The Great Recession stirs memories of lost life savings, foreclosed homes, and bailouts of the very firms that exacerbated the problem. “Toxic assets” and “too big to fail” became part of the daily vernacular while a whole generation of young professionals grew to mistrust large financial institutions. Yet, a seismic shift occurred in the wake of the Great Recession. A flood of regulations, a rise in unemployed professionals seeking new ways to apply their skills, and the launch of the smartphone brought about the next evolutionary phase in fintech.
The disruption that occurred after the Great Recession forever changed the way financial transactions take place and the ease of access to funds. But, how did we get there?
Evolution of Fintech
Although the term “fintech” dates back to the early 1990s, the application of technology to finance is not a new phenomenon. The use of technology by financial service institutions traces back to the 1800s. That is where we will start our story.
Infrastructure development best characterizes the first “period” of fintech. This development expanded financial services beyond the local bank.
Improved communication tools and frameworks such as the telegraph and the first trans-Atlantic cable allowed for long-range communication. The introduction of the credit card in the form of the Diners Club and the global telex network round out this epoch of fintech.
Up to this point, most of the innovations in fintech came from outside the financial services arena. In the digitalization period, financial institutions drive innovation. This altered how customers interacted with these entities.
The launch of the calculator and the ATM signal the start of this era. Other areas seeing improvement include:
- Payments: the SWIFT messaging protocol created a standard way for banks to handle payments.
- Securities: the first digital stock exchange, NASDAQ, was established.
- Electronic transactions: The Internet mainstreamed online transactions.
- Regulatory oversight: Regulatory attention increased with the “Black Monday” crash of 1987. Innovations on the regulatory front included the introduction of mechanisms to control drastic price changes (“circuit breakers”) and the use of quantitative models to measure risk (e.g., VaR).
Rise of the Start-ups
This era is marked by a global financial crisis that originated from the US sub-prime market that quickly spread to the rest of the world. The crisis caused massive job losses in the financial sector, drove a wave of regulatory changes, and pushed a younger generation of professionals towards tech companies and away from large financial institutions. In turn, the smartphone changed how individuals interacted with the world. This period brought about two identifiable results.
- Startups: Hundreds of startups took on the challenge of providing alternatives to traditional banking. Among the many startups, we witness the birth of cryptocurrency in the form of BitCoin and the crowdfunding platform, Kickstarter.
- Financial inclusion: Mobile-based financial services provided opportunities in emerging markets by allowing access to transactions that would regularly require a visit to the bank. In remote areas, a bank was not always accessible or required a multi-hour commitment. Examples of companies providing financial services in the emerging markets include M-Pesa and Alibaba. M-Pesa provided mobile-phone-based money services, and Alibaba introduced loans to small and medium-sized enterprises on its e-commerce platform.
Fintech, being one of the fastest-growing tech sectors, touched many, if not all, areas of the financial landscape. Let’s take a look at some of these areas.
In the area of banking, we see fintech’s influence through the growth of mobile banking and virtual banks. Most major banks begin offering mobile banking due to increased competition from virtual banks that have no physical building and run on an all-digital infrastructure.
Blockchain technology allows two parties who might not know or trust each other to engage in a secure transaction without the need for a trusted intermediary. Blockchain technology gave birth to cryptocurrencies that are digital currencies not issued by a central bank. Blockchain promises applications beyond cryptocurrencies such as fund transfers, settling trades, and voting.
Crowdfunding and robo-advising are a couple of innovations in the investment area.
- Crowdfunding is a method of raising capital by tapping a pool of individuals via social media and crowdfunding platforms. Crowdfunding provides interested parties access to opportunities normally not accessible to them. There are various types of crowdfunding. The type of crowdfunding used depends on the type of product or service pitched. The most common types of crowdfunding include donation-based, rewards-based, and equity crowdfunding.
- Rob-advising is an automated investing service that utilizes algorithms to build and manage an investment portfolio. These services typically have low or no minimum investment requirements, and they are much less expensive when compared to traditional portfolio management. Services provided can range from automatic rebalancing to tax optimization with little to no human interaction. That said, access to client service personnel is available for questions.
Peer-to-Peer (“P2P”) lending is a growing alternative to traditional lending. P2P platforms place borrowers in contact with funding sources/investors. Borrowers apply for loans on these platforms, and investors choose which loans they wish to fund. Investors can choose what percentage of the desired loan to fund. On the other hand, borrowers might receive loans from several individuals.
With the growth in fintech and non-traditional players in financial services, it was only a matter of time before technology would take up the challenge of regulatory monitoring and compliance. Historically, companies used a primarily manual approach to regulatory compliance. However, regtech solutions can now provide agility, high speed, and enhanced analytics to necessary regulatory activities. Regtech services include compliance, transaction monitoring, regulatory reporting, risk management, and identity management and control.
Where do we go from here?
Fintech’s dramatic growth since the Great Recession was driven by services not considered or avoided by larger, more traditional financial services firms. Where does fintech go from here? We would expect consolidation of the market as it matures along with continued growth in regtech and slow evolving industries like insurance. It will be interesting (and exciting) to see what the next phase in fintech’s evolution brings.