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By Mike Ross, Pie Funds

In 1994, in a world that was barely becoming familiar with dial-up internet, not everyone would have believed Bill Gates’ prediction that banking was necessary, but banks were not. 

Fast-forward a couple of decades and the banks find themselves in a race to innovate to remain relevant to their customers. This disruption is thanks to the ‘fintech’ industry – where financial services and technology intersect.

The fintech revolution is about companies using technology in novel ways to change the way financial transactions are carried out and services are delivered, and it’s changing traditional banking.

Some examples of disruptive technologies you may already use are:

•    Paying for goods and services via a non-bank payment platform such as PayPal.

•    Moving money overseas using a non-bank provider, such as OzForex.

•    Consumer or commercial lending alternatives, such as peer-to-peer platforms.

Because of innovations like these, our reliance on the teller at our local bank branch is decreasing every year.

In a recent PwC survey of chief executives and other senior managers within the global financial services industry, 83 per cent of respondents thought a part of their business was at risk of
being lost to stand-alone fintech companies. This number rose to 95 per cent among executives in the banking sector. 

The emergence of fintech

With these numbers suggesting fintech is a major threat, it’s not hard to see why global investment in the industry is increasing. KPMG estimates a total of US$19.1 billion was invested into the sector in 2015 – almost five times the $3.9 billion that was invested only two years earlier in 2013, and a big jump from the $12.2 billion invested in 2014. 

Most of this funding went into venture-capital-backed fintech firms based in the United States,
but there are also fintech firms in Australia and New Zealand. 

Although the boom in the fintech industry has made it a ‘buzzword’ today, this is not the first time technological entrepreneurs have tried to disrupt the financial services sector. McKinsey & Company estimates that in the seven years between 1995, when internet browser company Netscape listed on the share market, and 2002, when eBay bought PayPal, more than 450 technology firms ‘attacked’ the industry. Of these, many failed and only five remain as stand-alone entities today. So disrupting the industry longer term is not easy. 

This begs the question, why is it different this time?

Breaking through the moat

A couple of factors are allowing fintech to disrupt traditional financial services business models like never before. These driving forces will only strengthen as millennials become a more meaningful part of the global economy and as new generations emerge which are even more reliant on technology. 

First, finances are a sensitive subject, both for individuals and companies. For this reason, one of the most significant barriers to entry in the financial services industry has been the customer preference to engage with a provider that they trust implicitly (for instance banks). Yet the Global Financial Crisis appears to have changed this, with surveys showing sentiment towards banks has taken a significant hit among both consumers and businesses. This has meant customers are more willing to consider alternative providers. 

Another factor that has created an opening for fintech companies is the way in which technology has changed customer engagement. For banks, branches have always been a major distribution channel. This physical infrastructure is expensive to set up and run, and would cost billions of dollars to build and replicate. 

However, customers are spending more time online and can do more tasks on their phones or at their computers, so this barrier is also being broken down. While banks have also embraced technology (for example mobile banking), the shift in consumer engagement means fintech firms have a structural advantage to banks, as they don’t have high fixed costs. Culturally, they can be more nimble than banks, which are large, bureaucratic organisations, often slow to make decisions. 

What’s being disrupted?

Two types of transactions – consumer banking, and payments and funds transfer – have been the main targets in fintech’s crosshairs so far. These segments are likely to continue to be the focus of disruption over the next five years, say the respondents in the PwC survey.

Other financial services sectors increasingly being targeted by fintech firms include investment and wealth management, brokerage services and insurance.

One example is robo-advice, which provides financial advice and can even design and construct an investment portfolio for clients. Relatively speaking, robo-advice is still in its infancy. It was estimated that by the end of 2015, $55-60 billion was under digital advice. If successful, this could be a game-changer for the wealth-management industry, as robo-advisers will be able offer services for a fraction of the cost of current providers. 

Fintech companies are threatening the business models of financial services firms globally. Not all will be successful, but those that can capitalise on changes in consumer behaviour while offering superior products, or identical services at a fraction of the price, are in a strong position.