Sofia Lotto Persio spells out the future of financial services, reviewing the industry’s biggest trends.
Artificial Intelligence (AI)
AI is the crucial component of process automation – and of many film plots about the impending destruction of humanity. Far from being threatening (yet!), what AI essentially does is process a vast quantity of data at a speed no human can achieve. It is very useful in predicting markets, especially as algorithms are built to improve with the quantity of data they process. Financial services provide a fertile ground for AI applications because, like every computer program, AI’s strength comes from the quality of the data fed to it, and financial institutions are data mines. AI applications in trade finance can be found particularly in the field of compliance, to prevent money laundering and fraud.
Bitcoin is the best-known and most-used virtual currency of the hundreds in circulation, although it is struggling to achieve network effect due its negative reputation. While it provides a safe and cheap method of transferring assets, it is also used for ‘dodgy’ or illegal business (although cash is actually by and
large the preferred means of financing criminal activities).
One of the issues with bitcoin is that it is difficult to perform background checks on those involved in the transaction, due to the cryptographic identity of the users. “There is a big concern that when a company is engaging with bitcoin, they may inadvertently be mishandling proceeds of crime and not be able to identify those to the standards the industry requires,” Kevin Beardsley, Elliptic’s head of business development, tells GTR.
Elliptic recently developed a solution with LexisNexis that will allow for screening of transactions, which should encourage new banking relationships and help financial services providers feel more comfortable in engaging with bitcoin. Demand for transactions in bitcoin is increasing in countries like Venezuela, where the currency is volatile, and in various countries in Africa. Start-ups such as BitPesa are already enabling individuals and businesses to send payments to and from Kenya, Tanzania, Uganda and Nigeria using the cryptocurrency.
A group of digital-first banks have begun to receive authorisation from the financial authorities, offering accounts and lending services which are highly personalised and operating through slick-looking apps and websites. They primarily target younger customers in the retail banking sector, but, in time, they may come to eat the corporate bankers’ lunch, too.
A KPMG report released in May shows that smaller challenger banks, including Aldermore, Metro, OneSavings and Shawbrook, delivered a 17% return on equity last year from 15.8% in 2014. Larger challenger banks like Virgin Money and TSB got to 9.5% from 8.8%, while the UK’s big five grew from 2.8% to 4.6%.
Distributed ledger technology (DLT)
A term used to encompass the platform that works as a decentralised, immutable record of asset transfers – an alternative to the term ‘blockchain’ which, despite its increased acceptance, still makes some people uncomfortable. The innovation presented by blockchain affects payments, contracts, identity verification and more. In the bitcoin blockchain, the validation of transactions requires proof of work. This is obtained through a process called mining, which involves the solving of complex algorithmic calculations, and consumes electricity. This factor is important, because it allows participation of anonymous parties without prior approval.
Digital documents have been hailed as the trade finance innovation – before blockchain came along. Emerging e-trade finance solutions such as the bank payment obligation (BPO) – a payment guarantee and risk mitigation instrument that performs a similar function to a letter of credit, and the e-bill of lading, are good first steps to take on the innovation path for those who are still not 100% sure about going digital. But they are by no means the be all and end all of financial innovation.
What constitutes the financial technology (fintech) sector is a matter of loose interpretation, rotating around the concept of using software to provide financial services. It usually refers to the ecosystem of new companies, or start-ups, born to bring disruptive solutions to the market. Disruption is quite a popular term, albeit slightly overused. Its original meaning defines innovation that starts from the bottom of a market and relentlessly moves up, creating a new market and value network, allowing a whole new population to access that market, and eventually displacing market leaders. Basically, it’s as if an industry sector underwent a French revolution – and it seems like there is still a way to go for fintech to fully disrupt banking.
Just like in real estate, in the fintech space some locations are more prized than others – which explains the rise of fintech hotspots around the world. London, Singapore and New York’s position as global fintech hubs is hardly surprising, as these cities are also top financial centres, and the fintech industry, it turns out, needs proximity to financial centres more than to technology.
Global hubs are also often renowned for their accelerator or incubator programmes, to which start-ups apply to receive mentorship and capital, usually in exchange for an equity percentage. An accelerator programme usually lasts three to four months, at the end of which the start-ups graduate. Incubator programmes are often physical locations in which start-ups collaborate with one another and with external mentors. Think of accelerators as a very intensive college experience to jump-start a business, while incubators don’t set a timeframe for the start-up’s graduation, but are likely to take a bigger equity cut of the businesses they support.
An event of limited duration (one to a few days) in which people from different backgrounds, but particularly those involved in computer sciences (from developers to designers to data scientists), work in teams to create a new product to solve a certain challenge. They usually win monetary prizes, and eternal glory. The products developed are generally open-source. Banks like BNP Paribas have started hosting hackathons to encourage innovative thinking and collaboration among internal departments and external partners.
Start-ups working in this sector are making data collection and analysis for the insurance sector smoother and more efficient, giving rise to the term insurtech – which can be seen as a relative, or a sub-branch, of fintech. The sector is still relatively new and growing, but one to follow nonetheless!
The idea that competition should drive business forward is giving way to the notion that harnessing expertise from different perspectives produces better results. As a greater number of proof of concept and product pilots are spearheaded by groups of banks and institutions working together, innovation seems to be going hand-in-hand with collaboration between people from different sectors, different banks or simply different departments within an organisation. Down with the silos!
Financial services have a love-hate relationship with know your customer (KYC) requirements – while everyone agrees it is a good system to prevent money laundering and even terrorist financing, it is also costly and time-consuming. But for every costly and time-consuming process out there, there is a fintech solution, either in the making or in the market already. Innovation in this field includes blockchain-based solutions, AI-powered solutions, or even a blockchain-based AI-powered solution! Just make sure to understand where the liability falls if the system fails. Currently, it rests with the owner of the code, which is usually the institution that hired the coders, or the coders themselves, depending on the contract.
Letter of credit digitisation
A backbone of trade finance instruments, letters of credit are often reprimanded for being such a paper-intensive and time-consuming process. As such, they are a primary target for innovation. A number of banks are working on different projects to bring letter of credit transactions onto the blockchain, which can help streamline the manual processing of import/export documentation, improve security by reducing errors, make companies’ working capital more predictable and increase convenience for all parties through mobile interaction.
Digital money that exists and is exchanged over mobile message. With the increasing availability of smartphones, the term can be extended to mean digital currency, indicating various forms of non-physical money. But for countries in which smartphone use – or bank accounts, for that matter – is still limited to certain segments of the population, mobile payment systems connected to a person’s sim card have provided vital access to financial services, enabling money transfers domestically and internationally.
The future of financial services does not only rely on the latest technology, but also on getting new, young, fresh blood to take over and move the sector forward. The International Trade and Forfaiting Association (ITFA), with its Young Professionals initiative, has been looking for ways to make trade finance more accessible and attractive to young people, whom the industry needs to satisfy a skills gap and a demand for young talent.
Reaching out to universities is one of the strategies: at a seminar organised in London in March, the Master’s students from Madrid’s University College for Financial Studies (CUNEF) showed a keen interest for financial services technologies such as blockchain and digital currencies, and their applications for trade finance.
Open the bank!
Technological innovation thrives on open source, and involves making the code for products available online for anyone to understand, reproduce and build upon, even for commercial purposes. This is in stark cultural contrast with the modus operandi of financial institutions, which prize confidentiality and strict copyright enforcement. New legislation such as the Payment Services Directive 2 (PSD2), a European Union regulation, will force banks to become more open. Among other things, they will be required to offer third-party access to their APIs (a set of routines, protocols, and tools for building software applications), effectively allowing access to a bank’s architecture and data.
Also known as crowdfunding, peer-to-peer (P2P) lending allows for people or small businesses to receive funding from a decentralised group of lenders rather than a bank. These lending systems experienced a boom following the 2008 crisis and the ensuing restrictions on bank lending, but their growth has started to slow down in the past year, due to the increase in competition in the market, and the involvement of one of the biggest P2P platforms, The Lending Club, in an investigation over lending practices.
P2P lenders may come under greater scrutiny, but as long as banks struggle to lend to underserved sections of the market, they will still have a reason to exist. P2P transactions are also popular in the insurance sector, as proponents believe risk will be managed better by those directly affected by it.
The attitude needed to spur innovation involves the questioning of the status quo. Why are processes run the way they are? Can they be improved? How, and at what cost? These are key questions that deserve consideration in any business that wants to be innovative.
One of the many terms deriving from the meeting of an industry with technology, regtech refers to the technologies that will help regulators. Regtech tools can be developed to address tasks as diverse as compliance, health checks and transaction reporting. According to a Deloitte report on the subject, regtech solutions will help firms to automate the more mundane compliance tasks and provide data and insights to better manage a variety of risks.
Smart contracts are contracts written in computer code that can be executed automatically once certain conditions are satisfied. The parties involved in the transaction can visualise data in real time on their devices and see the next actions to be performed. They work best when exchanged on a distributed ledger as it provides a single, immutable record of a trade verified by all parties. They are seen as a key innovation in the trade finance space, with an increasing number of banks looking into real-world applications.
3D printing has been hailed as a breakthrough technology in changing the world of trade – the latest of these claims coming from the World Economic Forum. However, the technology has not yet fulfilled expectations, with very few manufacturing applications coming into the mainstream. But the potential is still there. Decentralising the production of goods could provide new opportunities for supply chain management and logistics, but also new challenges for those economies that rely on their manufacturing capacities. For now, 3D printing’s most successful applications have been in the medical sector, particularly in producing tissues, prosthetics, various kinds of human cells (from organs to skins) and medical equipment.
A term describing a start-up whose market evaluation, based on fundraising efforts, is valued at US$1bn at least – an eventuality that was thought to be a figment of someone’s imagination. For something that was once restricted to the mythical world, the unicorn universe is becoming increasingly populated, with over 100 companies and counting. This new reality is giving way to new equine-related terms to describe different kinds of billion-dollar start-ups. Watch out for the thoroughbreds, companies whose value is expected to last in time rather than pop in a market bubble.
Venture Capital (VC)
Bankers that leave the sector for fintech often end up becoming venture capitalist. Venture capital is the water needed to make start-ups grow and it is often easier to access than bank loans, on top of coming with the added value of mentorship. Applied in the right doses, VC can be instrumental in the growth of a company and a sector, but too much can kill it. The increase in investment in fintech companies is growing a bubble that some think is due to poor judgement from (some) venture capitalists.
Much like finance and technology, the fintech industry is often reprimanded for its lack of women and diversity, particularly at top management level. In Europe’s top 50 fintech firms, just 5% of top executive roles are filled by women, with only one female CEO. The reasons for this gap are many, and they include cultural attitudes, education access and financial opportunities. Closing it requires effort every step of the way, from supporting girls in accessing education, to encouraging a career in the scientific or economic fields, to then providing mentorship to grow into that career and finally reach management levels.
Raise your hand if you’ve already heard the sentence: “90% of the data in the world today has been created in the last two years alone.” Setting aside questions over the accuracy of the statement, the sentence is widely quoted because it clearly shows that the avalanche of data being created from various media and transactions is a recent phenomenon, one whose potential is yet to be fully explored. IBM estimates that 2.5 quintillion bytes of data is created daily: think of the possibilities this data presents, and aim to create new ways to exploit it. Innovation is a journey rather than an end in and of itself.