FINANCIAL TECHNOLOGY (FinTech): A GENIE OUT OF THE BOTTLE

Introduction

During my visit to Nairobi, Kenya in 2007, I was queuing at a grocery shop when I experienced an early aspect of the FinTech revolution in mobile-banking—sending money in seconds (via a Nokia 3310) outside the traditional, sophisticated, banking system. The Magic-Pesa is was what I named it!

The typical infrastructure of the banking system we know is based on physical branches, lengthy bureaucratic procedures, strict ID identification processes, elite customers and elegant dress-codes for the banks’ officers; governed with tough provisions and regulatory structure based on Basel regulations. Any transaction carried out beyond the banking system comes with a stigma of being illegal whereas any transaction within the system is charged with different types of fees. In this way, the banking sector can exert great control over global finances.

M-PESA was one of the core innovative technology drivers for FinTech made by young Kenyan entrepreneurs. When Steven Jobs introduced the all-powerful iPhone, mobile banking sparked. Even today, innovation in mobile banking is still taking place and it is hard to imagine how this sector will look like in a decade.

M-Pesa entrepreneurs were smart stenographers of the banking system. They focused only on the core elements of banking, namely software, connectivity and agents. They replaced the limited albeit sophisticated elite bank branches with an unlimited number of agents and embedded the banking services software within the telecommunication sector. Basically, they provided banking services with no banks. Since then, we have seen technology driver start-ups which have disrupted the industry and strongly influence our lives. They sought to change the way financial services are offered to the end consumer. According to EY’s 2017 FinTech Adoption Index, one-third of consumers utilise at least two or more FinTech services and those consumers are also increasingly aware of FinTech as a part of their daily lives.

Where Does the Story Start?

The first traditional bank as we know it was established way back in 1472 by Banca Monte dei Paschi di Siena in Italy. Then in 1953 we saw the first electronic recording for bank accounts. From that moment onward, modern technology started to transform banking. Computerised systems arrived in the 1950’s and underpinned the creation of general ledgers and core systems for banks. In the early 1980’s, with the creation of telephone banking and the access to the internet, there was a further technological transformation in banking. FinTech technology is now really kicking in dramatically and drastically changing the whole way people carry out their banking activities.

Banca Monte dei Paschi di Siena still just about functions as one of Italy’s largest banks although it is majority owned by the Italian state. I visited the original bank twice and always wondered how Siena’s municipality and the bank preserved its structure, history, and archives despite the many conflicts and upheaval the region went through. How did the bank not fall apart and vanish into bankruptcy, albeit in recent years it has been trying hard to achieve this fate?

Despite the creation and development of banks, after 650 years of banking,[i] an entire 1.7 billion people still live their lives without availing any banking services. But we are starting to see how FinTech can play a pivotal role in increasing banking usage in weaker economies. Furthermore, FinTech’s role in boosting the level of consumer satisfaction is growing; it has widened its complementary services to provide flexibility with low prices, along with an efficient and faster process. In a nutshell, Fintech reaches the type of consumer the banking sector could never reach.

Fintech and digital technology are bases for starting smart cities where traditional networks and services are made more efficient - using digital and telecommunication technologies - for the benefit of its inhabitants and business. This 21st century digital technology revolution, defined by its rapid acceleration and growth, is like a genie that has popped out of the bottle. However, we are unable to anticipate where it will lead or stop.

This article focuses on FinTech Technology, its opportunities, and sectors. It offers an overview on its current status and an appraisal of the impact of COVID-19 in accelerating its development. It concludes with a quick overview of the challenges associated with FinTech in the Middle East, North Africa and Europe, and outlines a number of recommendations for the sector.

What is FinTech?

KPMG’s 2018 figures note that global FinTech funding rose to $111.8 billion (USD) in 2018[ii], up 120% percent from $50.8 billion in 2017. Today, FinTech is a venture industry of around $140 billion a year.

The FinTech label is very broad and there is no consensus about its definition and it may be premature to define a field that is so rapidly evolving. What is clear is that it is technology and innovation that aims to compete with traditional financial methods in the delivery of financial services. We can use the definition of Dorfleitner (et al, 2017) who argues that: “FinTech” denotes companies or representatives of companies that combine financial services with modern, innovative technologies. It is an emerging industry that uses technology to improve financial services. It offers 24/7 access to bank customers and services that are available via channels such as social media and the internet. The application programme interfaces (APIs) enable FinTech to develop value-added solutions and features that can easily be integrated with banking platforms.

Meanwhile, the FinTech industry has sustained a double-sided contribution, with innovation coming not only from new start-ups and entrepreneurs, but also from within the ranks of some of the major financial players around the globe. It has solved problems with the help of latest technology and ensured it is accessible to everyone.

FinTech opportunities may be summarized as [iii]:

1. Greater access to capital—This appears in the Peer to Peer (P2P) and Equity Crowd Funding (ECF) platforms in providing credit to borrowers, especially Small and Medium Enterprises (SMEs), which do not have access to bank loans and opening new possibilities of access to equity finance.

2. Financial inclusion—Digital finance has improved access to financial services by under-served groups. Technology can reach remote locations.

3. Better and more tailored banking services—to deliver a cost effective and flexible service via, for instance, robo-advisors to help customers navigate the investment world and create a better and tailored customer experience.[iv]

4. Cost advantage—It provides lower transaction costs and faster banking services such as cross-border transfers.

5. Fragmenting incumbent banks—decrease their systemic risk and create positive impact on financial stability due to the increased competition of new players competing with incumbent banks.

6. Regulation Technology (Regtech)—Contemporary, innovative technologies can help financial institutions comply with regulatory requirements and pursue regulatory objectives.

7. Enhancement in security—as security is built into the blockchain through encryption of the blocks and linkages between the blocks. FinTech Platforms also provide various methods to ensure anonymity and prevent information leakage.

The industrial segments of FinTech include[v]:

Payment—is the largest sector of growth in financial services. FinTech’s disruption of the sector over the past decade was a great achievement in this era of innovation. It enhances convenience and the customer experience. It has also added a new layer of competition with FinTech start-ups competing in a space that has been dominated by credit card processors and financial institutions. FinTech innovation is also, in part, dependent on the blockchain innovation, which is a system that records transactions in literal blocks that form part of a chain (of transactions) resulting in a safe ledger system. The blockchain system itself is nothing short of revolutionary its applications are found not only in the financial sector, but also in many other sectors, most notably the cyber security sector.

Some of the disruptive trends taking place in the area of money and payments include:

· Mobile banking: The smartphone is already the centre of a modern consumer’s life.

· Peer-to-peer transfers: since blockchain intermediates the need for middlemen to facilitate and authorise transactions between two parties, there is a significant reduction in costs that the users are required to pay when transferring money.

Insurance—Changing consumer behaviour and advanced technologies are disrupting the insurance industry. Additionally, Insurtechs and technology start-ups continue to redefine customer experience through innovations, such as risk-free underwriting, on-the-spot purchasing, activation and claims processing.

Regtech—is the management of regulatory processes within the financial industry through technology. The main functions of Regtech include regulatory monitoring, reporting, and compliance. Regtech, or RegTech, consists of a group of companies that use cloud computing[vi] technology through software-as-a-service (SaaS) to help businesses comply with regulations efficiently and less expensively. Regtech is also known as regulatory technology.

Wealth Management—The emergence of robo-advisors, or the computer-automated investment platform, along with the proliferation of artificial intelligence (AI) tools, has transformed the way financial advisors interact with and provide services to their clients.

Crypto currencies/blockchain—blockchain is the technology that underlines digital currencies—such as bitcoin. It functions as a distributed ledger that enables transactions between peers without the need for mediations by centralised, trusted third parties. Its potential functionality is immense and is not confined to financial services. Although bitcoin is the best-known digital currency, there are various others in existence and in development. While cryptocurrency itself has endured an erratic history, the allure of virtual money continues to be its underlying attraction. The range of future products and services that could be built on top of this foundation are immense.

Cyber security—As the FinTech sector grows, so does the need for up-to-date cybersecurity. As the number of connected devices continues to rise steeply, financial technology becomes cheaper and easier to use. Processes and services which were once monopolised by banks are now much more accessible to companies and the wider public. This feature has the added benefit of increasing innovation, lowering operating costs and improving the efficiency of financial institutions. However, whether it be social security numbers, payment card numbers, PINs and passwords, financial information remains sensitive and must be protected. Currently, the banking sector does a decent job of protecting people’s data. The most pronounced challenge for FinTech is to prove that it provides at the very least a similar security level. If there is any lapse in this area, people will start distrusting applications and want to revert to traditional banking.

The FinTech ecosystem has stimulated technological innovation, made financial markets and systems more efficient and improved the overall customer experience. It is composed of five main elements:

1. The governments, embodying the regulations and legislations.

2. The financial institutions, traditional banks, stock markets, insurance companies, venture capital.

3. Start-ups and entrepreneurs, representing the payment systems, wealth management, crowdfunding, insurance FinTech, etc.

4. Technology Developers, cloud computing, Big Data Analytics, cryptocurrency, social media developers, etc.

5. Business environment/access to markets representing the financial customers, individuals and companies.

The quality of infrastructure is critically important. This includes the state of physical infrastructure, the ecosystem’s connections (such as distance to existing business hubs and ease of access), the utilities (power, water, telecommunication, etc.), and the overall quality of real estate and facilities. Governments can influence many aspects of the ecosystem, including easing business regulations, such as copyright.

The FinTech regulator covers land and real estate, equipment, technologies, and utilities. Another factor is the degree of integration and synergies among the players involved. Technology clusters or hubs, where entrepreneurs have similar business objectives and are integrated, make it easier for the ecosystem to flourish. These clusters promote the availability of skilled labour (notably banking analysts, IT developers, sales force, and management staff).

FinTech ecosystems are typically funded through four main sources. Governments may fund the construction of the FinTech hub by providing seed funds, interest-free grants, or even through provision of subsidised office and co-working spaces. This can be done with banks in a consortium. The government may also provide initial financial support to venture capital or private equity funds, banks, and incubators to encourage investment in small businesses. Venture capital funds and private equity shops are traditional investors in FinTech start-ups. Funds’ involvement will typically increase as these business models gain momentum. Incubators and accelerators prepare businesses for venture capital fundraising and provide grants and investments. By offering financial and due diligence services to entrepreneurs, they become a one-stop shop for buyers and sellers in the ecosystem.

Broad financial expertise and know-how is necessary to structure the ownership of a FinTech ecosystem, provide advisory services to entrepreneurs from the early stages of idea generation through commercialisation, and provide legal and regulatory counselling to ensure adherence to local law and tax regulations. These experts can also be instrumental in lobbying for financial or regulatory measures.

COVID-19’s Impact and Accelerating FinTech

Following the post-financial crisis of 2008, changes started taking place in the financial industry with regard to its societal impact. The Covid-19 crisis has both reinforced and fast-tracked these changes. The pandemic has drawn attention to the view held by some that capitalism was not really about solving problems such as a well-served public health service, income inequality and climate change.There is mounting concern that capitalism has lost sight of its social responsibility.

Technology is driving this awareness and is shaping a new demand for social and financial inclusion. The rise of what might be termed ‘techno-socialism’ has led to highly automated societies. In this context, there is an aspiration to create more social consciousness within capitalism. The problems surrounding climate change is a case in point.

Another positive outcome of the Covid-19 crisis is that it has caused an increased focus on cashless payments and digital identification. In this respect FinTech offers a number of advantages over fiat money, the latter defined as any money that is accepted by government for paying taxes or debt, but which is not pegged to or backed by gold or another tangible valuable.

The greater consumer use of mobile devices encouraged financial institutions to partner with FinTech providers in order to keep up with the pace of innovation in the financial sector. In turn, this led to more deliberate efforts by the FinTech companies to serve the communities in partnership with regulators, central banks and policy makers.

Digitalization embraced FinTech and expanded capital distribution to consumers and SMEs. For instance, the Challenger Bank N26 reached six million customers across Europe and the US. Meanwhile, Enjaz Saudi Arabia enabled nearly a third (27%) of its customers to transfer remittances remotely without needing to visit a branch.v.[vii] In addition, in an attempt to boost economic growth, the economy, policy makers and regulators are looking for ways to ease regulations on FinTech companies, thereby stimulating wealth creation.

E-commerce giants have expanded the goods and services they offer at lower costs because of FinTech innovation. This has helped reduce the cost of finance and opened up markets, optimising process efficiency and improving security. Industry silos are merging and we are seeing mkore and more partnerships between financial institutions, biotech platforms and FinTech startups. This has encouraged scale-ups that leverage the best of balance sheet, products, user engagement and technology to build something that is greater than the sum of its parts.

The Main Challenge in FinTech is Regulation

Technologists today are very advanced — specialising in areas that are generally under-appreciated by traditional banks. Digitalisation is applied to make processes easier for customers. Most of the major challenger banks were founded in the past five years and they tend to be characterised by mobile first apps, personalisation and customer centricity.

However, technology regulators tend not to be up to speed with these innovations. Consequently, it is essential to reinforce the banking sector to adopt and build around these technologies, for example, through personalisation in terms of security, documentation and facial recognition. Yet all too often this is delayed owing to regulatory approval. In this way, regulation is becoming a hurdle in improving the banking sector and getting it up to speed with the latest developments. Enhancing the efficiency of building, enabling, and adopting the eco-system of FinTech through the regulatory framework is a high priority. If this goal is fulfilled we can look forward to technical innovation starting to have a real practical impact on people’s quality of life.

Financial services are among the most heavily regulated sectors in the world. Financial regulations protect consumers’ investments, prevent financial fraud and limit the risks financial institutions can take with their investor’s money. Regulators oversee three main financial sectors: banking, financial markets, and consumers. Clearly, FinTech regulation is the chief concern among governments as FinTech companies take off. Yet it must be borne in mind that most of the regulatory environment governing banks is mainly about the stability of the financial system rather than issues to do with competition and innovation.

The extent to which the regulatory environment is supporting innovation and competition and how far the regulatory environment oversees these activities in a safe environment are crucial questions. The role of the regulators needs to be clearly defined so they can carry out their duties without hindrance. If regulators know the scope of their work, the rest of the community can benefit since they will be presented with a clear regulatory regime.

It is important to keep in mind that the benefits accruing from FinTech should not be gained to the deteriment of the soundness of the financial sector or the protection of consumers.

The Basel Committee on Banking Supervision in 2017 stated that banking standards and expectations should be sufficiently flexible to accommodate new innovations within the appropriate statutory authorities of jurisdictions. At the same time, robustly high standards for soundness and consumer protection need to be maintained.[viii]

Tight regulations can kill the FinTech industry and innovation.

The regulator should work as an enabler for emerging FinTech startups—not as an enforcer. There is a risk that , traditional regulations could cramp new entrants. . To avoid this risk of shackling innovation the regulator should move fast to catch up with FinTech and the consumer experience. The dqy to day consumer experience is so far ahead of regulation that it could cause a breakdown in the system.

The role of the innovation ecosystem that works outside of traditional organisations and interacts with evolving civil service environment should be encouraged and supported. The regulator can enable evolution within the financial industry yet it can also hinder evolution in the market. In the Nordic countries, for instance, considerable progress has been made in the transition towards cashless societies. Sweden tops the rankings. However, regulatory infrastructure rest at the heart of the problem in the Middle East.

In the US and Europe, the FinTech ecosystems have stimulated technological innovation, making financial markets and systems more efficient and improving the overall customer experience. Government’s role is limited to policy setting, regulations and property development. The private sector dominates the services scene. In contrast, in less-mature FinTech environments, such as Jordan or Saudi Arabia, the government is involved across the entire ecosystem.

Another way of improving the regulatory framework is to break down regulatory elements. A good model to consider is Singapore’s FinTech sector. Here, thegovernment encouraged financial innovation and mitigated risks brought about by FinTech through institutional improvements and regulatory reforms. It also identified potential regulatory limits and highlighted the methods through which these can be handled in four ways, namely:

1. They reformed the regulatory authorities to encourage financial innovation (re: the introduction of the FinTech Regulatory Sandbox and its improvement).

2. They improved the integration of regulatory infrastructure by establishing the Monitory Authority of Singapore (MAS) FinTech & Innovation Group.

3. They issued regulatory guidelines and passed laws to provide regulatory clarity in response to the evolving FinTech sector by the issuance of the Digital Token Guide.

4. They reformed legislation, notably amendments to the Payment Services Act.

Singapore’s experience can undoubtedly provide useful insights to regulators that are endeavouring to promote the formation and growth of their FinTech sectors.

There is also scope to improve new payment infrastructures, in partnership with large tech platforms, so as to distribute across their massive and highly engaged user-base. This can leverag payment networks and liquidity while plugging in new FinTech players to optimize payment process or digital identity verification.[ix] The FinTech industry needs to sustain and build on such collaboration and interoperability and provide help where it is needed for their customers and the wider economy. In short, the industry must change its business model, deployed technologies as well as operating procedures.

A Quick Glance at FinTech in the Middle East and Europe

In the Gulf region, policymakers and regulators began implementing forward-thinking and agile policies related to FinTech from 2017.[x] Since then, significant energy has gone into designing more diverse, competitive and innovative economies. The financial sector plays a key role in the massive effort to shift Gulf economies away from a heavy reliance on government spending and the energy sector. Indeed, FinTech is booming in the Middle East and North Africa (MENA), representing one of the fastest growing industries according to a new report by investment data platform Magnitt and the Abu Dhabi Global Market (ADGM) international financial centre.

Figure 1: Venture Capital Investment into Middle East FinTech Companies

In Bahrain—the financial sector is one of the most important non-oil sectors in the Kingdom’s economy. It accounts for over 17% of the gross domestic product (GDP).[xi] Fintech Bay was launched in February 2018 providing a physical hub to incubate insightful, scalable, and impactful Fintech initiatives through innovation labs, acceleration programmes, curated activities, educational opportunities and collaborative platforms.[xii]

In Saudi Arabia— venture capital financing increased by a remarkable 55% in 2020, reaching a record high of $ 152 million despite the impact of COVID-19. Financing for start-ups in Saudi Arabia grew faster than the average in the MENA region: 17 countries in the region saw a 13% increase in total funding from 2019 to 2020; Saudi Arabia saw a 35% increase.[xiii]

The UAE—is a great example where incubators, enterprise development funds and programmes along with innovation hubs are supporting the creation and growth of local entrepreneurs.

The FinTech ecosystem is seen as a leading pillar of economic diversification across member states of the GCC. However, the member countries themselves have not constructed a particularly refined FinTech ecosystem.. There are notable success stories in the Gulf, although the enabling and deepening of the innovative FinTech ecosystemis largely absent. This is in stark contrast to Europe, illustrated by the case of Sweden’s FinTech ecosystem (see figure 2).

The FinTech ecosystem is not about matching promising ideas to financing. Instead, it is about generating innovative ideas through the interplay elements of the FinTech ecosystem and the involvement of multiple stakeholders, including the media, disruptive non-bank players, universities, software and infrastructure providers, and venture capitalists.

Figure 2: The Stockholm Tech Ecosystem with an overview of some of the Swedish Tech companies

Figure 2: Most valuable FinTechs in Europe

Technology clusters (or hubs), where entrepreneurs have similar business objectives and are integrated, make it easier for the ecosystem to flourish. These clusters promote the availability of skilled labor (such as banking analysts, IT developers, sales force, and management staff). In the meantime, government and regulatory support can influence many aspects of the ecosystem, including easing and streamlining business regulations (such as copyright, product registration, initial public offering [IPO] requirements) and keeping taxes and fees low. However, the extent of the government’s involvement can vary. In mature FinTech countries, the government’s role is limited to policy setting, regulations and property development.

Final Word

The international financial system bears witness to the benefits to be derived from rapid development and an innovation-fuelled approach to problem-solving. The FinTech Community is taking over traditional banks to create an inclusive, greatly more democratised banking industry. . Many challenges remain but the industry can ensure that the disruption does not affect consumer protection and financial stability. In this context, policy makers should engage in greater focused investments and should rethink their responsibilities as regulators. The theme should be to focus on simplicity, as opposed to complexity, in order to accelerate innovation and a transformation of the financial sector that creates genuine beneficial results.

End Notes:

[i] See Jill Treanor (2016), ‘Monte dei Paschi di Siena: a brief guide to the world's oldest bank,’ The Guardian, available at: https://www.theguardian.com/business/2016/dec/22/monte-dei-paschi-the-history-of-the-worlds-oldest-bank

[ii] Lin Lin (2019), “Regulating FinTech: The Case of Singapore, SSRN Electronic Journal, 35, pp. 94-119.

[iii] Peters and Panayi (2017), Financial Stability Board, IOSCO.

[iv] A robo-advisory is a digital platform that provide automated, algorithm-driven financial planning services with little to no human supervision.

[v] Ahmed Taha Al Ajlouni, and Monir Suliaman Al – Hakim (2018), ‘Financial Technology in Banking Industry: Challenges and Opportunities,’ SSRN Electronic Journal.

[vi] Cloud computing is the delivery of different services through the Internet. These resources include tools and applications like data storage, servers, databases, networking, and software.

[vii] Challengers specialise in areas that are generally underserved by these bigger banks, using digitalisation to make processes easier and simpler for customers. Most of the major challenger banks were founded in the past five years. They are characterised by mobile first apps, personalisation and customer centricity.

[viii] KPMG, ‘The Pulse of FinTech, HI 2020,’ September 2020.

[ix] Thought machines comes in as many banks have the ambition to deliver better technology to their customers but are held back by legacy platforms and technology. The cost of change is huge and cost of operations is too expensive because of an inability to automate processes.

[x] Jackson Muller and Michael S. Piwowar (2019), ‘The Rise of FinTech in the Middle East: An Analysis of the Emergence of Bahrain and the United Arab Emirates,’ Special Report, Milken Institute, at: https://milkeninstitute.org/reports/rise-fintech-middle-east-analysis-emergence-bahrain-and-united-arab-emirates.

[xi] The Fintech Times, In-Depth Analysis: The Fintech and Financial Services Economy of Bahrain,12 September 2020.

[xii] See: https://www.bahrainfintechbay.com/press-release.

[xiii] Magnitt Report, ‘Venture Capitalization in Saudi Arabia in 2020.