The Economist Report on Financial Technology (Banks & Business)
I want to recommend an article in The Economist May 9th – 15th 2015 issue. This edition includes a 14 page special report on financial technology (fintech) and it is worth reading. Our economy is based on credit and money transfers. This will not change but the methods by which it will be done most definitely will. Technology will change the way we borrow, transfer money, and accept investment advice. This has implications for banks, business, and everyone individually.
First, about banks. There are three ways by which they make money.
- By margining. That is the difference between deposit interest and loan interest,
- By charging for making payment, such as credit and debit card transactions.
- Fees of all sorts such as for money transfers.
All three income stream are under attack by technology, implying that in the future banks will be less profitable.
To compete on margining, peer to peer lending already has several apps. People with money, who are not happy with the 1% or 2% their banks give them on savings deposits, can find people who need money and do not like the 6% to 8% their banks charge them. With this spread there is room to negotiate and plenty of new start-ups are coming into this lending market. Everyone should win, assuming no defaults, except banks tied to their old operating models. Crowd sourcing of investment capital is now much easier. There will be more websites that specialize in bringing together people with business ideas with those who wish to invest in them.
In terms of payments, Pay Pal and other transfer systems already do the job for much less than banks charge. Later this year iPhone will release an app that will allow people to use their cell phones like credit cards. VISA and MasterCard charges to the merchant can be as high as 3% of sales. Even debit card transactions can be as high as 1%. Apple Pay wants to do it for .15%, a considerable saving. Be aware, however, that this will only be an introductory rate and that the introduction will be in the US.
Credit cards will respond to these new competitors by expanding what they offer. These cards were once owned by the banks. VISA and MasterCard have since gone public and are now positioning themselves to compete with their former owners. Credit cards are expanding into student loans, business lending, and mortgages, areas that are now monopolized by banks and are lucrative revenue streams for them. This will put pressure on bank profits but give consumers more sources of financing.
Credit scoring techniques have also become high tech. This will go hand in hand with new fintech lenders who must find ways to vet and approve borrowers. Companies can tell a lot about a person by the way an application form is filled out. For example, by the way capital letters are used. They can also use social media such as Facebook to check on a person’s lifestyle and eligibility for a loan. The administration of these loans has also come down. The costs to banks average about 7% of the loan value. It also costs about the same to service a $20,000 loan as it does for a loan of $2 million. Thus banks like to focus on the larger loans that will bring in more profits. The gap is now being filled by fintech companies such as Lending Club. By using new ways of credit scoring, their costs tend to average about 2.7% of a loan value and this enables them to offer better terms to the smaller borrowers.
Wealth management is an unregulated industry whereby investment advice is offered for between 1% to 3% of a fund value. People in this industry do not have to give the best advice, just good enough. In addition to charging clients, they make money from transaction fees and kickbacks from fund managers. They often rely on formulas to determine the best investments given the client’s age, status, goals, and retirement needs. What is obvious to fintech start-ups is that these people can be replaced by algorithms. Robo advisors that are coming into this market charge much less, about .25%, and the advice is every bit as good.
Fintech can assist people who do not have bank accounts. This is hard to imagine in a developed nation such as Canada, but globally ½ of adults do not. Here phone systems have jumped into the gap by enabling payments through them. In third world countries, that do not have adequate banking infrastructures, this has been a fact of life for many years. Soon Applepay will provide a means to pay bills and transfer funds to first and second world countries. Google and Samsung are setting up rival systems and even Facebook is going into this market. In time debit and credit cards can be bypassed entirely.
Finally, no article about fintech is complete without mentioning the bitcoin. This is a currency that is not backed or associated with any national government. Sort of a gold without the glitter. It has experienced problems of late and its value has declined. In addition, the U.S. government disproves of it because transactions are not traceable. Hence, it is favoured by drug dealers and those participating in other illegal transactions. Despite these concerns, it is a means of exchange that should be watched as it will, without doubt, reappear in some form or other.
Different aspect of fintech will have different repercussions on the way each person does business. My intent is to highlight the major areas and let individuals pursue those areas that affect or benefit them most. The article is worth reading just to become aware of what will happen.
William Petryk is the resident resource reviewer here at TheGAAP.net. A graduate from the Schulich School of Business at York University and designated CMA, William Petryk is an accomplished accountant with years of experience.