a violation. Instability and risk are precursors for conservatism, especially in the financial sector.
But banks don’t operate in a vacuum. While banks were busily trying to change as little as possible, Silicon Valley was in full boom, having been one of the first geographical regions to recover from the great recession, and consumers everywhere were becoming accustomed to the pampering of the service economy. Game-changing innovations were seeping into the household through the smartphone, creating an ever-expanding gap between what traditional banks were willing to offer and what customers expected. And so grew consumer discontent. In a few words: the sector was ripe for disruption.
Enter the FinTech upheaval. Automatic chatbots began replacing call centers, mobile apps challenged brick & mortar (or, dare we say, marble & bronze) banks, and vocal recognition presented an impression of James-Bond-like security…
But it would be wrong to conclude that FinTech was ultimately solving a marketing problem, as the initial growth of the sector can be largely attributed to a growing societal issue: financial exclusion. In 2016, more than 2 billion people were still bankless worldwide. Over 500 million of them live in the First World.
By 2017 a stunning 700 million of these consumers could register with an online bank — FinTech’s answer to HSBC.
But are online banks really banks?
“Short answer: no, but it doesn’t really matter”, says Andrew Garvey, CCO of CountingUp. “Banks have to follow extremely strict regulations to call themselves banks, but there are simpler statutes that allow early-stage FinTech startups to do most of the stuff everyday users care about”.
These statutes vary tremendously between jurisdictions and are attributed by various Financial authorities. Statutes for traditional banks, by contrast, are extremely similar throughout the EEA, despite also being regulated on a per-country basis — so much so, in fact, that the European Central Bank and European Commission are pushing for a unifying set of rules. More to the point, these rules set a much higher standard of care than their FinTech counterparts.
As explained by Michael Mancusi, Christopher Allen and Kevin Toomey, all three lawyers from Arnold & Porter’s firm to Bloomberg, “the innovations fueling the current “FinTech” boom are certainly new, [but] the legal challenges presented by them are not. Indeed, the history of the financial services industry regulation is that of […] an accompanying need to incorporate changes into an existing legal framework that may never have contemplated the new technology”. In other words: the FinTech startup’s strategy is to do some of the things a bank can do, and benefit from its looser regulatory requirements to cut costs, and better serve the client.
And this is no minor point: the foundational premise of FinTech companies is to choose one (and only one) financial product, such as crowdlending or micro-payment, and dominate that segment.
Knowing what FinTech businesses are not, one can ask: what are they? As with any emerging legal landscape, there’s no simple answer.
In the EEA, France is the only country to attribute a special designation to FinTech businesses. A FinTech venture can fall into one of four categories: “Financial Investment Advisor”, “Intermediary in bank operations and payment services,” or “Intermediary in participative financing”. The difference resides mostly in the kinds of financial instruments and services they can provide.
In the US, the Office of the Comptroller of the Currency decided in 2016 to start giving banking licences to FinTech companies outright. They now allow online banks to offer three banking activities (deposits, checks and loans). Switzerland is following suit with a roughly-equivalent measure.
Most other countries have adopted what’s known as the “sandbox” system. This is a temporary measure in which, a local authority permits FinTech ventures to operate on a case-by-case, experimental basis. This provides a lighter regulatory framework at the cost of some instability for founders, who have to bear the cost of a changing legal landscape.
Banks and FinTech joining forces
Let’s recap. On one side, we have FinTech startups that are customer-centric and focused on specific financial products but lack trust and reputation. On the other side, we have the opposite: traditional banks, which enjoy consumer trust and reputation but lack the disposition for true technological innovation. Why don’t they partner up to fill in the gaps? They sort of already have.
Canadian banks, such as CIBC or Scotiabank, started partnering up with FinTechs in 2015, with startups like Thinking Capital, Borrowell or Kabbage. Santander UK also has found a way to work with the Infosys Finacle startup and Rakbank with Inpay. These examples are among many others.
The Singapore bank DBS is also making a partnership play with FinTech. To access the millions of bankless individuals in the Indian financial market (one of the largest on earth, yet still under-developed), the bank has launched a call for collaborators capable of reaching Indians on their mobile phones. DBS has yet to announce a partnership and declined to comment.
A recent regulatory framework in the UK offers an additional model for bank-FinTech symbiosis. In 2014, British regulators stipulated that banks could no longer deny loans to businesses without presenting them with alternative providers. The initiative, intended to stimulate financial competition between institutions and boost SME financing, has been a boon to FinTech businesses, especially since the latter often rely on traditional banks for much of their infrastructure.
This, of course, raises a conundrum. How stable is the relationship, and how long will interests between banks and FinTech companies remain aligned? In the EU, a new regulation called DSP2 is already altering this delicate power balance.
The regulation put in effect in January 2018, requires banks to make their customer’s account data available to third parties, provided the customer consents. This effectively allows payment service providers such as SoFort, Adyen, and HiPay of Paypal to completely circumvent the bank’s payment infrastructure that hosts the account. Customers can now transfer money from one of their accounts to another via a third-party mobile app. If the trend continues, these startups will eventually become the gate-keepers of B2C financial services, relegating banks to “dumb infrastructure”.
In only 5 years, from 2010 to 2015, the FinTech sector has multiplied its investments by 4, reaching more than 20 billion dollars at the end of this period. The British startup Revolut, which raised $250 million in April, has just obtained unicorn status in record time, going from a valuation of 0 to $1.7 billion in less than two years.