Fintech disruption of the banking industry has been driven by how consumer behaviour has changed over the last three decades – think back (if you’re old enough) to life in the 1990s.
Your local grocer would know which vegetables you tended to buy; your pharmacist would be aware of the prescriptions you took; and you’d likely have a personal relationship with your local bank manager. If you didn’t bring your wallet to a local store, you might have been able to add it to the tab to be settled at a later date.
It wasn’t all rosy, though. Customer service was often slow. There was no such thing as the “always-on” or “as-a-service” economy. Instead, you would be at the mercy of your local shops’ closing times. Consumer choice was far more restricted. And oftentimes, if you didn’t have cash in your wallet to pay, too bad.
The internet revolutionised – or more accurately, digitised – all this.
Suddenly you could order amenities online. Not only could you purchase goods and services beyond your immediate locality, but the entire world was at your doorstep. You could seek out and communicate with likeminded people with the same niche interests as yourself. And, when you were ready to make a purchase, you could pay digitally.
But banks lagged behind. They struggled to facilitate the new demands of online consumers. Their legacy back office technology couldn’t cope and suddenly their internal cultures had to undergo dramatic change – something which often proved near impossible. And these factors played a part in the rise of the first wave of financial technology.
There were three drivers which propelled the first wave of fintech, or Fintech 1.0.
The first was the rise of the internet. Constantly improving speeds and widespread access meant hundreds of millions of consumers were suddenly able to access digital services.
The second was the rise of the smartphone. This hardware transformed consumer behaviour beyond recognition. Apps and other software products providing significant upfront value made smartphones indispensable – just think of Shopify, Google Maps and Uber.
The third driver which paved the way for fintech providers’ success was the financial crisis in 2008. Not only did this bring the traditional banking system to the brink of collapse, but consumers were far less trusting of the big banks thereafter.
The new breed of financial services providers was not tied down by legacy infrastructures and, with smaller teams and flexible IT infrastructures, they were more agile. And this allowed them to easily circumnavigate the new regulatory and compliance requirements that were introduced in the wake of the financial downturn.
Fintech providers sought to solve problems the banks could not. Or at least to do what the banks do, but better. Huge levels of investment poured into the fintech industry as start-ups took business away from the banks.
But the first wave of fintech, of Fintech 1.0, had its limitations. Service providers have only tended to disrupt at the edges of banking. Sure, they competed with the banks, but they didn’t change the core infrastructure of banking. The incumbents haven’t fallen. Far from it.
Many big banks have updated their offerings by introducing new digital services. Others have created incubator programmes, supporting ambitious fintech start-ups. And this collaboration will be keen as we move towards Fintech 2.0.
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Regulation is there for a reason. And recent policy shifts specifically targeting fintech groups has not only favoured transparency and collaboration but has also offered an opportunity for new players who adhere to the rules to enhance consumer confidence and solidify their legitimacy.
Introduced by the European Banking Authority, the PDS2 legislation was intended to boost competition by forcing banks to share the data of customers who authorise it with third parties. And this led to the rise of open banking, the use of open APIs that enable third-party developers to build applications and services around financial institutions.
And, as a consequence of open banking, we’re now witnessing the rise of Banking-as-a-Service.
You’re probably familiar with the term software-as-a-service. Instead of paying for entire applications or building them in-house, software-as-a-service allows you to use an application on a pay-as-you-go model. Think of Dropbox, for example. Instead of purchasing a piece of hardware to store your data on, Dropbox lets you do so in the cloud. You just pay for the space you use.
It’s a revolutionary model that has swept the services industry. And that’s where banking is heading. Banking-as-a-Service applies a plug-and-play, on-demand model to financial services. And what that means is we’re going to see many more non-financial websites offering financial services that are relevant to their audiences. Some of the most forward looking companies have furthered their product offerings with Banking-as-a-Service.
Take Shopify, for example. Shopify, which provides infrastructure to e-commerce shops, has launched several financial services products. And if they don’t make the company a fintech, they certainly help blur the lines between retailers and the financial services industry. Most notably, US merchants on Shopify can offer instalment payments to their customers for purchases between $50 and $1,000, with zero interest. And added to that, the merchant receives the amount in full immediately.
The e-commerce company recognised that cash flow is an important consideration for its customers and that, in turn, the ability to borrow interest free for its customers’ end users will encourage new sales. By utilising embedded lending, Shopify has driven its retention rates higher while strategically boosting its fulfilment network.
As the above example demonstrates, the financial capabilities of banking-as-a-service go far beyond those associated with traditional financial services products. They can create new revenue streams, lower cart abandonment rates and improve customer retention levels.
Open banking has led to the rise of an entire ecosystem of regulated apps which share transaction data to improve customer experiences and empower consumers with new financial products. And the big banks should take note. If they don’t keep up with the rising demand for intuitive and personalised financial services, they risk falling behind their more innovative brethren.