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The modern history of fintech

Ian Pollari
— 1 minute read

This could be the 'year of fintech', with a perfect storm of conditions brewing that makes financial technology the right solution for the right conditions at the right time, writes KPMG's Ian Pollari.

Ian Pollari

The investment banking industry is in a state of flux. 

Seismic shifts, brought about in large part by the monumental costs and complexities associated with increasing regulation, have altered the economics of investment banking forever.

The challenges posed by the regulatory environment added to the pressures from customers for higher yields and lower fees present challenges for banks’ capital markets businesses.

And as the digital revolution and reduced information asymmetry continue to transfer more power to the buy-side with greater levels of electronic, or self-directed trading, the sustainability of intermediation must, at some point, come into question.

There is also the issue of trust. Beyond the investment banking and capital markets sector’s legacy technology systems, trust has weakened between customers, investors and the banks that serve them, between counterparties that trade with each other and even between regulators.

Power to the buy-side

Technological advances will continue to reshape capital markets’ operating models and service delivery paradigms over the next several years.

The ‘democratisation’ of technology has already seen buy-side institutions assuming more control over the trading systems they employ, reducing their dependency on the sell-side to supply them with the tools they need.

This shift will continue to gather momentum as the buy-side becomes more empowered, seeks to preserve returns in a difficult market, takes more control over the quality of execution and the sell-side struggles with its capacity to respond.

For those investment banks that wish to thrive, now is the time to adapt with new business processes and operational models, steeped in innovation and engineered for a new set of business realities and more intense levels of competition, particularly from ‘new world’ entrants.

Therefore, the emergence of fintech represents both a threat and an opportunity for the capital markets sector.

High technology, low barriers to entry

Interestingly, technology itself has eroded barriers to entry in the fintech marketplace.

It’s never been easier and less expensive to start a new financial services venture than today. It only takes a little capital to tap into almost any capability required – all delivered on demand ‘as a service’ through cloud computing anywhere in the world and requiring no upfront investment.

Some of the leading financial institutions are encouraging this wave of innovation by opening up their existing systems through new Application Program Interfaces (APIs) that can help build new global-calibre fintech software applications.

The price and timing couldn’t be better for development. The cost of computing and IT has fallen dramatically, even as the large banks continue to struggle under the weight of their legacy infrastructure and traditional application burden.

A symbiotic relationship is emerging in which traditional companies saddled by internal technology constraints are cultivating relationships with smaller, more nimble fintech companies.

Banks with more than 100 years of history are suddenly creating fintech-focused venture capitalist (VC) funds, asking staff to mentor start-ups in fintech incubators, forming research teams to understand every emerging fintech business model, writing API layers across their current systems and inviting newly formed ventures to company-sponsored accelerators and hackathons.

Demand for tech-inspired innovation is trickling into the thinking of investment banks – this traditional world is primed for 21st century modernisation.

Though this transition can be a challenge, outmoded IT systems are slowly being replaced by modern technology, often born of innovation outside the banking industry.

In some instances, investment banks are beginning to outsource critical IT infrastructure and to explore the creation of industry utilities in non-competitive, manually intensive and costly processes, such as anti-money laundering (AML), Know Your Customer (KYC) and customer onboarding.

We expect to see further development of these approaches and a new level of flexibility in technology implementation, particularly as legacy back-office IT systems are gradually removed from service.

Timing is everything

We believe the shift in the current environment is more than a mere window of opportunity.

In fact, we foresee a long-term and permanent shift in the way of doing business, as investment banks embrace financial technology in their daily dealings.

So, if you are not already engaged with fintech, the time is now. We are already seeing a change in capital markets.

Though these changes are not nearly as evident as online and mobile banking on the consumer side, a revolution is underway in the back-office space as the new business model takes hold.

Disruptive effects

Fintech is disruptive to banks’ ‘business as usual’ models.

The advent of fintech is generational – figuratively and literally – with a younger breed of innovators providing timely and creative solutions.

Fintechs bring radical ideas to build, deliver, access and advance IT infrastructure at investment banks.

This union of pacesetters and the established banking order seems to work: fintechs innovate in ways that banks find hard to do.

And the banks need this infusion of fresh thinking to remain competitive – or to get ahead. In capital markets, these disruptive players are getting a seat at the table.

Boards and bank leadership face a dilemma: They often are aware of fintech innovation but can’t duplicate it within their own walls.

The solution? Bypass their own IT providers in favour of fintech born in the digital age and not burdened by the entrenched constraints in the industry.

The downsides of disruptive fintech

It is not surprising that for all the benefits of fintech, there is an equal number of potential pitfalls.

There are always some downsides with new disruptive technologies, and the effects here are compounded in the world of investment banking and capital markets.

  1. Security risks – There are new risk exposures in the new world. While the banks and market providers generally consider themselves to be impenetrable fortresses, fintech can open the virtual vault door to criminal activities.

As the technology advances, so too do hackers’ abilities and resources.

Today, we see that the nature of attackers has grown highly organised and even reaches the level of nation states.

We are only now discovering how big the risk will really be for the industry, and whether or not the threats will hamper acceptance of fintech on a broader level.

  1. Regulatory attention– When it comes to regulatory issues, the downsides for fintech might even be more profound and immediate than potential security risks.

Technology generally helps circumnavigate traditional national borders.

In the case of fintech, national borders might seem less relevant, but regulatory agencies on all sides are keeping a close watch, particularly when it comes to international sovereignty issues, legal jurisdiction, protecting customer data and taxation.

While regulators with risk management on their agenda currently are a perceived barrier to fintech ventures, we expect to see a higher level of coordination among the banks, fintech firms and regulatory officials.

This might be easier said than done, but it would be a disservice to stifle such a promising industry change at this stage of development.

  1. Culture– There is a cultural challenge involved in how technology will be accepted in the institutional banks.

For example, in Seoul, the South Korean government realises that fintech is changing the nature of financial services.

But the industry there is highly regulated, and the government worries about the viability of its existing banking infrastructure going forward; without fintech innovation, is there a new risk of technology complacency and eventual obsolescence relative to other countries?

Without taking some steps to advance their financial technologies, South Korea’s financial institutions risk losing competitive advantage by allowing their financial environment to become non-competitive in the global arena.

While innovation usually emerges from highly refined areas of the world, sometimes true innovation emerges from more constrained environments, such as China and India, where they are accustomed to working in environments of low cost expectations, unsophisticated consumers of financial products, spotty infrastructure and rapid change.

Revolutionising financial markets

In the highly globalised world of investment and commercial banking, the financial capitals of New York and London are becoming the hubs of fintech innovation.

Fintech firms are sprouting up in places where the technology is needed most and where innovators congregate.

This crossroad where finance meets technology is potentially a whole new marketplace in the making.

Capital markets need to work with these fintechs to adapt to new opportunities – and they seem to be catching on.

Competitive advantage is the name of the game. As fintech takes hold, innovation matters most where it can impact the stability, simplicity, costs of doing business and profitability in financial institutions.

The futures of fintech and the investment banking industry will become more interconnected. The so-called perfect storm of technology and capital markets will not blow over – particularly as new advances on the technology front coupled with evolving thinking from banking leaders hold such great promise for the industry.

The investment banking landscape is changing rapidly and the stakes are high.

Ultimately, the firms that emerge as the leaders in the decades to come will be those that are best able to quickly respond to changes in their external environment, business mix and operating models, as well as to meet the needs of increasingly sophisticated and empowered corporate clients and investors.

Incumbent organisations will not be able to successfully innovate on their own.

Partnering with fintech companies provides large banks a broader range and lower cost access to innovation, greater agility, potential investment opportunities and, above all, strategic optionality for an uncertain future, where collaboration will be king.

Ian Pollari is a banking partner at KPMG Australia, and Bob Hayward is a principal adviser for management consulting at KPMG Singapore.

 

The modern history of fintech
Ian Pollari
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