Fintech is an emerging field that has caught the attention of many entrepreneurs in Silicon Valley and beyond. But what exactly is fintech?
As the name suggests, fintech is a combination of the words "financial" and "information" and refers to companies that are focused on creating technology-based products for the financial industry. Such products offer a range of benefits such as lowered costs, better quality of services, easy accessibility, fast processing time, and more.
Many fintech companies are pure innovators as they experiment with out-of-the-box business models to reduce costs and improve efficiency. Peer-to-peer lending marketplaces, crowdfunding platforms, and supply-chain finance are some examples of business models that provide quick capital to businesses at reduced costs, thereby making them great alternatives to credit and financing.
In some ways, fintech can be seen as a disruptor of the financial world as it is ushering in a new era of capabilities and analytics for one of the oldest industries in the world.
Current state of the fintech industry
Though fintech startups are increasing by the day, it's still at a nascent stage because the financial industry has been relatively slow to accept these changes. Currently, it represents only 1 percent of the global financial industry. By comparison, digital media accounts for 40 percent while eCommerce accounts for around 10 percent.
One of the reasons for this slow adoption is a complex regulatory environment. According to a report by the Information Technology and Innovation Foundation (ITIF), the existing regulatory environment is designed for older business models, so it's not conducive for these next-gen companies. Also, there hasn't been much support from policymakers toward changing this regulatory environment.
In addition, fintech companies that operate across different countries have to contend with restrictions on where to store data and how to transmit it. Many countries like Germany have regulations that all data pertaining to its residents should be stored only within its geographic boundaries. While this move is intended to protect its residents, it creates hardship for fintech companies.
Above all these, the financial industry as a whole, is facing security threats ranging from data breaches to large-scale frauds and thefts. Such instances have reduced the credibility of the use of technology in financial sector, and many customers have apprehensions about transacting online.
All these factors together have affected the growth of the fintech industry and have rubbed off much of the luster from it.
Future of the fintech industry
The good news though is, the fintech industry is seeing massive investments from many venture capitalists who believe it could shape the future. To give you a perspective, venture capitalists invested more than $13 billion across 840 different fintech holdings in 2016, according to a report by KPMG. This is 7 percent more than they invested in 2015.
Critics argue that this investment is a drop in the ocean, considering that the global financial industry is worth $11 trillion. Undoubtedly, yes. There is definitely some measure of skepticism about fintech companies because of the uncertainty of its adoption, but that doesn't mean there's no future for this industry.
Historically, that's always the case with any disruptor. Look at Facebook, for example. It raised a mere $16 billion in an IPO to take on the $2 trillion media industry. Will you call Facebook a failure? Definitely not.
True, the fintech industry has been growing slower than expected, but the signs are promising considering that we're still in the early stages of its lifecycle.
In fact, interest is picking up in this sector. The fintech industry set a new record when Ant Financials, Alibaba's digital payments division, raised $4.5 billion in a single round of funding last year.
Also, competition is heating up in this industry. In 2015, there were 4,000 fintech startups, according to The Economist. Out of these companies, more than a dozen were valued at more than $1 billion. Further, McKinsey estimates that new entrants to this industry will intensify competition that will eventually augur well for customers. According to the McKinsey report, five areas will see high growth over the next decade. They are consumer finance, mortgage, lending, retail payment, and wealth management.
Besides the emergence of new companies, many existing financial institutions are also embracing technology, though at a slow pace. The ITIF report shows that the number of financial institutions that have adopted or are in the process of adopting technology jumped from 37 percent in 2009 to 73 percent in 2015.
A few of these old-world financial institutions have even set up venture capital firms to acquire or invest in fintech startups. JP Morgan, for example, spent $9.5 billion on technology in 2016. Out of this, $3 billion was dedicated to new initiatives, with $600 million spent on emerging fintech solutions.
All these statistics show that fintech will see a boom in the next few years. Specifically, fintech companies are expected to innovate in these following broad financial areas:
One of the forerunners of fintech has been the payments industry. Success stories such as PayPal, HyperWallet, and TransferWise are a testimony to this trend. These companies have acquired an early lead with their efficient digital platforms and growing customer base. For example, PayPal handled $1.73 billion worth of transactions in the first quarter of 2017 alone, representing a 30 percent increase year-on-year.
This industry is expected to grow and adapt to the growing technological needs of customers and businesses, in the future, too. Specifically, they're likely to develop consumer analytics to predict their behavior and offer services pre-emptively.
That said, they'll still have to work on beefing up security and in preventing online frauds to widen their customer base. This is where a lot of innovation is expected to happen. Already, companies like Transmit Security are getting the funds to work on innovative security solutions.
Borrowing and lending
Lending is another area that has seen a ton of innovation over the last decade. Peer-to-peer lending companies have created an online platform that connects borrowers directly to lenders, thereby eliminating middlemen.
However, the delinquency rates have been increasing over the last few years. These rates have increased from 0.56 percent in January 2015 to 0.75 percent in December of the same year.
This rise in delinquency rates is alarming as it could put companies in trouble. Already, Moody's has downgraded Prosper, a peer-to-peer lending company. Also, shares of companies like LendingTree and OnDeck have been taking a beating lately.
This means that these companies have to invest in innovative credit and monitoring capabilities to continue to have the trust of their lender base. And they have to do it fast because competitors are entering the market. EFL, for example, is a fintech that uses behavioral science over traditional credit scores to decide the trustworthiness of borrowers.
This is one area that's expected to see explosive growth and hence, opens up a world of opportunities for fintech companies.
Today, almost one-third of the world's workforce is millennials. However, they are facing job insecurity and want to invest early in good opportunities with the ultimate aim of having a future income from these investments. At the same time, they want to stay away from traditional investment advisers because of poor track records.
Fintech companies like Learnvest are using education to gain trust and transparency with customers. Going forward, this financial literacy and prudent investments are expected to open opportunities for many companies in the fintech industry.
Digital currencies have the potential to be the biggest disruptors of the traditional world of finance. The emergence of bitcoins and other related technologies like blockchain have made digital currency a reality today, and existing financial institutions have started embracing it in one form or another.
For example, Canada's big banks want to move the online identities of customers to a blockchain system developed jointly by IBM and SecureKey. Likewise, European banks have agreed to use blockchain to create a trade finance platform.
Due to these developments, investments in the blockchain industry increased by 20 percent in 2016 to reach $544 million. This trend will only get bigger in the coming years.
In short, the fintech industry hasn't grown as much as analysts expected, but that doesn't mean it won’t. On the contrary, interest has picked up in this industry and we're seeing more investments coming in. Also, existing financial companies are entering into strategic partnerships or are financing fintech startups to make the most of technological advancements.
It's only a matter of time before we start reaping the benefits of this investment. Low costs, high efficiency, improved quality of products and services, and quick customer support are some aspects that we can expect to see soon.
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