The FinTech revolution is well and truly underway and is showing no signs of slowing down anytime soon. FinTech refers to new technological innovations which compete with conventional financial techniques in the delivery of financial services. Arguably the most cited example of FinTech is the use of smartphones for mobile banking.
In recent weeks there has been a great deal of buzz surrounding one particular area of FinTech: blockchain technology. Perhaps the simplest explanation of the workings of blockchains is given by Martin Arnold of the Financial Times:
“Blockchains allow encrypted data on anything, from money to medical records, to be shared between many companies, people and institutions. This protects data from fraud while instantly updating all parties concerned.”
Another important point to note about the information stored on blockchains is that, by design, it cannot be altered.
The Benefits of Blockchain in Banking
According to a study published by Accenture and McLagan in January, eight of the world’s ten biggest investment banks are expected to implement a blockchain. It is estimated that this will cut their costs by 30% – a figure between $8bn – $12bn. While the concept of blockchains is simple, the expected savings from their adoption are sizeable and their benefits can be realised in several different ways.
Firstly, there is still excessive bureaucracy and large inefficiencies in the back office set-ups of most – if not all – banks. These issues are particularly prevalent in clearing and settlement. Richard Lumb, head of financial services at Accenture, believes that:
“The first place we will see [blockchain] have an impact is clearing houses, such as Deutsche Börse…Today [clearing and settlement] is managed through a myriad of messages and manual reconciliation.”
Accenture estimates that by adopting blockchain technology to restructure clearing and settlement, the biggest investment banks could save $10bn. Interestingly, the Australian Securities Exchange has already implemented a project to transfer its post-trade clearing and settlement to a blockchain system.
Source: Aite Group
Secondly, central banks across the globe are evaluating the potential for using blockchain technology to launch their own digital currencies, to compete with standalone cryptocurrencies, such as bitcoin, which cannot be regulated or influenced by monetary policy. The aim is that the competition provided by the digital currencies regulated by the central bank will reduce the popularity of standalone cryptocurrencies, and give the central banks greater control of their monetary policy. Additionally, central banks are taking note of the benefits of using blockchain technology for payments systems (such as faster transactions at a lower cost) and are exploring the potential for shifting segments of their payments systems onto blockchains.
Thirdly, blockchains can revolutionize trade finance, a primarily paper-based aspect of finance which still relies on documents being faxed or posted across the world. Despite being a crucial aspect of the supply chain, trade finance is primarily communicated via fax machines, and often requires a physical stamp. Martin Arnold of the Financial Times reports that a group of banks, consisting of the Bank of Montreal, Caixabank, Erste Bank and Commerzbank have partnered with IBM and UBS to “build a new global system for trade finance using blockchain technology that is designed to track goods and automatically release payments as they move around the world by plane, ship or truck.”
While this may drastically speed up the process of trade finance, Vivek Ramachandran, Head of Innovation for Commercial Banking at HSBC, warns that this may be a pointless exercise: for the benefits of blockchain to be fully realized, the whole ecosystem of trade needs to be digitised. This would require all parties involved in trade – from the shipping companies to the ports – to fully digitise their administration as any necessity for paperwork will counteract the time-saving benefits of blockchain.
Fourthly, identity is a major part of banking: banks must ensure that the customers to whom they lend money are not criminals or crooks, otherwise, they would lose their position as trustworthy and reliable holders of individuals’ money, and would be fined by regulators. Thus, banks must have an air-tight system of verification of customers and counterparties. For several years, banks have struggled to set up a shared, easily updatable database of customers’ identity. However, blockchains could offer a solution because of their extremely strong encryption, and because they can be quickly updated and shared with many parties. Whilst this solution would enable banks to verify their customers’ identities quickly, and crack down on money-laundering, Simon Whitehouse from Accenture warns that, “the costs are huge for banks and the costs of messing it up are also huge.”
Finally, blockchains can also be used to radically increase the efficiency of the syndicated loans market. On average, it takes 19 days for a syndicated loan transaction to be settled by banks in the USA. If the loan is repaid early, or is transferred between banks, the communications are primarily delivered by fax. Credit Suisse is part of a consortium of 19 financial institutions who have partnered with Synaps to transfer syndicated loans onto blockchains. Much like trade finance, however, the head of blockchain at Credit Suisse, warns that blockchains will not resolve all of the inefficiencies in the syndicated loans market, “”Blockchain is not a silver bullet, it will not fix [the market] by itself, it will take business process changes.”
In summation, blockchain presents a solution to a range of problems and the adoption of blockchain technology can vastly increase the speed and efficiency of the delivery of financial services. As with any new technology, there are pitfalls: blockchains will not resolve all of the inefficiencies in markets by themselves, and implementation of blockchains may come at a high cost. However, the benefits of blockchain outweigh the potential pitfalls, and the technology is already being adopted by firms such as Credit Suisse and Australian Securities Exchange. This is a testament to how quickly FinTech has developed in recent years, and evidence that the revolution is well and truly underway.
Predictions for the Future
Given the development of FinTech in recent years, one can make some predictions on how the financial services industry will develop over the next two to three years. While I have already discussed the increasing relevance and adoption of blockchain technology in finance, it is more than likely that the number of disruptive FinTech firms will continue to increase. Global investment in the FinTech market hit $8.4bn in the second quarter of 2017, with a healthy total of 293 transactions taking place. This suggests the FinTech market has plenty of momentum and will continue to grow for the foreseeable future.
Secondly, the sharing economy may become integrated seamlessly into the financial system. There already exists a strong sharing economy with regards to goods such as taxis, and hotel rooms, but this may well extend into financial services. In the near future, consumers will still need banking services, but may not use a bank as an intermediary in order to get them. It is possible that advances in FinTech will enable lenders to match seamlessly with borrowers without the use of a bank.
Thirdly, “customer intelligence” will become an increasingly important factor in the success of financial institutions. Historically, customers’ preferences were measured with relatively simple tools such as focus groups and surveys. In the modern era, financial institutions have far greater access to customer data and can get a clearer idea of customers’ preferences. Mastery of this data and a methodical application of the insights derived from it will be crucial in determining the success of a financial institution.
Fourthly, the adoption of artificial intelligence and robotics by financial institutions will continue to increase. These technologies are still in their infancy but they have proven to work extremely well with self-driving cars being a prime example. While it is unlikely that any radical changes will be seen in the very short run, advances in AI and robotics may lead to a wave of ‘re-shoring’ and localisation in the medium to long-term: these technologies have the potential to replace much more than a typical bank teller.
With the increased adoption of new, more complex technologies, cybersecurity will become an even greater risk for financial institutions. While advances have been made in cybersecurity, the increasing use of third-party vendors, an increase in cross-border data exchanges and the increasing use of mobile technologies by customers are all factors which will expose financial institutions to greater cyber threats.
Additionally, Asia will become an even more important market for financial institutions and become a centre for technological innovation. By 2020 the majority of the world’s population which is considered ‘middle class’ will shift from Europe and North America to Asia-Pacific. Not only will this lead to a larger market for financial services in Asia, it will lead to greater urbanisation, better urban infrastructure, and a more conducive environment for technological innovation.
Finally, it is likely that regulators will also adopt an increasing number of new technologies. By gathering and analysing a greater quantity of data, regulators will be able to monitor financial institutions more efficiently and supervise the financial services industry more effectively. This will enable them to forecast and prepare for any problems before they occur. A prime example of this is the Bank of England, which runs stress tests on corporate banks, and runs a wide range of scenarios to ensure they have enough capital to survive in the case of an economic downturn.
The lines between technology and finance are getting increasingly blurred. “The traditional boundaries of what industry I am in are fading away,” says Ashok Vaswani, head of Barclays UK. The increased adoption of FinTech, and the increased disruption of the financial services market by new technological developments (such as blockchains), suggest that society is at the beginning of a very exciting period in finance. Traditional banking techniques are being made obsolete at an increasing rate, and the survival of financial institutions rests heavily on their ability to master new technologies, and make the most of the large volumes of data they have available to them. – The Market Mogul