How startups are leading innovation in Fintech 3.0

15 September, 2016

Financial technology, or fintech, is often seen today as a new phenomenon. However, the interlinkage of finance and technology has evolved over three distinct eras. 

Fintech 1.0, from 1866 to 1987, was the first period of financial globalisation supported by technological infrastructure such as transatlantic transmission cables, SWIFT interbank transaction communications, ATMs, credit cards etc. 

This was followed by Fintech 2.0 from 1987-2008, during which financial services firms, just like most other traditional industries, increasingly digitised their processes. Internet usage spread across the world and all industries, including banking, came online during this period. Since 2008 a new era of fintech has emerged that is defined not by the financial products or services delivered but by who delivers them. The key difference in this era of Fintech 3.0 is that many of these innovations are led by startups. 

However, it is not right to think of fintech only as a startup phenomenon. Fintech now refers to a rapidly growing industry representing between $12 billion and $197 billion in investment as of 2014, depending on whether one considers independent startups (Fintech 3.0) or traditional financial institutions (Fintech 2.0).

McKinsey’s proprietary Panorama Fintech Database tracks the launch of new fintech companies – i.e., startups and other companies that use technology to conduct the fundamental functions provided by financial services, impacting how consumers store, save, borrow, invest, move, pay and protect money. In April 2015, this database included approximately 800 fintech startups globally; now that number stands at more than 2,000.

It’s an evolution, not a revolution

One key feature of the Fintech 3.0 era is the unbundling of financial services. Fintech startups are cherry picking specific segments of financial products and consumers segments to design their offerings. At a high level, these can be categorized as –

Debt Funding Platforms Online platforms that help small businesses and entrepreneurs to get loans. These can be crowdfunding platforms or credit marketplaces using institutional money of various types. Some examples are – Lending Club, OnDeck, GroupLend, Kiva, Capital Float, Neogrowth, Indifi, LendingKart etc.

Equity Funding Platforms Online platforms for crowd-sourcing of equity investments in startups and early stage businesses. E.g. – Fundersclub, Globevestor.

Wealth Management Platforms – Technology-driven solutions for automated wealth management recommendations. E.g. – Wealthfront, Betterment, Intelligent Portfolios.

Payment Processing Solutions – Products for simplifying and/or automating various steps of the payment / cash flow value chains. E.g. – Currency Cloud, Square, Tipalti, Flint, Check, Zipmark, Stripe, Astropay, WePay

Others – Various other kinds of solutions like personal finance tracking and fraud monitoring (e.g. BillGuard), virtual banking (e.g. BankingUp), alternate Credit rating services (using big data, social profiling etc).

And then there is the whole ecosystem of virtual currencies / digital wallets and the platforms built around them. Each one of these categories has a world of depth in its own right. 

Driven by big changes

Banking has historically been one of the sectors that are most resistant to new start-up driven disruption. Since the first mortgage was issued in England in the 11th century, banks have built robust businesses with multiple moats: ubiquitous distribution through branches, unique expertise such as credit underwriting underpinned both by data and judgment, even the special status of being regulated institutions that supply credit, and have sovereign insurance for their liabilities (deposits). Moreover, consumer inertia in financial services has traditionally been high. Consumers have generally been slow to change financial services providers.

The Global Financial Crisis of 2008 was a watershed moment and is part of the reason why fintech is now such a hot area of growth. The key factors driving this rapid growth of fintech startups right are: 

Demand side

Loss of trust in banks –One big reason why banks continued to hold a monopoly over financial services was because consumers put a large trust premium on established banks while entrusting them with their money. However, the 2008 banking crises caused by reckless actions of bankers made consumers loose that trust. People are now willing to trust non-bank entities with their money decisions. A 2015 survey reported that American trust levels in technology firms handling their finances is not only on the rise, but actually exceeds the confidence placed in banks. For example, the level of trust Americans have in CitiBank is 37%, whilst trust in Amazon and Google respectively reaches 71% and 64%.  Digital entrepreneurs are viewed as more trustworthy champions of consumer interest as compared to over-paid bankers who are perceived to be manipulating the system to make fat profits.

Expectation of ‘one click’ delivery – In an era where people get simple single click fulfilment of their day to day needs, traditional banking feels way too outdated. The millennial generation is now used to the user experience levels of iTunes for listening to music, Amazon for same day delivery of online shopping, Expedia for global travel bookings, AirBnB for economical international lodging, Uber for inter-city transport, WhatsApp for communication and Tinder for dating. Traditional banking feels way too bulky and outdated in this context. Consumers have no patience for an industry that takes weeks to process mortgage requests and small working capital loans; nor do people accept silently the non-transparent charges for services like cross-border money transfers and investment brokerages etc.  There is a strong demand for simple, fast and transparent financial solutions that can be accessed at a click of the mobile phone touch-screen. 

Supply side

Abundance of skilled financial entrepreneurs – As the financial crisis morphed into an economic crisis, large numbers of highly skilled professionals lost their jobs or were now less well compensated. This under-utilized educated workforce found a new industry – Fintech 3.0, in which to apply their skills. These highly skilled individuals were inspired by the success stories of high profile digital startups in other industries. There was also the newer generation of highly educated, fresh graduates facing a difficult job market. Their educational background often equipped them with the tools to understand financial markets, and their skills were well adapted for Fintech 3.0 startups.

Regulation – After the 2008 financial crises, regulators have become more acceptable to opening up the financial industry to specialized players who serve specific parts of the financial value chain. This can be seen happening both in developed and developing countries. E.g. in the US, the JOBs Act assisted small businesses to by-pass the credit contraction caused by banks’ increased costs and limited capacity to originate loans. The JOBs Act made it possible for start-ups to raise directly the finance to support their business by raising capital in lieu of equity on P2P platforms. 

The UK’s FCA is facilitating innovative fintech’s through Project Innovate and its ‘Regulatory Sandbox’ that provides these fintechs to operate in safe spaces to test their models.  South Korea is developing a specific regime for online-only banks. In India, the banking regulator recently created two new types of banking licenses that are specially tailored for fintech companies – The Payments Bank License and The Small Bank License. Similarly, the Chinese government issued Internet Finance Guidelines in July 2015 to continue growth of fintech innovation. Similar examples of financial technology innovation friendly regulation can be seen across many developed and developing countries. 

Telecom revolution – In many parts of developing world, mobile phone has become ubiquitous. Mobile phone ownership far exceeds formal banking coverage in these countries. E.g. while only 40% of Indians have active formal banking relationships, 80% of Indians have mobile phones. For these unbanked people, the “reputational” factors that provided an edge to banks for offering banking services are not relevant. Mobile based financial services are often the only, and the preferred, means of reaching these populations. For these populations, “banking is essentials, banks are not,” as it was rightly captured by Bill Gates.

Rantej Singh works with a boutique Swiss management consulting firm specialising in emerging market financial institutions. He has previously worked with Thomson Reuters, Bank of America Merrill Lynch and ICICI Bank in strategy, innovation, product management and operations roles, and founded/co-founded two businesses. He is a co-author of ‘Practitioners book on Trade Finance’, the recommended course book at Indian Institute of Banking and Finance.

This is the first of a two-part column. Read the second part here.

Like this column? Sign up for our daily newsletter to get our top reports.


Leave Your Comment
How fintech startups can disrupt the financial services industry

How fintech startups can disrupt the financial services industry

Rantej Singh 8 months ago
The headlines may give the impression that fintech startups are coming to eliminate traditional banks. That may not be the case yet.  Unlike startups, banks...
VC investors scout for fintech bets in Europe as US market cools

VC investors scout for fintech bets in Europe as US market cools

Reuters 4 weeks ago
Venture capital investments in financial services startups are showing a geographical split, with funding for so-called “fintech” companies in the United States cooling but soaring...
Is fintech here to stay?

Is fintech here to stay?

Serguei Netessine 1 year ago
There are more than 5000 financial technology (fintech) startups in the world now. Many unicorns are emerging among them. There are now about 50 fintech-unicorns...
No Comments

How startups are leading innovation in Fintech 3.0

Powered by WordPress.com VIP