The Fintech 2.0 Paper: Rebooting Financial Services by Oliver Wyman

Banks can boast of some important innovations. ATMs, credit cards, securitisation, swaps and mobile banking are now taken for granted, but each was ground-breaking when first launched.

Over the last decade, however, a new source of innovation in financial services has emerged from financial technology start-ups (“fintechs”) and technology companies (“techos”). These new firms have been quicker than banks to take advantage of advances in digital technology, developing banking products that are more user-friendly, cost less to deliver and are optimised for digital channels.

This relative success is unsurprising. These new players are less burdened by the demands of regulatory compliance which banks are subject to. They are unencumbered by complex and costly to maintain legacy systems. They can focus on creating single-purpose solutions, designed to offer an improved experience within just one product or service. They are more in tune with the peer-to-peer (P2P) culture engendered by the explosion of social media. And they are smaller organisations, designed for the purpose of innovation.

Capital has flowed into the fintech sector: $23.5 billion1 of venture capital investment in 2013/14. Of this investment, 27% has been in consumer lending, 23% in payments and 16% in business lending. Fintechs have two unique selling points: better use of data and frictionless customer experience. But to date these have been limited to relatively simple propositions such as e-wallets and P2P lending.

The impact of fintechs to date

After a slow start, fintechs are now capturing a growing market share in these areas. Yet their overall effect on the banking market has been minor. Banks have not crumbled in the face of this new competition. We characterise this first phase of fintech as Fintech 1.0. Yet the conditions for significant change are present: policy shifts towards open data and APIs2, the emergence of enhanced technologies such as cloud computing, changing customer dynamics and intense pressure to cut costs in banking.

We believe that by extending the use of data and frictionless processes Fintechs can and will expand well beyond the confines of payments and consumer credit. It will move deeper into middle and back office processes providing new, richer propositions for end customers.

Fintech 2.0 is just around the corner. It will deliver fundamental changes to the infrastructure and processes at the core of the financial services industry. In this report we consider some important banking innovations based on the “Internet of Things” (IoT), smart data, distributed ledgers and frictionless processes beyond payments and consumer credit.

Fintech 2.0 will cause a major disruption of the banking market, as digital technology has in other markets, such as travel and entertainment. Pre-digital business models and processes will be rendered obsolete, and billions of dollars of value will shift to “new model” suppliers.

Banks are aware of these changes and the opportunities they present. Many have decided they need to participate in this disruptive trend by actively supporting fintechs – the list includes Citigroup, Santander, UBS, BBVA, Barclays, NAB and Capital One, among others. They have launched incubation and acceleration initiatives, and created investment vehicles to harness, foster and scale up innovation.

While banks have disadvantages relative to start-ups, they also have advantages. Being regulated is a burden in many ways, but it creates consumer confidence. A long history brings legacy systems with it, but it also builds trusted brands (albeit tested by the global financial crisis) and provides rich historic data, not to mention a banking licence and a sizable head start in compliance initiatives. And, of course, banks understand banking; especially the risks involved, which new entrants often do not.

Collaboration is the key

The strengths and weaknesses of both banks and fintechs mean that both will often do better by cooperating rather than by competing. New digital businesses must either grow quickly or die. Banks can offer fintechs immediate scale and critical mass through access to demand.

While some fintechs are today focused on the race to build standalone “Unicorns” (a company with a $1 billion valuation), we believe Fintech 2.0 represents a far broader opportunity to re-engineer the infrastructure and processes of the global financial services industry, in which the top 300 banks command a revenue pool worth $3.8 trillion.

This is the central premise of this report: that, to realize the opportunity of Fintech 2.0, banks and fintechs will need to collaborate, each providing the other with what it now lacks, be that data, brand, distribution or technical and regulatory expertise.

Only by collaborating will the opportunity of Fintech 2.0 be realized.

Applications for the Internet of Things

The “Internet of Things” (IoT) describes the widespread embedding of sensory and wireless technology within objects, giving them the ability to transmit data about themselves: their identity, condition and environment.

The number of objects able to record and transmit data to other objects is continually rising. 50 billion objects are expected to be linked to the internet by 2020.4 This network of connected devices creates continuous streams of data which can increase efficiency across a wide range of business practices.

Many applications already exist: in transport, tracking when a bus will arrive; in pharmaceuticals, monitoring temperature-sensitive products; and in insurance, monitoring the driving style of car owners to preferentially price premiums for safer drivers. As the cost of sensors and data transmission continues to reduce, we are reaching a tipping point where commercial use of the IoT will take off.

In financial services, compelling uses have not yet emerged into the marketplace. But the IoT could have many valuable applications (see Figure 1), including:

  • Product design: Asset financing, for example, could be based
    on parameters such as kilometres driven or load carried rather
    than simply the period of time for which the asset is leased, as with
    traditional models.
  • Risk management and pricing: Collateral management is a key element of risk management. Better data on the quality and condition of collateral provides more accurate assessment and pricing of risk.
  • Understanding customer needs: Tracking a business’s activity could indicate when it may have additional growth financing needs, for example, by revealing when leased machinery is working at full capacity.
  • Streamlining contractual processes: IoT devices will be able to capture data and feed it into digital platforms that govern and verify “smart contracts” (computer protocols that verify or enforce contracts). The collation of real-time data on these platforms can facilitate efficient covenant monitoring, automatic disbursement of assets and automatic release of liens or goods.

Fintech 2.0

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