Disrupting the Financial Industry

There have been tremendous changes in the financial industry since the financial crisis of 2008. The industry was transformed not only due to population’s loss of trust in larger banks and their increased regulation, but also because of the rapidly developing digital infrastructure and the emergence of FinTech companies. This thesis thoroughly analyses the financial technology industry by investigating key innovations and companies that have successfully implemented them. Research includes framework analysis of current trends in the FinTech industry. The framework, as described by Puschmann 2017, differentiate innovation in three dimensions. The first one is called an innovation object and is divided in five subcategories: business model, product/service, organization, process and system. The second one is the innovation degree, which is either disruptive or incremental, and the last dimension is the innovation scope, which is either intra- or interorganizational. For each subsection of Puschmann’s framework a disruptive FinTech innovation and a company that excels, implementing it, are thoroughly investigated. The second part of this paper is an analysis that pinpoints the success factors of two of the highest valued FinTech companies in the US and Europe — Stripe and Revolut. The final part of this paper conducts a linear regression test of the correlation of two factors defining sustainability in finance — Global ESG Index and Global Fintech Index — with market risk.

Disruptive Innovations

The majority of FinTech firms have transaction-, subscription- and platform-based business models. According to the 2016 article of Deloitte “Banking Business models of the future” FinTech creates value through reduction of intermediaries, use of advanced data analytics and through the development of alternative business models such as crowdfunding. By directly connecting customers with each other or with institutions, FinTech firms reduce fees (e.g. TransferWise using cross-border transactions), increase automation (e.g. Wealthfront using robo-advising) and increase access to capital (e.g. Indiegogo developing a crowdfunding platform). Furthermore, FinTech firms have adapted to their customers’ needs and demands, thanks to personalized products powered by data analysis and AI. For example, young adults (Gen Z and Millennials) have shown a clear preference for practical and simple solutions delivered on a single, user-friendly platform (e.g. the fee-free trading platform Robinhood). On the other hand, Baby Boomers, the generation born between 1946 and 1964 for whom FinTech has just recently started to create financial solutions, prefer highly personalized services, tailored to their goals (e.g. the ability to sell one’s life insurance online).

First introduced in the early 1990s by Harvard Business School professor Clayton Christensen, disruptive innovation describes the process of making products and services more accessible and affordable, thereby making them available to a larger population. Unlike innovations of traditional banks, FinTech innovation tends to be disruptive. FinTech companies are often responsible for developing automated financial services that transform market liquidity and for creating private markets as alternatives to traditional financing and trading such as dark pools, trading platforms, crowdfunding websites, electronic networks, etc. The specialised focus and heavy digitalization of FinTech platforms also lead to lower transaction costs, better user experience and increased access to credit and investments (Bergara & Ponce 2017). A highly disruptive innovation in the FinTech world is artificial intelligence (AI) and big data analysis, especially in wealth management. IBM Watson Client Insight service, for example, has proven to be useful to wealth managers by providing advanced customer segmentation based on a client behaviour profile, predicting life events using historical data analysis and personalising advice and portfolio recommendation.

Strategy

Research has shown that incumbent financial institutions are rather slow at adapting to digital financial solutions available in today’s technology world. Their slow to change infrastructure, cannibalization effects and challenges to integrate new technology into their business operations in a sustainable way are all factors that contribute to customers becoming increasingly more interested in FinTech companies (D’Acunto et al. 2017). However, incumbents tend to undergo incremental innovation, such as reduction of branches and increase of online banking services. In order to stay competitive, large banks have started partnering with FinTech firms; thus, combining their strong market position and deep financial knowledge with the technological expertise and agility of a FinTech company (Figure 1). A major obstacle to successful collaboration has proven to be sharing of risk. Incumbents need to realise that FinTech ventures are risky and often fail, however, if successful, they can lead to competitive advantage gains (EY FinTech Partnership 2020).

Figure 1

According to the 2019 McKinsey article: “Next-generation core banking platforms: A golden ticket?”, another way for incumbents to innovate is through core banking system (CBS) providers. CBS providers help banks to reduce IT costs, to accelerate time to market of innovative products, to leverage data for the creation of customer-centric propositions and to introduce modularity to a bank’s structure. However, trust in CBS providers is still lacking and mostly digital banks take advantage of their services.

The analysis of Revolut showcased that an important reason for its success is that the company applies vertical integration and thanks to being independent from third-party service providers, can remove the middleman, drive down costs and enable flexibility when changing products. On the other hand, Stripe’s superior value proposition is thanks to the developer-first approach the company adopted, making it very easy to integrate Stripe’s APIs in businesses. Both companies showed that successful FinTech firms try to create an ecosystem — a wide variety of complementary products and services. This strategy creates a seamless experience of everything a customer may need regarding his finances, and leads to higher customer retention and brand awareness.

Internal organization

The internal organization of a FinTech venture plays a crucial role for its success. FinTech firms are organized in the typical fashion of tech firms: small and cross-functional teams, flat hierarchies, good access to information and emphasis on growth. Furthermore, the analysis of Stripe, the most successful American FinTech, has shown that it is very important for senior management to communicate the culture of the company and to adapt it to changing size and long-term strategy. Working at rapidly growing FinTech firms requires, next to expertise and knowledge, an extremely high devotion. That is why, FinTech companies should take their time when hiring new employees and should also clearly communicate what is expected from workers at the company. This practice facilitates high motivation and productivity from employees.

Contribution to sustainability

Customers nowadays value sustainability to a much higher degree and while people tend to distrust banks, mostly due to the 2008 financial crisis, FinTech firms are viewed to be contributing to society. That is why, this paper presents a summary of two linear regressions, testing the following two hypotheses:

H1: Countries with better (=lower) results in the Global ESG Index (ESGI) positively correlate with lower Market Risk Premium (MRP).

H2: Higher results in the Global Fintech Index (GFI) negatively correlate with higher Market Risk Premium of the respective country.

In a sample of 50 countries lower points in the Global ESG Index (ESGI) rank countries higher and higher results in the Global FinTech Index are considered better. Lower percentage in the Market Risk Premium indicates a lower required premium from investors due to lower risk on the market. The p-values of both tests are very low; thus, the results are significant. The explanatory power of the first model is relatively good (45.38%) and of the second is rather low, but still statistically significant — 28.06% (Figure 2). Therefore, it can be stated with a moderate degree of certainty that the conducted statistical analysis rejects the null hypotheses and confirms the suggested correlations.

Figure 2

Conclusion

FinTech companies have undoubtedly disrupted the financial industry by empowering customers and making the world of finance much more transparent. Initially, FinTech companies were considered to be direct competitors to big banks, but large financial institutions quickly realized that cooperation with financial technology firms has the potential to create a competitive advantage. The reality is that incumbents who refuse to update their infrastructure and operations with modern financial technology will be displaced from the market in the next 5 to 10 years. FinTech will continue to create solutions that benefit customers, to improve customer experience and to contribute to a more transparent and sustainable environment. By leveraging state-of-the-art technologies, financial start-ups support businesses to overcome multiple hurdles and to concentrate on what matters most — delivering the right product to the right customer. In times of crisis, such as the current global pandemic, the FinTech industry increases peoples’ financial security and provides the mass customer with alternative ways to access and earn money on a global scale — in this way FinTech relieves the current burden on the world economy that inevitably will be borne by taxpayers. Ultimately, financial technology has the ability to regain the trust in the financial system that has rapidly declined after the 2008 crisis.

References

Bergara, M., & Ponce, J. (2017). How disruptive are Fintechs?. Monetaria, (2), 203–241.

D’Acunto, F., Prabhala, N., & Rossi, A. G. (2019). The promises and pitfalls of robo-advising. The Review of Financial Studies, 32(5), 1983–2020.

Puschmann, T. (2017). Fintech. Business & Information Systems Engineering, 59(1), 69–76. https://doi.org/10.1007/s12599-017-0464-6

Banking Business Models of the Future
tw-banking-business-models-of-the-future-2016.pdf (deloitte.com)

How do FinTechs engage millennials and Gen Z? (onfido.com)

After Millennials, it’s fintech time for baby boomers — Fintech Circle

Disruptive Innovations — Christensen Institute : Christensen Institute

Watson Assistant Demo
https://www.youtube.com/watch?v=mnhb2fwkS_Y

Next-generation core banking platforms: A golden ticket? | McKinsey & Company

Revolut’s Nikolay Storonsky Is Building The Amazon Of Banking (forbes.com)

Blitzscaling 11: Patrick Collison on Hiring at Stripe and the Role of a Product-Focused CEO
https://youtu.be/qrDZhAxpKrQ

Revolut: How Digital Banking Alternatives Are Helping Customers Take Back Control
https://youtu.be/99i3Y_Y44kY

Nikolay Storonsky and Revolut, the home of hard work and no play (charliehr.com)

Revolut’s Nikolay Storonsky Is Building The Amazon Of Banking (forbes.com)

Value of Fintech (assets.kpmg)