Fintech

The New DNA of Financial Services

Pranay Gupta, T. Mandy Tham

• Publisher: De Gruyter
• Year: 2018
• ISBN:
  9781547400928
• Edition: 1
• Topic: Business
• Subtopic: Financial Services
• Index: Business

This extraordinary book, written by leading players in a burgeoning technology revolution, is about the merger of finance and technology (fintech), and covers its various aspects and how they impact each discipline within the financial services industry. It is an honest and direct analysis of where each segment of financial services will stand.

Fintech: The New DNA of Financial Services provides an in-depth introduction to understanding the various areas of fintech and terminology such as AI, big data, robo-advisory, blockchain, cryptocurrency, InsurTech, cloud computing, crowdfunding and many more. Contributions from fintech innovators discuss banking, insurance and investment management applications, as well as the legal and human resource implications of fintech in the future.

Part 1:An Overview of Fintech

Chapter 1
Fintech and the Disruption of Financial Services

The financial services industry is comprised of multiple businesses, each of which is structured either as a division within a large financial firm or an independent standalone business unit. Regardless of how they are organized none of these business units produce real assets but rather they act as intermediaries or advisors to market participants. The financial services industry is basically an industry of middlemen.

Technology as a tool has had three principal impacts on business and industry:

–It has allowed the automation of processes, where manual work performed by humans is replaced by machines or algorithms.

–It has lowered the cost of information acquisition and hence made information more accessible to everyone. As a result, any business whose main reason for existence was information asymmetry has faced an existential threat. Examples of this include brokers and agents of any asset or product.

–It has made all manufacturing and distribution processes far more efficient. As a result, any middlemen in the chain between the producer to the consumer of a product or service may find that they are no longer required. An example of this is in the consumer retail industry, where automation has reduced the number of agents, wholesale distributors, and salespeople.

Arguably, given these facts, the financial services industry should have been deeply impacted a long time ago. However, in a structure where financial services are often deeply regulated and segregated by countries, a dramatic change has not happened until now. Since the global financial crisis in 2018, financial regulation across the world has become more uniform, the financial services industry has become dominated by global players rather than local players, and cross-border communication and transactions have been facilitated by the use of technology. The key implication of all these developments is that the industry today is at the stage where its business model and processes are about to undergo a profound change with the advent of fintech, or financial technology, as a discipline.

The Ecosystem of Financial Services Intermediaries

Figure 1.1 displays the principal external and internal activities in financial services, which happen due to customer requirements or services provided. One common characteristic of any of these activities is that it is either an exchange of information or an exchange of capital, and this sole objective enables the business for the financial intermediary. With the deployment of technology in every part of this ecosystem, there are two possibilities, or combinations thereof:

–The institution adopts fintech as a technique that makes the existing process more efficient in every aspect, or

–The newcomer startups have a sufficiently improved business model and value proposition that they are able to disrupt the incumbents.

Although the jury is still out as to who is the business beneficiary of fintech (i.e. the incumbent or the newcomer), it is clear that the consumer stands to benefit from decreased cost or increased efficiency.

Figure 1.1: External and internal activities in financial services

Basic Skills of the Fintech Revolution

Fintech as a discipline relies on three basic concepts, no matter where it is deployed. These are

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

–Data analysis: Methodologies and tools to analyze these large and growing datasets to arrive at succinct information that can drive future decisions

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

These concepts, when applied to each of the preceding activities, result in new business models either within or outside the incumbent financial services institutions.

The Evolution of Financial Services Activities

Each of the activities in Figure 1.1 is being increasingly impacted by the use of financial technology. In this book, we describe how each of these activities is evolving and what may lie ahead as this revolution progresses.

Compliance Processes

Every financial institution in every country today is required by regulation to know various details about their clients and their sources of funds. This “know your client” process to prevent money laundering and the circulation of funds from illicit sources has largely been a client-by-client process that has been done manually. The advent of fintech provides a remarkable tool to make this process more efficient and has resulted in a branch of fintech called RegTech (or regulatory technologies). Whether used as an in-house tool within a financial institution or as an outsourced service provided by a specialized provider, it will make the compliance process far more effective than it is today.

Transaction Processing

Something common to financial services is the large number and variety of transactions that are performed by corporate and individual customers around the world and across borders. Although technology has been used for these processes for a long time, the invention of blockchain has the potential to completely change this landscape. The way simple financial transactions—such as payments at the point of purchase and money transfers between institutions or between customers and institutions—will likely change dramatically as and when these systems become widely implemented.

Insurance Calculations

Since its inception, the insurance business has relied upon estimates of risk based on long-term historical data. These are then used to calculate liabilities and thus insurance premiums. With the capture of data on every aspect of the insured, the risk calculations can be made much more accurately and transition the insurance business from a group-based average premium calculation to a customized calculation for the risk of an individual.

Investment and Risk Management Decisions

Collecting data on every aspect of any participant naturally leads to a wealth of information that can be used to forecast asset prices more accurately and at a higher frequency. This then enables investment and risk management decisions with a greater depth of knowledge.

Investment Solutions

Creating investment solutions for retail individuals, high net worth individuals and corporations has historically been done in a framework which is driven by distribution of standardized investment products and liability unaware. The ability to know the specific requirements of every customer will transition this framework to become liability aware and customized to the situation of every client. This encompasses investment solutions for all asset owners, as well as retirement solutions for individuals.

Financing Solutions

Every one of us and every company has the requirement of financing in the natural course of business. Individuals may take a loan or a mortgage, and companies may want credit or sell their equity through an IPO. This funding structure provided by the financial services industry relies on an estimation of the credit worthiness of the borrower and the ability to source capital through their network of institutions. Both of these aspects will be impacted by fintech. Assessments of creditworthiness can become 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, as well.

The Journey of Evolution for Financial Services Organizations

Companies and their management teams fall into four categories of progressive phases ...