Chapter 2

Understanding What’s Disrupting the Financial Industry (and Why)

IN THIS CHAPTER

Balancing trust and value

Discovering where disruptors live

Looking at BigTech’s role

Seeing where disruptions are happening

Searching for new opportunities

During this era of post-financial- crisis, the financial services industry has been thrown into a state of massive disruption. Venerable, traditional financial institutions are on the defensive as new upstarts change the playing field in fundamental ways. This disruption is a growing concern for financial services firms at risk from potential displacement by nimbler, data-driven competitors, including those in banking, capital markets, insurance, and wealth management, and is forcing them to evolve to remain competitive.

Some of this disruption is coming from the perception that BigTech giants, such as Amazon, Ant Financial, Apple, Facebook, and Google, are likely to roll out industry-changing platforms and technologies that compete with more traditional offerings. However, emerging FinTech start-ups are also challenging the status quo by providing innovative services and increased personalization, particularly in the consumer space rather than the wholesale arena.

FinTech, which is shorthand for “financial technology,” is the drive to bring transformative and disruptive innovation to financial services by applying new and emerging technologies and satisfying consumer needs through automation. Flip to Chapter 1 for an introduction to FinTech.

Traditional financial services institutions are right to be nervous about the growing successes of FinTech firms. By their very nature, FinTech start-ups have a number of advantages. Here’s a brief comparison:

• For starters, FinTech start-ups are nimble. Because they aren’t disadvantaged by inherited older systems and methodologies, they can move faster to create new solutions. Their top leadership is also focused on creating the future, rather than maintaining the status quo, so they aren’t resistant to investing heavily in technological development and innovation.
• In contrast, traditional banks, brokers, and asset managers have weighty existing systems to support, limiting what they can spend on innovation. They are also subject to greater regulatory and institutional constraints that limit their ability to fully focus resources on new technology.

In this chapter, you find out about the key competitors in the financial services market today, the challenges they face, and what they bring to the table.

Providing Trust and Value

Both consumers and businesses select financial services using two basic criteria:

• Is it a trustworthy institution?
• Do the services offered meet my needs at a competitive price while providing value-added services that make my life easier?

Because of this, every financial sector firm faces the same basic challenges today. They are all trying to restore public trust in a post-financial-crisis environment, deliver the services that customers want, and offer the customer an attractive value — all while still making a profit.

Trust

In today’s environment, a “trustworthy” financial institution is one that can be relied on to hold up its end of the relationship by being a responsible steward of the customer’s assets and information. This means safeguarding every aspect of the relationship, preventing harm from both internal and external sources. This can include

• Maintaining the financial services company’s ongoing solvency and success. Nobody wants to use a financial services company that might go out of business at any moment or that doesn’t have the resources to invest in the latest and best capabilities.
• Safeguarding the customer’s investment, both physically and digitally, maintaining effective vigilance against data thieves and saboteurs. Cybersecurity is critical for this point; a cybersecurity breach that exposes customer or supplier data can damage an institution’s reputation irreparably.
• Safeguarding the customer’s privacy. Customers want to know that their sensitive financial data is going to stay private and not be compromised by hackers or careless internal handling.

So who has the edge in this area: traditional institutions or FinTech start-ups? It’s a mixed bag, because they both bring advantages to the table. Customers may perceive large, traditional institutions as being more trustworthy because of their history and gravitas, and a large, well-established business may be more solvent and less likely to crash and burn (although it’s no guarantee, as we’ve seen in recent years). However, FinTech start-ups may actually have an edge on the data-safeguarding front because of their focus on the latest technologies.

Value

The second part of the equation is the services and their value. What does the financial service provider bring to the table that the customer wants? In an ideal world, the customer wants all the services, and all the options for receiving them, for the lowest possible price. The challenge, then, is to be the provider that best meets that demand.

One way that providers are able to offer greater value to customers is through disintermediation. To disintermediate means to cut out some or all the steps between two points — in other words, to “cut out the middleman.” Financial services has traditionally had lots of intermediate steps between a consumer’s need and its fulfillment, creating lucrative careers for stockbrokers, tellers, credit card processors, personal bankers, and even check-printing companies. However, in today’s market, disintermediation is becoming not only the norm but a near imperative to keep up with demand for lower costs and better value.

Fortunately, advancing technology has made it possible to automate many areas of the financial services value chain that were strictly manual operations in the past. This has enabled companies to economically provide services to customers that were expensive in the past due to the labor involved. In this endeavor, FinTech companies are better positioned than their traditional counterparts. They can be more responsive, more focused, and less distracted by legacy issues such as fixed cost, old infrastructure, and dated technology.

The established players have been slow to respond to FinTech’s disintermediation and disruption because they haven’t wanted to cannibalize their legacy franchises. Many have attempted to offer digitalization only in noncore businesses or geographical areas. For example, some large banking institutions have experimented with offering new experiences such as payment services that compete with FinTech payment providers. However, these new offerings often require significant investment in new technologies to “get in the game,” such as mobile-friendly site design, cryptocurrency, and digital wallets. They must respond to continually advancing technology, changing consumer habits, and in some cases underserved and underbanked markets.

In China, the most successful FinTech firms have been BigTech companies that developed financial ecosystems in conjunction with their highly engaged consumers. One example, Ant Financial, was created on the back of Alibaba’s e-commerce platform, offering online payments, investments, digital banking, lending, and wallets. This was possible because China’s FinTech ecosystem is fundamentally different from those of the United States and Europe. In Western economies, successful FinTech firms have been disruptors, particularly in the payments, lending, and wealth management sectors. They have benefited from extensive consumer adoption of mobile technologies and Internet access. Ant Financial is closer to the notion of TechFin rather than FinTech, where a large technology firm leverages its technology prowess to deliver financial products within its more efficient, broader service offering. It can also do this because it has generated a level of trust with clients that was previously reserved for traditional financial institutions.

2008: THE MARKET COLLAPSES

On July 30, 2007, Jeff Larson, the fair-haired child of the hedge fund world, closed his famous fund, Sowood, after it lost half its value in just one month. Sowood had gained fame and investors because of its tie to Harvard University’s endowment fund. In the month of July, Sowood’s two funds declined by 57 percent and 53 percent, and Citadel, LLC, bought Sowood’s position, taking over its credit portfolio at a huge discount. This sale allowed Sowood to return the remaining $1.5 billion to its investors. The closing of these funds followed the Bear Stearns bailout, a failure tied to the subprime mortgage failures.

The fears over the subprime fiasco widened credit spreads (the difference between corporate and government debt) and tightened cash. The gamble that Sowood made through the use of derivatives resulted in its unrecoverable loss. Debt securities went into free fall, and Larson couldn’t fully repay his lenders. The bailout of Bear Stearns and failure of Sowood caused the cost of private debt to skyrocket. From 2005 through 2006, Larson’s strategy had yielded more than 16 percent returns per annum — twice the historic rate. His strategy was predicated on the difference between a company’s debt and its stock value. The hedge was in the short selling of a company’s stock against its debt. This strategy wasn’t considered risky at the time and would probably not have brought the company down had he not borrowed excessively to offset his risks and increase his positions. Larson had insufficient cash to repay all debts when the subprime crisis was exposed. This crisis caused investors to retract support for all corporate debt indiscriminately. Sowood’s hedge failed as a result.

At the time in which this was transpiring, Sowood was a customer of Numerix, with a five-year contract. It was this defining moment when Steve O’Hanlon heeded this early warning yet at the same time did something about it. He attempted to fully understand the extent of what was taking place in the industry, and he embraced the bad news. Seeing that Sowood’s pedigree founder had been caught in this market collapse along with the prestigious Bear Stearns, he began quickly reflecting on what just happened and became more concerned about the derivative marketplace, a market to which Numerix was completely dedicated. In fact, Numerix was on the verge of being recognized by Celent as the industry leader of multi-asset class derivative pricing, and Steve wanted to be certain that the business would still have legs.

He recognized that Numerix was providing Risk Greeks, an important component used by traders and portfolio managers to hedge and to create scenarios that predict the potential changes on the profit and loss based on different pricing stresses, as part of the Numerix pricing system for free. Steve and his senior management team quickly started to analyze the risk market and realized that a pivot into that market was possible. Numerix separated out the risk technology from the pricing and offered two different kinds of licenses. This reorganization and product positioning set Numerix on the road to becoming a leader in Risk years later. It was because he got Numerix intimately involved and engaged in Risk deals that he learned a lot about what banks would need, and this knowledge set the basis for what later on became known to the market as a front-to-risk product called Oneview.

Weighing Wall Street against Silicon Valley: Where Disruptors Live

As you discover earlier in this chapter, recent disruptions in the financial industry have led both businesses and consumers to consider alternatives. This section reviews some of those alternatives and where they reside.

When people think about the financial services industry, many think about Wall Street, New York City. However, an important secondary concentration of budding financial services companies can be found in Silicon Valley, a region of the San Francisco Bay area that serves as a global center for high technology, innovation, and social media. In fact, some of those Silicon Valley companies have far larger balance sheets and market capitalization than traditional financial services firms.

Moreover, the success of Silicon Valley as a focal point for new technology innovation has resulted in imitators in the financial services industry somewhat closer to their traditional financial roots, in areas such as Silicon Alley, a growing community of FinTech businesses in downtown New York City, and Silicon Roundabout, a cluster of high-tech companies located around the Old Street Roundabout in London. And let’s not ignore the rise of Asian FinTech firms, given some major household names already exist, such as Ant Financial and Tencent.

In addition, FinTech hubs are growing globally, as the map in Figure 2-1 illustrates based on a 2018 research study. While the “usual suspects” in China, the United Kingdom, and the United States are well publicized, some other hubs deserve a favorable reference. In Europe, centers such as Berlin and Tel Aviv have built up their presence in recent years, while in Asia and Australia, Singapore and Sydney have dedicated huge efforts to attract more global focus. Last but not least, in North America, Chicago has leveraged its traditional futures market ties, and Toronto has grown a dedicated expertise in artificial intelligence.

Source: Sinai Lab from Academy of Internet Finance (AIF), Zhejiang University, and Hangzhou Moses Technology, 2018

FIGURE 2-1: An overview of the global ranking of FinTech centers relative to funds invested in 2018.

2008: THE LEHMAN BANKRUPTCY

The subprime mortgage failure went on to take down other organizations, the largest of which was Lehman. On September 15, 2008, Lehman filed for bankruptcy. Lehman had $639 billion in assets and $619 billion in debt. A large amount of those holdings and debt were tied to mortgage-backed securities and illiquid trades. The valuation of its assets and liabilities was a difficult Gordian knot to untie.

When Lehman Brothers collapsed in 2008, Steve O’Hanlon saw how this event exposed serious gaps in the risk-management practices of financial institutions. He became determined to improve risk management and create the tools financial institutions needed to best structure their risk controls. He quickly spearheaded Numerix efforts to introduce new risk analytics offerings, which soon became game changers for the firm and the financial services industry.

The fall of Lehman Brothers was a watershed moment that continues to shape Numerix to this day. With trillions of dollars in outstanding derivatives needing to be reconciled with counterparties, Numerix was selected on behalf of the Lehman creditors to value millions of terminated trades. This was arguably the most complex and one of the largest derivatives portfolios in the world.

Not only did Numerix facilitate the unwinding of these positions, but because of its work, Lehman was able to return billions of dollars to creditors.

As Numerix worked side-by-side with the Lehman traders and IT staff, beginning January 2, 2009, it was clear that a more integrated and holistic approach for managing risk was a requirement, not just something that was nice to have. Through this experience, Steve recognized an opportunity to look at risk differently. He made the key decision to reevaluate Numerix’s core analytics solution and creatively determine how it could be maximized to pivot the organization into what became a rapidly changing market of derivatives risk management.

The first deliverable was front-office credit value adjustment (CVA) calculations. When Numerix delivered this, it was quickly embraced by the marketplace as a game changer. This led Numerix to calculate all the value adjustments, now commonly referred to as XVA. At the same time Numerix created these calculations, it had immediately, under Steve’s direction, begun building out an entirely new Java stack from the Numerix Analytics to the presentation layer. As XVA was being adopted, the new stack enabled financial institutions to leverage the “cloud” like Microsoft Azure, to enable economy of scale.

Today, the pivot to risk, and the creation of a next-generation technology stack leveraging Java so that Numerix could be cloud agnostic, was the most visionary accomplishment for Steve, propelling Numerix from a “multi-asset class pricing leader” to the leader in “front-to-risk enterprise systems.”

Examining the Role of BigTech

In addition to companies that specialize in technologically advanced financial services (FinTech), several very large tech companies, such as Apple, Microsoft, Amazon, and Google, provide products and services across multiple industries. We’ll call those BigTech as a shorthand. Whereas FinTech companies are focused on financial services activities, BigTech firms can offer financial services as part of their much wider offering.

Financial services represent a relatively small percentage of a BigTech company’s customer base, but the services that BigTech can provide match up well with what financial companies need more of to stay competitive. For example, Amazon Web Services (AWS) provides financial companies (and others) with a cloud presence without them having to reinvent the wheel by building their own cloud infrastructure. Other useful BigTech services of interest to financial companies include data analysis and customer relationship management. Therefore, BigTech’s entry into financial services can be seen not only as a potential competitive threat but also as an opportunity for win-win partnerships that allow financial companies to focus on what they do best and outsource some of the technology aspects.

BigTech and payment platforms

To date, the main focus of most BigTech companies has been to provide basic financial services to their large, global ecosystems of clients. They have also acted as a delivery channel for established wealth management and insurance providers, largely driven by advertising revenue associated with search engine or targeted advertising.

However, some BigTech companies have moved into actively providing payment services to help increase the confidence level between buyer and seller on e-commerce online platforms. Payment services, such as Alipay (of which Alibaba is still a minority shareholder) or PayPal (owned by eBay), can provide secured settlement at delivery by buyers and are fully integrated into e-commerce platforms. In fact, the payment services market has developed to a point where buyers and sellers often use it as a replacement for other electronic payment channels such as credit and debit cards.

While BigTech payment platforms compete with those that banks provide, they still predominantly depend on banks. Services such as Apple Pay and PayPal, for example, need established suppliers of given infrastructure, such as debit/credit cards or trade payment systems, to manage and reconcile payments. Even where they allow payments that are processed and settled on their own proprietary system, such as Alipay, users still require a bank account or a credit/debit card to direct money into and out of the network and hold the funds in their bank accounts until they request repayment.

In addition, BigTech companies also need the banks’ services to settle between banks, because the BigTech companies don’t participate in interbank payment systems for settlement in central bank money. Therefore, for payment services, BigTech both competes and cooperates with established banks.

It will be interesting to see how Facebook’s launch of its own digital currency, Libra, may change this dynamic. Interestingly, credit card behemoths Mastercard and Visa and payment specialists eBay and Stripe were among the initial collaborators announced among the Libra partners, but they have all subsequently stepped back, waiting for the “association to satisfy all the requisite regulatory requirements.”

BigTech partnership opportunities

BigTech companies are approaching their financial services engagement from several different angles, and these are likely to develop further over time. BigTech typically enters areas of financial services where they have acquired an established customer base and brand recognition. This reflects crossovers between financial services and core nonfinancial activities, where they identify enough economies of scale. For example, companies such as Apple, Google, and Microsoft are application-centric and data-centric, providing financial cloud computing from data management and technology perspectives. E-commerce firms such as Alibaba and Amazon are more focused on delivering frictionless client experience, using customer data to better manage credit risk and working capital.

As a result, rather than seeing BigTech as an imminent threat, many financial institutions are looking at potential partnerships and collaboration benefits. According to various reports, many financial institutions have started to partner with some of the BigTech giants, such as Apple with Goldman Sachs and Google with Citigroup, while others are planning to develop such partnerships in the near future. Some of the key features of their business models are those that financial institutions are hoping to replicate, largely because they haven’t been so successful at implementing them internally.

How BigTech can help utilize data

Traditional financial institutions have always had huge amounts of data at their disposal, yet they have mostly failed to exploit it in the way that BigTech has. Banks, asset managers, and insurance companies have all developed their own internal platforms from which customer data can be leveraged. The more transactions facilitated on the platform, the more data available for analytics that can enhance existing services and attract further users. The potential for improvement industry-wide is huge in this area.

BigTech companies have been masters at increasing the number of users on their platforms, which provides the critical mass of customers to further offer a broader range of services, which in turn develops even more data. Offering financial services in addition can supplement and strengthen BigTech’s commercial activities. Payment transactions, consumer loans, and credit scoring are all examples of data generated from transactional activity. The synergies to be leveraged depend on the type of data collected, but BigTech companies, with their large user bases in social media or Internet search, can record user preferences and use them to promote, distribute, and price third-party financial services such as wealth management or insurance products.

Large financial institutions also have many customers, to whom they offer a broad range of services, but they have not been as effective as BigTech in exploiting the feedback benefits. One reason for this is the mandatory separation of banking and commerce data in many jurisdictions, which limits the data that banks can access to transaction data. In addition, legacy IT systems have not been traditionally linked to various other services through application programming interfaces (APIs).

By using more advanced technology, coupled with richer data and a clearer customer focus, BigTech companies have more proficiently developed and marketed new products and services. As a result, they have lowered the barriers to delivery by reducing information and transaction costs, and they have enhanced financial inclusion by making financial accounts more widely available (in other words, “banking the unbanked”). However, the gains available through these actions may vary by service and could generate new risks or market failures.

Barriers to greater BigTech participation

BigTech companies will face a lot more regulation if they want to enter the financial services arena in a more meaningful way. Consider the following:

• Policy regulators will have to create a level playing field between financial institutions and BigTech, particularly considering their established client base, the ability to access information, and wide-ranging commercial models. Many observers question why BigTech would want to threaten their dominant position across many industries if they must overcome many prospective obstacles to direct entry into the financial institution community.
• There are also many examples where BigTech companies have shown themselves to be averse to regulation and wouldn’t want to face a potentially strong anti-trust backlash.
• Moreover, their entry will raise many new and multifaceted trade-offs between financial strength, rivalry, and data protection.
• It’s also uncertain whether BigTech companies will have the required domain expertise in the complexities of financial services. In other words, just because a company can do something technologically doesn’t mean it will automatically be good at it.

2008: SUCCEEDING AGAINST ALL ODDS

Since 2004, when Steve O’Hanlon took leadership of Numerix, it has always taken bold moves and never worried about stagnating around one offering for too long. Inherently, Steve knew that Numerix possessed many of the key attributes (analytics) that both Bloomberg and Blackrock possessed. As a result, climbing hills to take ownership of a product category has always been Steve’s style.

In 2008, before Lehman’s collapse and two years after signing an incredibly exciting partnership with Bloomberg, Numerix became the recognized leader of multi-asset class pricing. Having achieved this stature and after the collapse of Lehman, Numerix reinvented itself as both a pricing and risk company. This was a bold move; to be able to build out a significant Enterprise Risk product from the Numerix Pricing analytics stack to the presentation layer was the boldest move ever. Maintaining a significant pricing business while investing in a completely new path was possible only because Numerix became Lehman’s partner in bankruptcy and Numerix invested all of that money into the pivot to risk.

Steve always believed that making choices that are managed is just as critical as willing a new direction or initiative to happen. In other words, we must always attempt to do new things while succeeding against all odds, both morally and ethically. The journey that Steve has been on with Numerix since 2002 is living proof that if you want something badly enough, if you’re willing to do what it takes, and if you take an unorthodox approach but get a team to follow you into the heat of battle, then you can succeed against all odds!

Understanding Where the Disruptions Are Happening

As mentioned earlier, FinTech is an overarching term for the combination of finance and technology. However, within FinTech, many subcategories apply to specific sectors of the financial world. Here’s a quick summary of them:

• Capital Markets Tech, in which companies leverage newer technology such as artificial intelligence, machine learning, and blockchain, is led by seasoned capital markets veterans and is both collaborating with and disrupting the financial services incumbents.
• WealthTech unites wealth and technology to provide digital tools for personal and professional wealth management and investing. This sector includes brokerage platforms, automated/semiautomated robo-advisors, and self-directed investment tools for individual investors and advisors to navigate the changing landscape in wealth management. For more information, check out The WealthTech Book, edited by Susanne Chishti and Thomas Puschmann (published by Wiley).
• InsurTech is a combination of insurance and technology. It refers to innovations that generate efficiency and cost savings from the existing insurance industry model. For more information, see The InsurTech Book, edited by Sabine L. B. VanderLinden, Shân M. Millie, Nicole Anderson, and Susanne Chishti (published by Wiley).
• RegTech is a community of technology companies that solve regulatory challenges through automation. The increase in major regulatory policy and the rise in digital products have made it imperative for companies to check for and implement compliance issues, and this can be difficult with old, manual processes. For more information, refer to The RegTech Book, edited by Janos Barberis, Douglas W. Arner, and Ross P. Buckley (published by Wiley).
• PayTech refers to the combination of payments and technology. Innovative payment services now form part of the PayTech ecosystem and have dominated the early days of the FinTech revolution through mobile, cross-border, peer-to-peer, and cryptocurrency payments. Financial institutions have had to digitize their current offerings to create new channels linked to a digital platform. For more information, see The PayTech Book, edited by Susanne Chishti, Tony Craddock, Robert Courtneidge, and Markos Zachariadis (published by Wiley).
• AI in Finance refers to how artificial intelligence, machine learning, and deep learning are applied across financial services companies today and how they could be used in the future. For more information, see The AI Book, edited by Ivana Bartoletti, Susanne Chishti, Anne Leslie, and Shân M. Millie (published by Wiley).
• LegalTech combines the nature of legal technologies and their relationship with data, the Internet of Things (IOT), cybersecurity, and distributed ledger technologies as well as ethical considerations of the technological advancement. For more information, refer to The LegalTech Book, edited by Sophia Adams Bhatti, Susanne Chishti, Akber Datoo, and Drago Indjic (published by Wiley).

In the following sections, we look at some business types in more detail to see how traditional financial firms are being shaken up — and improved — by FinTech disruptions.

Banks

Some larger financial institutions have adopted the phrase “We’re just a technology company that happens to have a banking license.” This is mostly a marketing gimmick, although it’s perhaps partially true for some of the new challenger banks that are attempting to disrupt the incumbent banks. However, with customer acquisition costs high and increasing regulatory hurdles to surmount, new challenger banks need to decide whether they will build their technology stack themselves or work with FinTech partners to develop the innovation required to topple the incumbents.

The financial institutions that are effectively managing this move to become FinTech companies are those that understand how to move quickly to deliver what the consumer needs in an industry on the verge of further change. Most of those who succeed have taken a hybrid approach, focusing on partnerships, acquisitions, and internal initiatives.

Several incumbent banks are known to be developing new digital-first products in a bid to keep the new wave of challenger banks and providers in the background; an example is Bo from the Royal Bank of Scotland. They are also gradually adopting much more ambitious cloud-based platforms (despite their paranoia about their data being hacked) on which they can offer or launch numerous products. These initiatives are being supported by the likes of Amazon, Google, and Microsoft, which provide cloud hosting services and enable banks to develop core banking Software-as-a-Service (SaaS) platforms with the required encryption security.

Asset managers

Traditionally, serious investors have valued personal investment advice from human experts, and they haven’t minded paying for it. However, the asset management industry has been attacked from two different angles:

• One of these is the march toward passive investments (such as exchange traded funds, or ETFs) over active asset management. ETFs are traded like stocks where the holdings track to some well-known index, such as the Standard & Poor’s (S&P) 500.
• The other is the rise in popularity of robo-advisors, which use ETFs as a strong part of their strategy. A robo-advisor is an investment selection tool that uses algorithms and machine learning to offer investment advice and management to users.

The trend toward passive asset management has been apparent for some time in the retail/business-to-consumer (B2C) space, but we’re lately also seeing it with the larger business-to-business (B2B) investors as the stock market index returns continue to rise and they are looking to cut costs to further enhance returns for their clients.

WealthTech firms are enabling investors to self-manage their portfolios by offering users technology-enabled tools to help make investing decisions. These tools can include full-service brokerage alternatives, automated and semiautomated robo-advisors, self-service investment platforms, asset class specific marketplaces, and portfolio management tools for both individual investors and advisors. They consider not only investment opportunities but also factors such as a user’s goals, income, marital status, and risk aversion to differentiate on their offering. They enable those who can’t afford a traditional financial advisor to have similar — if not more informed — advice at a lower cost.

Insurance

If the banking and asset management firms think they have it tough with the rise of FinTech firms, there are many that believe that the insurance industry is even more prone to disruption — and innovation.

InsurTech firms initially started to explore offerings that large insurance firms had little incentive to pursue. For example, they offered customers the ability to customize their policies, and they used Internet-enabled devices to collect information about behavior (such as driving habits) that could be used to dynamically price insurance premiums. Traditionally, the insurance market has worked with relatively basic levels of data to group respective policyholders together to generate a diversified portfolio of people. However, InsurTech firms are tackling their data and analysis issues by taking inputs from various devices, including GPS tracking of cars and activity trackers on wearables so that they can monitor more defined risk grouping and therefore allow certain products to be more competitively priced.

In addition to better pricing models, InsurTech firms are using highly trained artificial intelligence (AI) to help brokers find the right mix of policies to complete an individual’s insurance coverage and credit score. In some cases, they can replace brokers entirely, further disintermediating the process (and saving costs). Apps are also being developed that can combine contrasting policies into one platform for management and monitoring. Some of the benefits of that might include enabling customers to purchase on-demand policies for micro-events and enabling groups of individual policyholders to become part of a customized group that is eligible for rebates or discounts.

Insurance is also a highly regulated industry. Major brokers and underwriters have survived by being both prudent and risk averse. They are therefore suspicious of working with InsurTech start-ups, particularly those that want to disrupt their stable industry. Many InsurTech start-ups require the help of traditional insurers to handle underwriting issues, so the incumbent players here are likely to collaborate with and invest in their junior partners.

Regulation and legal work

RegTech is the management of and compliance with regulatory processes within the financial industry, using technology to address regulatory monitoring, reporting, and ongoing compliance. The predominantly cloud-based, SaaS offerings to help businesses comply with regulations efficiently and more cheaply act as the glue between the various sectors of the financial services industry described earlier.

LegalTech describes technological innovation to enhance or replace traditional methods for delivering legal services across financial services and beyond. This innovation includes document automation, predictive artificial intelligence, advanced chat bots, knowledge management, research systems, and smart legal contracts to increase efficiency and productivity and reduce costs.

With the use of big data and machine-learning technology, RegTech and LegalTech firms reduce the risk to a financial institution’s compliance and legal departments by identifying potential threats earlier to minimize the risks and costs associated with regulatory breaches and any legal work. RegTech firms can combine information from a financial institution with precedent data extracted from prior regulatory events to forecast probable risk areas that the institution should focus on. LegalTech firms can help financial institutions draft documents, undertake legal research, disclose documents in litigation, perform due diligence, and provide legal guidance.

These analytical tools can save institutions significant time and money, including saving them from having to pay fines levied for misconduct. The institutions also have an effective tool to comply with ongoing rules and regulations specified by financial authorities, which are constantly prone to amendments.

Payments

From banknotes to coins to plastic cards and mobile devices, payments have evolved over the centuries to include a number of ways to help financial transactions take place between individuals, institutions, and governments. Payment technologies and global infrastructures that facilitate payments around the world also are changing.

Over the last few years, mobile money has helped millions of people in developing countries get access to the financial system and tackle the goal of financial inclusion. Digital and cryptocurrencies such as Bitcoin, Ripple, and Ether have also entered the payments sector, which is innovating more rapidly than ever with the goal to move value cost-efficiently in real time and at near zero cost. As a result, the PayTech sector is booming; established players closely work with newcomers as there is no end to the creativity of the PayTech and payment industry.

Looking for the Opportunities

Disruption isn’t a bad thing necessarily, as we hope you’ve picked up in this chapter. In fact, another word for it is innovation. Disruption interrupts the status quo, inviting traditional businesses to adopt new approaches as well as opening the door for new businesses to try their hand at it. Here are some ways that FinTech is opening the door to innovation for all financial services companies.

Partnership opportunities

Traditional financial institutions and FinTech firms are increasingly combining their strengths in partnership models. Even some of the business-to-consumer (B2C) retail-driven FinTech firms realize that they may reach a saturation point with their digital marketing coverage before they meet their revenue targets, so they need distribution partners to grow their business. FinTech companies offer greater speed, risk tolerance, and agile processes to react to change, while larger institutions bring the depth and breadth from their core businesses to the table.

Exploiting digitalization with AI

Digitalization has generated huge amounts of data, which FinTech firms have been quicker to exploit. New data feeds and evolving AI know-how have made labor-intensive workflow processes more efficient and have produced new insight into financial services applications and products. AI and machine learning technologies are critical for both small and large players within the expanding FinTech ecosystem. These technologies make it possible to extract unique and relative insights from data, and companies that invest in it will be able to exploit its capabilities in years to come.

AI isn’t without its drawbacks, however. For example, many industry experts have said that managing the security risk of AI systems will be a challenge. In addition, developing AI tools that can improve decision-making, but are also transparent to the user in how they operate, could be potential barriers to the technology’s development if users don’t feel the results have been clearly explained.

Introducing some additional rules regarding privacy of data, while simultaneously allowing users to selectively determine the types of data to be shared, could enlarge the efficient analysis of AI and the new products it creates. This would ensure that customers determine which of their data sets are used and providers have sufficient data to improve their products.

Enhancing data portability

Data portability, whereby clients are allowed to transfer personal data seamlessly across multiple services, will also be key in defining the terms of competition in the financial sector. For example, open banking regulations subjectively limit what data can be communicated (for example, only financial transaction data), as well as the sort of organizations among which this data can be shared (for example, only certified deposit-taking organizations). Likewise, the European Union’s General Data Protection Regulation (GDPR) requires clients’ active consent prior to a financial institution using their personal data.