A financial technology revolution, still in its infancy, is beginning to reshape societies and economies by ushering in the global democratization of finance. While digital currencies and robo-advising have attracted attention in the popular media, little has been written about how financial technology, or fintech, is affecting the overall economic outlook of nations.
In this book we explain how fintech promises to impact a range of economic and social outcomes, including financial inclusion, income and wealth inequality, economic growth, and investment. As we will examine, decisions and innovations by governments and technology entrepreneurs will affect the international balance of power between nations and the rates of economic inclusion among underserved populations. The fintech revolution will influence every person in the world.
The term fintech has been used to refer to a wide variety of financial technologies, but for our purposes in this book we will use it to refer to any new technology and innovation that has been developed or is being developed in the twenty-first century to compete with traditional methods of delivering financial services. Examples of fintech, according to this definition, include mobile banking with smartphones, digital investing services, and cryptocurrencies like Bitcoin. These technologies have a common goal: they are designed to make financial services more accessible to the public. Today’s fintech revolution enables consumers to transfer funds, raise money for business start-ups, and manage personal finances without the help of an intermediary or professional. Fintech is also improving economic inclusion, providing access to banking and commerce in rural areas, and allowing individuals to receive social security transfers. In summary, modern fintech is democratizing finance.
Since the late twentieth century, banks and insurance companies have grown massively. We have seen intense merger and acquisition activity as national banks and insurance firms have been gobbled up by regional players, who are themselves devoured by global companies. Mergers and acquisitions in the banking sector peaked in 1998 and 1999, and then again in 2007, with more than $450 billion of transaction value for each of those years. This consolidation process has enabled banks to expand into adjacent financial services, such as asset management or insurance, and has fueled enormous economies of scale in three critical areas that pertain to financial services.1
First, the mutualization of funding gives large and diversified financial services companies access to “cheaper” money. For example, funding mutualization allows big banks to more easily attract deposits to lend to its consumers and customers, and large insurance companies can reinvest revenues from policy sales to its own asset manager.
Second, a large network and product base benefits from being able to offer every financial service that consumers might need (loans, current accounts, payments, insurance, and so on) with one account and at one branch. Across most developed countries, we now see oligopolies dominated by just three to seven banks and / or insurance companies, each with a widely distributed network of local branches.
Third, massive companies benefit when they can absorb the cost of managing and analyzing data, which are core functions of a financial services company. To accomplish these functions—storing, processing, and analyzing consumer data, making credit decisions, and tracking account movements—without a more expensive third party, banks and insurance companies need to scale up.
The three factors mentioned above, coupled with the rise of new technologies, have helped fuel a process of consolidation leading to the emergence of financial service behemoths. These giant firms are now capable of capturing a significant slice of the global economic pie. The share of GDP held by the financial services sector has nearly doubled since the 1980s, growing from less than 4 percent of US GDP to 8 percent just before the 2008 financial crisis. The major financial services companies have become so large that they are now considered to be “too big to fail.”2
However, we believe the consolidation tidal wave is losing its steam. Since 2010 the yearly value of mergers and acquisitions has been, on average, around $100 million, which is less than one-fourth of its peak value in the previous decade.3 The 2007–2008 financial crisis significantly modified the supply–demand equilibrium in financial services. Large financial institutions were all weakened by the crisis and were forced by capital or liquidity constraints, or by regulators, to significantly reduce their activity. This left new areas of unmet demand, in particular within the lower income quartile of the population and among small businesses.4
In response, the spectacular development of digital technologies has offered new solutions and models for conducting financial services. Online brokers have been increasingly competing with bank and insurance branches. Digital wallets and mobile payments have offered consumers alternatives to exchanging and storing cash. Peer-to-peer platforms have emerged as a new way to match deposits and lending activity. Cryptocurrencies have reduced the intermediary role of banks in money exchange. Blockchain and other data-management technologies have begun to significantly disrupt back-office processes and organizations.
We should recognize that it will be easier to analyze the impact of these technologies after they have matured. Many of today’s innovations will not impact our world as much as the paper bill or credit card. Some may become fads or be replaced by newer, more ambitious technologies. Some technologies might not be as widely adopted as expected, but they could still serve as seeds for a future, life-changing ecosystem. Nevertheless, we can already see that fintech is democratizing finance and extending affordable banking services to the world’s 1.7 billion unbanked adults. Our goal in this book is to provide an accessible summary of these impacts and, despite uncertainty, to offer an informed assessment of the potential impacts of a wide range of fintech innovations.
What might that democratizing trend mean for people around the world? As we demonstrate in this book, fintech has already helped millions escape the poverty trap.
During the twentieth century, those with extensive access to financial services had an unfair advantage over those in developing nations who lacked access to even the most basic financial services, such as bank accounts and government identification cards. This disparity in access had been one of the leading drivers of inequality.
Thomas Piketty has famously argued that the rate of return on capital over the past three centuries has been significantly greater than the economic growth rate, and that, therefore, income from capital investment has outpaced income from labor activity. At the very top of the distribution, incomes skyrocketed. Between 1980 and 2016, the top 0.001 percent rose by 650 percent in the United States, and by 200 percent in Europe.5 Unequal access to financial services has played a critical role in bringing about these outcomes. Anthony Atkinson and his colleagues have shown, for example, that the wealthiest individuals have access to investment products—asset management funds and hedge funds, for example—with significantly higher financial returns than the mainstream products available to most people. Small investors, by contrast, are typically directed to so-called vanilla investments, such as low-yield bank deposits and government bonds. The role of capital in driving inequality is reinforced by the fact that an increasing share of wealth is inherited, which is unequally distributed.6
Over the past decade, the income of the middle class, which represents the largest share of the population in advanced countries, has stagnated or declined. Only a third of households in developed countries saw their incomes rise between 2005 and 2014. In the aftermath of the 2008 global financial crisis, the traditional banking industry has left “subprime” individuals and many small businesses either underbanked or without any banking options at all.
Fintech innovations today are beginning to disrupt those twentieth-century systems of access to financial services. Frustrated by limited access to quality financial services, middle- and lower-class populations are looking for other options—and fintech innovators are providing them. Peer-to-peer platforms in transportation (Uber) and hospitality (Airbnb), for example, are serving as models for new peer-to-peer lending marketplaces that are disintermediating banks. The changing landscape of health care and retirement funding, driven by digital innovation and algorithmic solutions, may offer alternative retirement solutions, especially for millennials.
As for the billions of underbanked people trapped in poverty, we will show in this book that fintech innovation is providing improvements in health care, government infrastructure, farming, and manufacturing. These advancements often give poor people an opportunity to launch their own businesses. Fintech can help small-scale entrepreneurs in their struggle to escape poverty by providing them with basic banking services through which to grow businesses and store wealth. Fintech can improve infrastructure for financial transactions, such as saving, spending, and borrowing money. Through these services, underbanked individuals can better weather economic shocks and health setbacks, which leads to greater long-term financial stability.
The scope of fintech improvements is vast because there are so many unbanked people in the world. According to the World Bank’s Global Financial Inclusion Database, about 1.7 billion adults in 2017 did not have an account at a financial institution. Women are disproportionately excluded from the formal financial system, constituting 56 percent of all unbanked adults. Nearly half of the world’s unbanked population is concentrated in just seven developing economies: Bangladesh, China, India, Indonesia, Mexico, Nigeria, and Pakistan.
Most people in poor households in these countries own smartphones, but they almost always use cash, physical assets (jewelry and livestock), or informal money lenders and cash couriers to make payments or save. Informal banking mechanisms can be insecure, expensive, and usurious. In addition, they offer limited or no help after a personal catastrophe, such as a serious illness or a poor harvest.
A growing body of evidence suggests that access to secure financial tools at critical moments in life can help poor families move out of poverty or absorb financial shocks without being forced deeper into debt. Unfortunately, today’s brick-and-mortar banking system was not designed to aid the poor. Banks, utility companies, and other institutions pass to consumers the costs of storing, transporting, and processing cash. This creates a vicious cycle, one that can lock poor people into the cash economy and prevent them from advancing toward electronic transactions and savings.7
Digital banking can help millions of unbanked poor people in both advanced and developing countries to overcome daily financial problems like those described above. The mobile phone and internet revolutions have already reached most corners of the world, including in Africa’s developing economies, and rapid advances in digital payment systems have fueled the emergence of online financial services that allow for virtual saving and instantaneous transfers.
At the outset, it is important to emphasize that this book does not present a simplistic view of fintech’s potential impact on global economic inequality. While many claim that technology, globalization, and finance are primary sources of rising inequalities, we offer a research-based view of how the fintech revolution will influence societies and economies. Our research shows, for example, that technological disruption simultaneously widens inequalities in developed markets while reducing poverty in less-developed economies. Countries advance when they implement technology, and they stay behind when they do not pursue technological development. This occurs because fintech provides people in emerging markets greater access to information and labor markets, thereby offering increased opportunity to join global competition. In some circumstances, the expansion of opportunity in developing nations may crowd out people in established markets.
By presenting our extensive research on the existing and potential impacts of fintech, this book will serve as a helpful study for policymakers and entrepreneurs. To date, existing research on the problem of increasing inequality has centered primarily on fiscal policy. By contrast, this book presents an in-depth study of the connections between financial technology and inequality. From this solid foundation we can build our understanding of the fintech revolution and its socioeconomic implications.
The structure of the book strongly emphasizes the differentiation between the challenges of fintech in advanced and emerging economies. In advanced countries, fintech helps to improve the existing financial framework and tackles a wide range of issues, such as convenience in payments, retirement and financial planning, and the delivery of government services. In emerging countries, fintech innovation mostly solves an issue of financial inclusion and access to financial services. This is similar to how telecom infrastructure enabled some countries to leapfrog landline phone systems to cellular phone systems, including smartphones.
Chapter 1 discusses today’s serious economic challenges that the millennials in particular are facing: low growth, unsustainable public debt, high pension liabilities, and a job market that is more unstable than ever. These macro trends have accelerated the development of a new generation of financial services that we commonly name fintech. Chapters 2–4 describe the disruptive impacts of fintech: first, how banks are facing new competitors; second, how fintech affects consumers and financial planning; and third, how governments are responding to technological progress. Chapters 5–7 highlight the key issues and restrictions that emerging economies must overcome to expand their economies. We explain how fintech develops hand in hand with other economic and physical infrastructure, which government should proactively develop to promote commerce and trade. Chapters 8–9 present a practical overview of recent developments in payment systems and digital currencies.
More specifically, Chapter 1 describes the coming revolution in banking. Entering the workforce in the aftermath of the 2007–2008 financial crisis, millennials will have to cope with stagnating or declining household income, an unstable economy, a job market impacted by a new digital economy, and elevated housing prices—a perfect storm. Many have started their careers with low savings, high student debt, and unstable self-employment incomes. They will struggle to save for property purchases and pensions. Many new emerging financial services (fintech) have been designed to solve these new challenges—by, for example, offering more convenience, new ways to save money despite unstable job income, and improved access to credit.
Chapter 2 first briefly considers four major economic revolutions, the fourth of which we are experiencing today, and discusses the dramatic impact of the 2007–2008 global financial crisis on the general economic environment. We then look at how the world’s banking sector is being dramatically transformed by new and innovative technologies that are likely to have a lasting impact on banks. By the end of the chapter, readers will have a satellite view of the fintech terrain, a good orientation for the deeper analysis in subsequent chapters.
Chapter 3 demonstrates how services like “robo-advisors” make investing easier and more affordable for people with limited financial literacy and little or no investment exposure. This chapter also discusses the changing landscape of health care and retirement financing, along with the cost and performance differences between robo-advisors and human advisors. It also presents a thorough and nuanced picture of fintech products being developed by entrepreneurs, venture investors, and traditional financial specialists.
Chapter 4 concentrates on how governments at all levels need to modernize fiscal policies to be aligned with the new era of peer-to-peer employment platforms and cross-border digital commerce. Blockchain, already adopted by large banks and start-ups, offers a great backbone for centralizing and managing citizen data, simplifying back-office processes, tracking government-public financials, and taxing transactions. Opportunities for better services are vast, and some countries, such as Estonia and the UAE, have embraced the digitalization of their government processes and interactions with citizens.
Chapter 5 explores the interconnections between economic development and inequalities, thereby providing the macroeconomic context for more-specific analysis of fintech in subsequent chapters. It focuses on the issue of the unbanked population in emerging economies and explains the relationship of financial inclusion to broader social and political phenomena. Examples from South Africa, China, and Colombia illustrate the importance of policy efforts to help broaden access to financial services as an economy develops.
Chapter 6 provides detailed analyses of the current development of financial services in emerging markets and the unfulfilled needs of the population. The chapter specifically focuses on how essential it is to fulfill these needs in order for individuals to climb out of poverty. We explore how fintech companies such as Paytm, Jumia, and Lazada have managed to design new products and models to offer low-cost financial services even to people in the most remote rural areas.
Chapter 7 addresses the specific fintech tools that governments of emerging economies can deploy to promote economic growth and financial inclusion. Governments can use private-sector innovations—digitization, blockchain, and artificial intelligence are examples—to foster greater financial inclusion, improve public service payments, expand government identity documentation, and distribute wealth and social welfare benefits. As we demonstrate, there is an inextricable link between digitized payments and the quality of publicly delivered services such as roads, electricity, and health care facilities.
Chapter 8 focuses on the digitization of money, including an analysis of twentieth-century innovation and the more recent rapid growth of global digital payment systems. It describes the strategic battle between banks, card companies, and tech innovators as the mobile phone becomes the next credit card. For this chapter and for Chapter 9, we did an exclusive survey of over 3,600 customers in China, France, Germany, Italy, the UK, and the United States, some of the results of which are given in Appendixes A and B.
Chapter 9 provides a detailed overview of digital currencies, including Bitcoin, Facebook’s Diem, and sovereign digital currencies in India and China. It explores the factors that are moving these currencies into the mainstream and what is at stake for regulators. Overall, this chapter provides the reader with an understanding of the latest issues that will shape currencies and payments by 2030.
As we finalized this book in early 2020, we were confined in our homes and teaching courses online rather than at Harvard’s campus in Cambridge, Massachusetts. We could not foresee all the ways the pandemic would change the world, but we knew there would be a “before and an after.”
With regard to fintech, we could already witness profound changes in the way people were handling payments. Many governments saw cash as a potential transmitter of Covid-19. The Federal Reserve quarantined physical dollars flowing into the United States from Asia to avoid spreading the pathogen. China and South Korea quarantined and disinfected banknotes to stem the spread of the virus. Concern over spreading the disease caused many people to increasingly use contactless payment methods. Even the elderly, who typically shun technological change, began to use new forms of fintech.
Based on what we see today, we think that Covid-19 will be a catalyst for bringing digital payment methods into mainstream use. In Asia, and specifically in China, the pandemic may accelerate trends among younger populations to switch to digital payments. China’s electronic payment system is relatively advanced. At of the end of 2020, around 86 percent of internet users in China used online payments services (up from 18 percent in 2008).
In advanced economies, elderly people are most at risk of contracting the virus, but also the most attached to cash. Extreme circumstances and fear may push them to try card payments, increase their use of e-commerce, and reduce in-store purchases. The hardest step toward change is always the first, but once people have tried a new technology or service, they are often quick to adopt it permanently.
The coronavirus may accelerate efforts by governments to deploy central bank digital currencies (CBDCs), a topic we discuss extensively in Chapter 9. In early 2021, 86 percent of central banks were working on a government-operated digital currency, 60 percent were experimenting with proofs of concept for a CBDC, and 14 percent, mostly in emerging economies, were running pilot projects. Central banks in China and India, where one-fifth of the world’s population resides, are likely to issue a general-purpose, government-authorized digital currency in the near future.
At the time of this writing, we are in the middle of the storm, but economists are forecasting a deep global recession and governments have already announced massive stimulus packages to preserve companies and workers. The US Federal Reserve has contemplated using a “digital dollar” and digital wallet to send payments to individuals and businesses. Extraordinary circumstances and the need for fast responses will force governments to rethink the distribution of social transfers.
Nobody has a crystal ball, but we can assume that today’s extreme circumstances will catalyze change. The 2008 financial crisis is an example; it acted as an enabler for innovative companies to launch and thrive. Likewise, the coronavirus crisis may act as a catalyst, or perhaps a fertilizer, for these technologies to become mainstream.
Despite many uncertainties, it is clear that fintech will continue to cause massive changes in the world’s economies and cultures.