Fintech Insights: 2023 Update

By Rupert Nicolay

Discover more about the forces changing financial services and disruption in everything from payments to insurance. Short snackable sections explain in simple terms how new fintechs and features operate under the hood and deliver insights into the technologies that support them.
Any views expressed are the author's own.

• Language: English
• Publisher: Rupert Nicolay
• Release date: Dec 22, 2021
• ISBN: 9781399904742

Book preview

1

Introduction - Tech Intensity

Every company is a software company. You have to start thinking and operating like a digital company.

Satya Nadella, CEO – Microsoft¹

The CEO of Microsoft coined the term ‘tech intensity’ to indicate the extent to which an organization or industry is subject to digital disruption. One measure of this is the proportion of software developers within the total staff complement of an organization. Across many industries this proportion has been steadily increasing.

This shift represents not only the extent to which software forms part of the products and services that the organization offers – but also the extent to which the culture of the organization may have to evolve to support the rapid release and management of software powered products and services – including supporting the experimental nature of some software-based products. Many industries are getting to grips with the extent of the shift required.

‘Development of [our] own software expertise is the biggest switch that the automotive industry has to make – much bigger than the transition to e-mobility.’ – Herbert Diess – ex CEO, Volkswagen.²

Mastercard redefined itself as a technology company some years ago recognizing that modern payments are primarily technology solutions: Mastercard is a global technology company in the payments industry. – Mastercard.³

Unsurprisingly – given the focus on ‘fintech’ in the past decade, this evolution can already be seen widely across the financial services industry today. Nevertheless, in aggregate across the industry there are noticeable differences in the pace of development. A subjective view of the extent of ‘tech intensity’ in different parts of the Financial Services industry is shown below. Note that this is a simple aggregated view and that there may be significant differences between participants and markets.

Bankers have recognized this situation for some time. In Jamie Dimon’s 2020 letter to shareholders⁴ he called out that Banks (face) Enormous Competitive Threats — from Virtually Every Angle.:

•Banks are playing an increasingly smaller role in the financial system.

•The growth in shadow and fintech banking calls for level playing field regulation.

•AI, the cloud and digital are transforming how we do business.

•Fintech and Big Tech are here … big time!

•JPMorgan Chase is aggressively adapting to new challenges.

Let’s consider some examples of tech intensity in subsectors of the financial services industry – each of which we delve into in more detail later in this book:

•Payments: Alipay and Wechat apps process trillions of dollars of transactions in China – up from very few transactions a decade ago. Mastercard represents itself as a ‘global technology company’. In Norway, VIPPS – an app and software platform processes the majority of Norwegian payments.

Payment facilitators (‘payfacs’) that have emerged in the past decade have worked with existing financial institutions to provide capabilities to merchants to embed payments in easy ways in places such as online points of sale. Building on this success they have extended to offering merchant lending and many other value-added services – once again with the underlying service mostly being provided by existing financial institutions.

Traditional software vendors have recognized their software engineering skills are most critical to success in payments and have purchased payment processors – for example, Fiserv purchased First Data in 2019 and FIS purchased Worldpay in the same year – although as of 2023 it has announced intentions to dispose of the business.

Nevertheless, under the hood of what may often appear to consumers or merchants as entirely new payment solutions are often traditional payment rails. This phenomenon is explored in more detail in the chapter on payments.

•Consumer Forex: Costs have been driven down by virtual forex solutions that replace both traditional forex and also some consumer foreign card payments (for ecommerce, travel and more) by issuing banks. Operating in this space, Wise became one of the biggest fintechs in Europe. Others such as Revolut have also made lower cost, faster and more accessible consumer forex a key part of their offer.

•‘Neobanks’ – used here to represent the licensed banks built on a new technology foundation – abound – from Monzo in the UK, Marcus in the US, NUBank in LATAM and more. At least a few hundred neobanks have been established. Perhaps as many as half of the top 100 retail banks globally have created a neobank offshoot that addresses a new market segment, defends against a competitive threat, or helps them overcome the constraints that may be imposed on them by legacy systems. Thus far profitability has been mixed for true neobanks. Nevertheless, many established banks have managed to launch new services or migrate existing services to platforms that they are able to operate off a lower cost base.

•Small & Medium Enterprise (SME) Banking – may be a less visible area of disruption – but changes have nonetheless been impactful. Not only have merchant payment services extended in many areas to cover small business, but lending and other services have been transformed by data and new technology partnerships. For example, many banks globally partner with payments, point-of-sale (POS) or accounting software vendors. Xero, a popular online small business accounting solution is one such. It lists many banking partners on its website. A bank’s lending offer might be a software integration built into Xero to interpret a chart of accounts and make a decision or offer.

•Reinsurance: There is persistent coverage of the importance of data in financial services. As will be discussed later, there are important distinctions to be drawn between building models to generate insights from data and ownership of the actual data to help drive those models. As analytics skills and technologies become more commonplace, the competitive advantage shifts to the owners of deep sets of data that can be used to build and train models. Reinsurers – who often own data from across the industry - have recognized the powerful position they are in and probably lead in ‘tech intensity’ in the insurance business. Swiss Re, Munich Re and RGA are all examples of reinsurers offering both software as a service underwriting solutions and risk models that leverage data insights.

•Property & Casualty (P&C) Insurance has shifted to offering behavioral insurance products and monitoring the risks they underwrite. Onboarding and claiming has become increasingly digitized. Advanced insurers work with partners and authorities to reduce risks based on their analysis of accident zones.

As financial institutions grapple with the pace of change all of the above implies, partnerships are evolving in which traditional financial services firms are now partnering with technology firms as they offer services on technology platforms.

We are also increasingly seeing the embedding of financial services in new technology platforms such as the example of Xero cited above. It now allows banks around the world to embed services like payments, reconciliations and lending offers directly into the Xero environment. Banks can take advantage of the data available to deliver convenient services to customers. In the past few years, SAP has advanced a new joint venture named Fioneer that also appears to aim to facilitate embedding financial services in SAP product offers.⁵ In other straightforward and widely adopted examples of embedding , lending may be embedded in a purchase experience (through ‘Buy Now Pay Later’ offers and more) or insurance might be embedded in an ecommerce service.

Having been hot through 2021, VC funding for fintech has cooled in 2022 along with rising interest rates. Global VC funding for fintech peaked at $37B in Q4 of 2021 and dropped to $13.3B in Q3 of 2022⁶. For those businesses that raised further funds in 2022 implied valuations often dropped significantly. For example, Buy Now Pay Later provider Klarna’s implied valuation dropped 85% between 2021 and 2022 to $6.7B⁷. The failure of Silicon Valley Bank (SVB) in March 2023 may place more pressure on fintechs and investors given its significant presence in the fintech banking market.

Navigating this Book

Focused on technology-enabled disruption in finance, the first part of this book contains snackable coverage of key areas in financial services. The beginning of each chapter provides a summary of the key trends and forces at work in a particular area. In cases where the underlying business model or plumbing that underpins the solution is not necessarily clear, an effort is made to go deeper and explain the mechanics of certain financial services solutions – for example, a deeper dive is provided into the mechanics of many modern payment solutions.

The second part provides a brief overview of how technologies – in particular cloud computing capabilites - are being used to enable this disruption.

Chapters are designed to be read independently for a short briefing on a particular topic.

_________

1 Microsoft CEO Satya Nadella on fuelling ‘tech intensity’ in the UK

2 Software issues cost Volkswagen CEO Herbert Diess his job • The Register

3 (99+) Mastercard: Overview | LinkedIn

4 Jamie Dimon’s Letter to Shareholders, Annual Report 2020 | JPMorgan Chase & Co.

5 Embedded finance | SAP Fioneer

6 Fintech Q3 2022 (dealroom.co)

7 Klarna confirms $800M raise as valuation drops 85% to $6.7B | TechCrunch

2

Regulatory Trends

Regulatory trends particular to geographies or parts of the market will be highlighted in the relevant chapters of this book. Nevertheless, there are a number of overarching trends affecting the disruption of financial services that are worth watching.

Key Forces at Work in the Financial Services Regulation

Consumer Innovation, Empowerment and Value Delivery

In areas and countries as diverse as the EU, Brazil, Australia and the UK there has been an ongoing regulator focus on delivering better value, more inclusive and potentially more diverse financial services. This has manifested itself in a number of ways:

a)Licensing a bank or financial service provider has been made somewhat easier– with sandbox capabilities to allow service providers to launch services with a lower regulatory bar. For example, the UK’s FCA Sandbox provides such a capability.

The US remains something of an exception to this with complex state and federal requirements. As a result, many fintechs choose to partner with existing registered financial services providers rather than seek a license in their own right.

b)Open Banking services in many countries and regions (excluding the US) have made it compulsory for banks to share customer account information when the customer authorizes their bank to do so. Similarly, they may be required to offer payment initiation services so that an account-to-account payment can be initiated by a third party and authorized by the customer. The intent of these regulations is to make it simpler for new entrants to offer new services that leverage the data held by banks or to integrate their services. In the chapter on Open Banking the global landscape is covered in more detail. Account-to-account payments – particularly as an alternative to card payments (that may