Technological innovation and the banking dilemma
“Disruptive technologies typically enable new markets to emerge.” ― Clayton M. Christensen
In today’s financial technology (‘FinTech’) maelstrom, this quote is hardly headline-worthy until you consider that Clayton Christensen wrote The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail in 1997; a year before Apple’s iMac and Google were launched and the year that at $261 billion, Microsoft became the most valuable company in the world. Today, the most valuable company is Apple, which at $725 billion is more than twice the value of Microsoft.
The premise of Christensen’s book is that successful companies put too much emphasis on customers’ current needs and fail to adopt new technology or business models that will meet their customers’ unstated or future needs. A concept succinctly captured by Henry Ford: “If I had asked people what they wanted, they would have said faster horses.” Steve Jobs was of a similar view: “Customers don’t know what they want until we’ve shown them.”
An eye to the future is perhaps Jack Ma’s secret. Founder of China’s biggest online commerce company, Alibaba had transactions of $248 billion in 2013, more than eBay and Amazon combined, according to the Wall Street Journal. “Most companies, when they’re doing good, they enjoy today’s wonderful life. They don’t worry about five years later—but I worry about five years later.”
Today, Alibaba, which a year ago ranked as the biggest IPO in the world, not only owns Taobao, China’s equivalent of eBay, but has a third-party payment affiliate called Alipay through which it has entered the financial services industry with a money market fund called Yu’e Bao Fund that can be bought with a few clicks on a smart phone.
At March 2014, with $87 billion, the ‘Leftover Treasure’ mutual fund was the 4th largest money market fund in the world after Vanguard, Fidelity and JP Morgan’s offerings. While the assets in Chinese money market funds are currently small, many believe that they will grow in the next few years to challenge the banks and their lower return offerings.
Alibaba’s foray into financial services through the smart phone is the perfect example of Christensen’s prediction that innovative technology will disintermediate traditional industries.
In collaboration with Deloitte, The World Economic Forum published a comprehensive report called The Future of Financial Services: How disruptive innovations are reshaping the way financial services are structured, provisioned and consumed.
The report, published in June 2015, explored the transformative potential of new entrants and innovations on business models in financial services. It posed three questions: which emerging innovations are the most impactful and relevant to the financial services industry; how will these innovations impact the ways in which financial services are structure, provisioned and consumed in the future; and what would be the implications of these changes on customers, financial institution and the overall financial services industry.
The final 178 page document is the first consolidated taxonomy for 11 clusters of disruptive innovation that are exerting pressure on the main functions of financial services: payments, market provisioning, insurance, deposits and lending, capital raising and investment management.
For example, in the cashless world of mobile money connected via PayPal or Apple Pay, the worlds of e-commerce and insurance can connect in ways that were not possible before. But one of the principal World Economic Forum conclusions is that it will be decentralised systems, such as the blockchain protocol, which will threaten to disintermediate almost every process in financial services.
The arrival of Blythe Masters on the blockchain scene could be an indicator of the potential of this new technology that was, until now, reserved for cryptocurrencies. Masters, the investment banker and financial engineer behind credit default swaps, a market that peaked at $58 trillion in notional terms in 2007, is now chief executive officer of Digital Asset Holdings, a New York-based technology start up.
Masters believes blockchain changes everything. Settlement time for syndicated loan trades is roughly 20 days, but what if blockchain technology could reduce this to 10 minutes? The distributed ledger—the technical term for blockchain, the software codes behind cryptocurrencies—is the solution, which is why her new firm has invested in a few similar ventures.
Analysis in The FinTech 2.0 Paper: Rebooting Financial Services by Oliver Wyman, Santander InnoVentures and Anthemis Group suggests that distributed ledger technology could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance by between $15 billion to $20 billion per annum by 2022.
Technology is not banks’ strong point, but Goldman Sachs, UBS and Santander are exploring cryptocurrencies. Goldman joined forces with IDG Capital Partners, a Chinese investment firm, to lead a $50 million investment into Circle Internet Financial, a start-up that aims to use blockchain to improve consumer payments. In fact, Goldman Sachs seems to be on a FinTech drive investing in big data and payment start-ups, including a strategic $15 million in Kensho, a Cambridge-based firm that answers complex financial questions by automating research previously done by quants.
Asset management is another area that the World Economic Forum believes could be transformed by FinTech. Not only is it being revolutionised by robo-advisers such as Nutmeg that are improving accessibility to investments cheaply, but core processes such as data collection, analysis, trade strategy and execution, monitoring, risk and compliance all have ‘pain points’ that can be alleviated by their respective FinTech solutions, the World Economic Forum report stated.
For example, Novus aggregates performance and position data of funds; Kensho automates the modelling of investment scenarios; Ayasdi uses data analysis to draw out correlations and outliers from big data; RedKite monitors erroneous trading patterns; OpenGamma is an open source platform for real-time market risk management; and FundApps organises regulatory information. Peer to peer lending is another popular area, with platforms such as Lending Club in San Francisco, and London-based Zopa, among the largest five players in consumer lending.
So will banks be part of the future financial landscape? Traditional banks are generally not well equipped to deal with the digital age, says Accenture in its report The Future of FinTech and Banking, but their entrance would bring credibility and, ironically, trust, in what is still an emerging ‘wild West’ new economy.
Groaning under the weight of the after-the-horse-has-bolted regulation, oversight and increased risk capital charges, banks can no longer afford to be ‘universal’ and offer all things to all people. Their clients, now used to ordering their airline tickets, taxis and fine dining from their smartphone, will wonder why they can’t buy their funds on iTunes.
At the same time, more and more engineer-technologists are looking at traditional banking and asset management business models and seeing scope for process and client service improvement. One London-based example is Paul McGuire, who started and sold Paymo, a non-bank payment company, and is now working on Just Investing, a cloud-based venture platform.
Irrespective of whoever ends up dominating the space, the FinTech industry is booming, with funding growing at a rate of 45% per annum and $13.7 billion invested globally in 2014.
Virtual banks such as Germany’s Fidor Bank, also a player in bitcoins, are emerging to challenge the global banking megaliths. Fidor has partnered with Currency Cloud, the London-based international payment processing system, to become the first bank in the world to have a multi-currency regulated eWallet where customers can access sterling, US, Australian and New Zealand dollars, Swiss franc, Norwegian Krone, Turkish lira and Polish Zloty.
But it is the interaction through social media to receive rewards that makes Fidor unlike any old style bank. It is the first bank in the world where users and their social interactions shape the interest rate they receive on their account. Put simply, the more Facebook ‘likes’ the more favourable the interest rate.
In the UK, Starling Bank and app-based bank-to-be Mondo are among some of the emerging names. Mondo, founded by former Starling chief technology officer, Tom Bloomfield, has secured £2 million in funding from Passion Capital, a London-based early stage technology where Eileen Burbidge, the UK Treasury’s ‘special envoy’ for FinTech and ‘Queen of British VCs’ is a partner.
Some 20% of the companies that Passion Capital invests with are in FinTech. According to EY and UK Trade & Investment, the UK FinTech market is worth roughly £20 billion in annual revenue, the majority of which is generated by what it terms ‘traditional’ FinTech (larger technology firms that support the financial services sector), as opposed to ‘emergent’ FinTech, smaller ‘disruptive’ companies such as LendInvest, TransferWise and Seedrs among the 11 biggest names in London.
The founders of Kensho chose a Japanese word for a Zen term, meaning initial insight or awakening. Whether or not the banks join in, buy in or simply walk away from technological enlightenment is still a chapter that is being written. Christensen’s main point, though, was this: “disruptive technology should be framed as a marketing challenge, not a technological one.”