5 Main Issues With FinTech Innovation and How To Overcome Them
Written by Mateusz Lukaszewski on May 2, 2017
Written by Mateusz Lukaszewski on May 2, 2017
We’re learning a lot
so you will too.
Start-up founders that say they have a hard time might just not realise how easy they have it compared to those in fintech, where acquiring market share comes with plenty of challenges to overcome.
Challenges like finding team members who understand the complexities of the financial world, complex and globally varied regulatory environments, hard-to-reach customers who are used to traditional finances, or worrying that a bank might steal your idea to build a product (disregarding your contribution completely).
Governments have been slowly waking up to the bells of much needed regulatory improvements. But even Sillicon Valley, the start-up dreamland of founders around the world, seems to be bad at helping fintech – as California is currently ranked as the worst regulatory environment out of seven global centers for FinTech companies.
Fintech start-ups that offer tech-enabled payments, currency exchange, crowdfunding, online lending and wealth management services are working hard to be able to compete with traditional banking and financial services firms.
Some start-ups can overcome the burdens of traditional finances by going around existing financial infrastructure – but many reports imply that the best direction for fintech might be to collaborate instead of competing, as new consumer-facing financial applications can be built on top of old banking infrastructure.
Regardless of how it unveils – a revolution in finances has already started, and these are the biggest obstacles that fintech innovators face today.
Obstacle #1 – Increase in Regulations After 2008’s Market Crash, Complex and Dynamic Regulatory Environment
It has been almost 10 years since financial markets last crashed on such a big scale, but the 2008 crisis has had long-term consequences that are still influencing the whole industry.
The crash has forced policymakers to concentrate on making finance safer.
The global financial crisis paved the way for new regulations that were supposed to restore confidence in the banking industry; for example, introducing a greater emphasis on intraday liquidity and risk management.
Many banks have pointed out that a substantial proportion of the savings generated through efficiency programs have been reinvested in regulatory compliance. But with approximately US$150 billion in fines having been paid to supervisory authorities between 2009 and 2015, just a few big-ticket cases left to be resolved, most banks believe the worst is over. Now, when regulators demand innovation within the financial markets, they also need to create the right environment.
Fintech start-ups eventually need to expand beyond their home country to make services like international payments possible. Regulations in one’s home country can be daunting and expensive, legal fees are a burden for start-up budgets, making cross-border expansion an expensive legal and compliance undertaking.
Obstacle #2 – Traditional Banking and Financial Institutions Are Not Stepping Down Easily
Make no mistake – fintech start-ups aren’t about to kill traditional banking.
Commentators of the financial sector were quick to point out the incoming *fall* of traditional banking, but new data proves that they were too quick to do so – retail banking has flourished up until now.
Leading fintech companies still look pale compared to banks when you look at data. For instance, the top peer-to-peer lending platform in the US, Lending Club, has arranged $9 billion in loans in 2014, whereas the total credit-card debt in America in the same period amounted to $885 billion.
But the fact that banks are heavily entrenched doesn’t mean that they were built to withstand today’s environment – where consumers have endless access to information, demand transparency, value, and won’t use complex products or services because they almost always have another choice that will more conveniently suit their needs.
The post-crisis increase in regulations wasn’t all bad for banks, because it has helped them increase transparency and data visibility, which in turn aids cash management and can generate cost savings for clients. The level of security that banks can provide and their effective, efficient management of risk (including Know Your Customers “KYC” and AML processes) are still unmatched by non-banks. To add to it, banks currently have access to a far larger pool of clients than fintechs.
Obstacle #3 – Fintech Innovation Requires a Very Particular Set Of Skills
Jazz improvisers would say that to break the rules you must first learn them by heart – you can’t truly improvise without knowing what can be created, and what has been created before you.
Product development works similarly, in the way that it’s hard to create technologically sophisticated products and disrupt industries without access to huge software development know-how and deep market insights.
Sponsors of innovation have consistently say that FinTechs with credible ex-industry practitioners were better able, on the whole, to articulate and contextualize their value proposition. In contrast, startups that presented neat solutions without a clearly defined problem to address were more likely to be perceived as naive.
Moreover, founders in fintech tend to be, on average, 10 years more experienced that founders in other start-up sectors. They often have experience working in banks, strong domain knowledge and a deep understanding of the processes and problems which need to be fixed.
Fintech, then, requires a particular set of skills, and a team that understand the complexities of the market well enough to know how to operate in compliance with regulations and user expectations.
It’s easy to see how this makes hiring for Fintech start-ups challenging – especially for start-ups that aren’t based in any of the fintech innovation centers around the world.
Obstacle #4 – New Challenges in Data and Information Safety and Privacy
Innovations in cloud computing have improved information and data storage, access and analysis. While beneficial for all, these changes also yield the need for greater information protection.
74% of Americans believe it’s very important for them to be in control of who can get their private information.
Then there’s the issue of cyber attacks on startups. It’s obvious that early stage start-ups are not able to establish bank-like security, and risk only grows as more customers join and use a fintech platform. There haven’t been any large scale cyber attacks or data breaches in the fintech startup world yet. But FBI Director, Robert Mueller, warned founders at RSA’s Cyber Security Conference in 2012, saying “I am convinced that there are only two types of companies: those that have been hacked and those that will be.” Consulting experts in the cyber security area recommend that startups have data protection protocols and recovery procedures. Others advise startups to store as little sensitive and personal data as possible, only adding to challenges already faced by fintech start-ups.
Apart from customer data, something else is at risk here as well – the “crown jewels” – intellectual property (IP), as there have been many instances where ideas have been shared in confidence with investment banks, only for its in-house IT function to build something comparable.
Result – long product development cycles and endless obstacles
Most consumer-faced start-ups could create a product and put it in front of users to collect customer feedback within days.
Consumer fintech start-ups might be able to overcome existing financial systems completely, like P2P lending platforms or blockchain products, but they have a hard time reaching customers that only trust traditional institutions with providing financial services.
B2B fintech start-ups don’t even have that luxury – they need deep insights into how traditional finances work and a valid, complex proposition to solve them. Even getting in front of corporate customers can become an unremovable obstacle.
This is a grim picture that I’ve painted – but there are plenty of increasingly popular initiatives that are simplifying innovation in fintech.
Overcoming Obstacles In Fintech Innovation – What Roles Can Traditional Institutions, Regulatory Bodies and Start-Ups Play To Improve The Situation
Spending in the FinTech market has been going – global investment in fintech ventures in just the first quarter of 2016 reached $5.3 billion, 67% more than in Q1 2015.
Governments and companies have realised the importance of removing obstacles in fintech innovation, and are joining forces to make space for innovative technological products in the financial market.
The most important changes that are happening right now include:
Regulators are setting a very positive example through introducing regulatory sanboxes. The driving idea is to allow financial organizations to test new ideas with live consumers benefitting from loosened regulatory restrictions, but only for a limited period of time. This also offers fintech start-ups an opportunity to partner with established financial institutions and other fintechs.
Chief among these has been the regulatory sandbox. Countries such Abu Dhabi, Australia, Hong Kong and Singapore have all announced intentions to launch a regulatory sandbox.
In the UK, the Financial Conduct Authority (FCA), opened its regulatory sandbox to firms on May 9th, 2016. In it’s official release, the FCA described it as a ‘safe space’ in which businesses can test innovative products, services, business models and delivery mechanisms while ensuring that consumers are appropriately protected.
When the sandbox time is over, fintech products are expected to exit the program and be deployed to the public in full compliance with all regulations.
It is a win-win situation, in that it’s a way for regulators to demonstrate their commitment to fostering innovation, as well as a way for start-ups to reduce the obstacles that they’re facing.
Other Ways That Governments and Regulators Are Helping – Support, Education, Regulations
In UK, the Government Office for Science and regulators (FCA) work together to support industry adoption. The FCA’s Project Innovate offers support to new FinTechs, and the regulatory sandbox mentioned above is just one element of that support. In Asia, more progressive authorities hold regular industry dialogues with market participants (financial institutions, training academies and universities) to understand technology innovation and assess whether existing rules, policies and guidance are restricting innovation. In Australia there’s the FinTech Advisory Group and the Innovation Collaboration Committee. In the US, The Office of the Comptroller of the Currency (OCC) is looking at a framework to allow startups to submit new business ideas.
Even in Poland, on 13th of January this year, the first meeting of an operational commission for developing fintech innovations was held, consisting of representatives from the most important financial institutions in the country and the FinTech Poland Foundation which was the starting agent behind the whole initiative.
In retail financial services, collaboration has to be fueled by regulation, such as the Payment Services Directive 2 (PSD2) and open API standards that are currently coming into force.
To increase payment processing harmonization, initatives such as SEPA and ISO 20022 have been introduced, and they’re an important part of growth for national and international payment infrastructures. These common standards have enabled a more modular approach to IT in which new services can be added to existing systems without the need for complex intermediary layers. ISO 20022 and the associated XML and ASN.1 standards have provided a common language for banks’ and payment providers’ systems to communicate. Other iinitiatives are the International Payments Framework (between the USA and Europe), the China International Payments System (CIPS), and SEPA and TARGET2-Securities (T2S) in Europe. T2S, for example, is a single pan-european settlement platform designed to address Europe’s fragmented infrastructure and the complexities of cooperating across national boundaries, aiming to reduce cross-border transaction costs and post-trade risk.
Fintech Supporting Fintech
Waves of support are coming from unexpected directions. Software development in fintech has been heavily influenced by new trends in software architecture, which has become more *open-source*.
One of the trends are Open Web APIs – they enable the interaction between two or more cloud services, making it much easier to build solutions that integrate and combine services and data sources. Which is why APIs have been instrumental in enabling the start-up sector to disrupt traditional finances.
Much as in other industries, financial services architecture has opened up on an unprecedented scale in recent years.
Data APIs like Yodlee allow developers to pull user financial data, SDKs (Software Development Kits) like Card.io make it easy to onboard payment cards into mobile apps, financial market APIs like Xignite pull live stock prices, and payments APIs like Stripe make it simple for developers to accept payments.[9
However, even with openly available *blueprints* for software architecture and easy access to data and computing power, fintech start-ups still need developers. But problems with lack of developers with the right experience for fintech can also be solved.
This is something that, together with the Ideas On team, we intend to help with by introducing products like MVP In a Week – a process, based on our existing infrastructure for outsourced hiring of software developers, that’s being designed to allow fintech start-ups to create an MVP that’s regulatory-compliant and usable within a week.
Banks Aren’t Waiting – Proactive Banking+Fintech Initiatives
Banks might not be leaving the financial playing field anytime soon but they still stand to be disrupted by fintech. All reports about the situation in fintech, that I’ve read for the purpose of writing this article, point towards a unified goal that banks and fintech start-ups should be headed for.
That goal is to achieve real collaboration between traditional institutions and fintechs – which isn’t easy and requires compromise on both sides.
Banks might not always benefit from it in terms of ROI, but for fintech start-ups the ability to have established banks as strategic collaboration partners is priceless.
There are currently 16 bank-funded corporate accelerators around the world that invest in fintech. The banking sector is among the leaders in adopting open innovation and creating accelerators.
In order to survive in the new environment, banks should act open, collaborate and invest in fintech startups. The open concept can be illustrated by an example from Germany, where Fidor Bank has established FidorOS3 – software with an open Application Programming Interface (API) that can connect to existing banking platforms to offer a range of modern services including lending money to friends, sending money via Twitter and arranging an emergency 24-hour loan. The bank has also moved into partnership with foreign exchange specialist Currency Cloud4 to offer a current account product that can be viewed in seven currencies and offers foreign exchange transactions.
A great example from capital markets has been given by Goldman Sachs. It placed its proprietary source code on the online collaboration tool GitHub, allowing coders outside the bank to try and optimise it. French bank Credit Agricole launched an open API in 2012, enabling developers to build apps on top of its services, and now has a range of apps providing expense management, social payment and finance analysis tools to customers.
There’s also the FinTech Innovation Lab, which provides a mentor programme and fosters relationships between start-ups and the biggest and most established banks in London, New York and Hong-Kong.
Polish mBank (part of Commerzbank Group) partnered with telco giant Orange Polska in 2014 to offer banking services for phones and tablets. mBank itself is a leader in mobile banking in the region, with an app that allows full online banking functionality using a smartphone and a PIN code.
Fintech start-ups need capital, and banks need to innovate – for banks to invest in FinTech is a win-win situation in the current market reality.
In February 2015 AXA, the insurance and investment management firm, launched a €200 million fund. American Express, BBVA, HSBC, Santander and Sberbank have all developed corporate investment vehicles over the last four years, each with at least US$100 million to invest. Santander’s Innoventures is a US$100 million fintech venture capital fund based in London. Don’t forget about HSBC’s US$200 million fund, or Sberbank’s SBT Venture Capital with US$100 million fund for the fintech sector.
2017 might hold very interesting developments in the world of fintech. Regulations like the european PSD2 are steadily coming into play, established financial institutions provide support and financing for innovative fintech start-ups, and members of the fintech industry are supporting each other through new services and initiatives.
The obstacles to fintech innovation are being stripped away, and all signs point towards the conclusion that in the coming years we will see an increasing convergence between traditional and new financial services and companies, which will result in completely new products and services. This is the right time to be in fintech.
Let us know in the comment section below what do you think are the other obstacles Fintechs can meet!
1. EY and Innovate Finance global report – “Capital Markets: Innovation and the FinTech landscape. How collaboration with FinTech can transform investment banking”
2. Accenture banking report – “The Future of Fintech and Banking: Digitally Disrupted or Reimagined?”
3. Forbes contributor Falguni Desai – “The Fintech Boom And Bank Innovation”
4. Forbes contributor Falguni Desai – “The Evolution Of Fintech”
6. BNY Mellon report – “Innovation In Payments: The Future Is Fintech”
7. First meeting of polish KNFs Operational Team for Developing Innovation in Finance (Fintech) in Poland – Polish Financial Supervision Authority website
8. The Economist – “The fintech revolution”
9. TechCrunch contributor Matt Heiman – “Innovation under the hood will rev the engines of a fintech revolution”
10. Pew Research – “Ethics and Big Data”
11. Cryptocoin News – “Bitcoin Supporter Peter Thiel Considering Bid for California Governor”
13. Finance Magnates – “Regulatory Sandboxes: The Road to Fintech Redemption?”
We’re learning a lot
so you will too.