Digital disruptions in finance

By Dr. Ernie G.S. Teo

Sim Kee Boon Institute for Financial Economics

Singapore Management University

7th October, Citibank

Global investments in

Fintech ventures

2013: $4.05 Bn 2014: $12.21 Bn

Tripled

Growth of Fintech

What is Fintech?

• Financial services or products built

upon technology

• Fintech should be:

• Highly innovative

• Pioneering

• Disruptive

• Customer-focused

Financial Technologies

and Disruption

• Financial Technologies will play a major role in

redefining finance

• Business costs (capital adequacy

requirements and compliance) are rising for

traditional financial institutions

• With financial technology, business costs can

be lowered and the unbanked and

underbanked can be reached for financial

inclusion

Financial Technologies

and Disruption

• Lower margin businesses like micro-finance

and micro-insurance will become viable

• Consumers will be attracted by the low costs

and convenience these new technologies will

bring

• Traditional financial institutions with heavy

assets and large fixed costs will be unable to

respond to these disruptions

Unbundling the bank

with Fintech

• Why is unbundling the trend?

• Millennials demand personal control and

transparency of their financial interactions from

banking to insurance

• Less than half of Millennials (46%) see themselves

staying with their current financial services

companies over the next few years

• 76% of affluent millennials would seek information

about personal investing on a social network, as

opposed to just 18% of the affluent Gen Xers

What are the types of

Fintech?

• Money Transfer / Remittance

• Equity Funding / Crowdfunding

• P2P / Marketplace Lending

• Mobile Payments / eWallets

• Trading Platforms

• Others

• Financial Advise

• Data Analytics

• Credit Scoring

• Insurance

Why use Fintech?

Why do consumers choose these institutions instead

of trusted banks?

• Lower fees, better rates

• Lower thresholds for investments

• Lower thresholds for loans

• Ease of use, convenience

How does Fintech do it?

• Lower costs with technology

• Lower margins

• Minimum physical/fixed assets

• Highly scalable

• Innovative use of technology

• Social networks

• Crowd knowledge/wisdom

• Big data: market analysis, credit scoring

Rebundling the Bank

• Some Fintech companies expand into other

financial services after initial success

• Next, we look at some examples of how this

rebundling occurs

• MPESA

• Fidor Bank

• Alibaba and Alipay

M-PESA

• Launched in 2007, M-PESA (pesa meaning money

in Swahili) is a mobile money transfer service

introduced by Safaricom (a telecommunications

provider in Kenya)

• It drives financial inclusion by providing money

transfer services, local payments and international

remittance services

M-PESA

• Mobile penetration rates are increasing all over the

world

• In developing countries where internet services and

smart devices are not widespread, simple mobile

technology such as SMS can be used as a means

to transfer money

• M-PESA from Kenya is one such successful

example

M-PESA

• As of 2014, M-PESA has

• 81,025 agents

• 122,000 registered merchants (24,137 active),

• 19.3 mil registered customers (12.2 mil active)

• It accounts for 18% of Safaricom revenue and has

penetrated 90% of Safaricom’s customers

Mobile money subscribers in Kenya, April 2014

December 2013 December 2012

Total mobile subscribers 31.31 million 30.43 million

Mobile money subscribers 26.02 million 21.41 million

Number of Agents 93,689 62,300 Source: © Communications Commission of Kenya (CCK), April 2014). Via © mobiThinking

M-PESA

Figure 5. Percentage of Safaricom customers registered on M-PESA

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

0

5

10

15

20

25

FY08 FY09 FY10 FY11 FY12 FY13 FY14

M-PESA: Percentage of Safaricom Users

M-PESA Users (mil) Safaricom Users (mil)

Penetration Rate for M-PESA

M-PESA

• Customers are only charged for “doing something”

• Transaction fees are kept low and stable

• Agents are attracted to join, a store can earn US$

5.70 per day (with 60 transactions), double the

prevailing wage for a clerk in Kenya

M-PESA

• Agent system works well and does not require

infrastructure investment

• With an established consumer, merchant and agent

network, it can start expanding to more than

payments

M-PESA

• M-PESA has since expanded to Tanzania,

Afghanistan, South Africa, India and Eastern

Europe

• It has also expanded into more products:

• M-Shwari, a paperless banking platform with loan

services

• Lipa Na M-PESA, payment for goods and services

• Lipa Kodi, rental payments to landlords

• Pay bills, public transport, insurance premiums

• Receive pension or social welfare payments

Fidor Bank

• Fidor Bank was established in Germany in 2007

• It is the world’s first online-only bank that operates

only through the internet and using social media

• In 2014, Fidor has more than 300,000 people

registered and 250,000 community members

• €200m worth of deposits, and its lending totals

about €160m

• Only 34 staff and no branches

• Cost of only €20.00 to set up a customer with full

banking, the overheads are low compared with

traditional banks

Fidor Bank

• Fidor Bank is a leader in innovative banking

processes with several awards including:

• Most Innovative Bank for Social Media- Germany

(2013, Global Banking and Finance Review Award)

• Most Innovative Bank- Germany (2013,

International Finance Magazine)

• Bank Innovation Award (2013, Bankinnovation.net)

Fidor Bank

• Ways they engage customers through social media

Fidor Bank

• Ways they engage customers through internet community

• Rate Products, Rate Bank Advisors

Fidor Bank

• Products

Fidor Bank

• Fidor’s strategy is based upon two distinguishing

concepts, both centered on openness:

• Community banking – Members can share advice

on forums and collaborate on product development.

• “App store” banking – The bank operates an

open platform that hosts independent services from

third parties.

Fidor Tecs

• fidorOS is an open middleware software on top of

local core banking systems and provides next

generation community, payment, and banking

service solutions

• fidorOS is also a middleware written specifically for

modern banking which enables:

• Send money instantly to friends via Twitter, Email or

mobile number

• Lend money to friends

• Social trading, Social lending

• Crowdfinance: Funding & Investing

Fidor TecS

Fidor TECS

• Using public APIs, Fidor seeks B2B clients to do for

banking what Apple did for mobile applications with

iTunes

• A completely new technology that is not tied to any

legacy code

• Flexible enough to be used on nearly any core

banking system and powerful enough to be used by

banks as white label

• Full white label: look and feel can be customized

• Content of In-Account App-Store can be defined by

white label partner

Alibaba and Alipay

• Amazon Lending was started in the last quarter of

2012

• The company provided loans to online merchants.

Amazon provided loans to small sized merchants,

enabling them to purchase inventory

• Loans took only 4 days for approval and interest rates

were lower than small-business credit cards

• This increased revenue for Amazon as merchants were

able to expand their inventory and make more sales.

• However, Three years before Amazon Lending,

Alibaba has already started offering financial

services in China!

Alibaba and Alipay

• The Alibaba Group is a Chinese e-commerce

company started in 1999 by Jack Ma

• It provides c2c, b2c and b2b sales services via the

internet

Alibaba and Alipay

• In 2004, Alipay was established as a payment

platform and provide an escrow service

• It quickly expanded to include movie, plane and lottery

tickets, ordering of takeaways, insurance, payment of

utility bills

• Soon, it went offline and is used as a POS system by

small businesses

• However, the payment platform was just the

beginning

Alibaba and Alipay

Pay at KFC

Or pay your

Fishmonger

Alibaba and Alipay

• In April 2010, Alibaba Microfinance started lending

to merchants dealing with Taobao and Tmall

• As of end June 2013, it had extended a cumulative

total of over RMB 100 billion to more than 320,000

microenterprises and individuals

• The default rate on its microloans, of which lending

amount never exceeds RMB 1 million, is only

0.87% of its total portfolio

• The loan terms are usually short and ranging from

a few days to several months

Alibaba and Alipay

• Using big data analysis on SMEs to assess their

credit worthiness, Alibaba grow their loan books to

USD 16 billion in three years

• It also raised USD 87 billion to be the largest fund

manager in China by offering 15 times higher than

the standard saving rates

• It captured 20% of all new RMB deposit only nine

months after launch.

Alibaba and Alipay

• Alibaba launched a new financial product Yu’E Bao

in June 2013

• It is a money market fund and allows Alipay’s

account holders to invest their excess cash in the

fund

• Accounts holders are allowed to redeem the fund at

any time to pay for their online purchase on Alibaba

• Account holders can handle all transactions online

through personal computers and via Alipay Wallet-

enabled smartphones

Alibaba and Alipay

• Yu’e bao accounts can be used to shop, pay utility

bills, buy lottery and train tickets, book holidays,

and pay off credit cards, among other services.

• Other financial services which Alibaba subsidiaries

has branched into include retail and SME peer to

peer (P2P) lending, crowdfunding, micro-insurance

and a whole range of other funds such as gold

ETFs

Alibaba and Alipay

Digital Money

• Fundamental to most Fintech products is the need

for there to be a trusted way to digitize money and

hold it electronically

• Money held in M-PESA and Alipay are all forms of

digital money

• These systems relies on a central authority which

can be subjected to malicious attacks

• Cryptocurrencies is a decentralized way to account

for digital money

Cryptocurrencies

• Cryptocurrencies are a type of programmable

digital money that

• relies on cryptography to ensure secure transfer

for tokens

• make records of all transactions on a

decentralized digital register

• Cryptography is used to ensure the token spent is

recorded on the register and is never spent twice

• Bitcoin is the best known Cryptocurrency

Bitcoin

• Created in 2008 in a whitepaper by Satoshi

Nakamoto

• Bitcoin is a cryptocurrency that gives incentives to

those who are willing to participate in solving a

cryptography quiz

• Mining

• Through the mining process, transactions are

stored in a decentralized digital ledger called the

blockchain

Bitcoin

• Instead of a centralized authority maintaining the

records, everyone who is part of the network holds

a copy

• A majority of the network need to agree in order to

change any record or ass new transactions to the

ledger

• Its decentralized nature means that it is hard for

any single entity to control it

New York Stock

Exchange

Bitcoin

• Cryptocurrencies can open the door to a whole new

economy of sharing and financial inclusion

• It can allow the monetization of a person’s social

network (http://getgems.org/);

• distribute music (Bitshares Music Foundation);

• allow for crowdfunding (Swarm, Counterparty, Colored

Coins);

• decentralize data storage (Maidsafe, Storj)

• and also the issue of shares through cryptoequity

(Hyperledger)

• Blockchain: The technology behind Bitcoin is also

of interest

Banks looking at Bitcoin

Technology

• Standard Chartered Bank:

• Anju Patwardhan, chief innovation officer, shared her opinion on the bitcoin blockchain, noting how it could help reduce credit card, money transfers and remittance costs

• DBS:

• Ran a blockchain hackathon in May 2015, looking at solutions for the banking industry

• Citibank:

• Citi Innovation Labs: have been looking at blockchain for several years

• Sopnendu Mohanty, Chief FinTech Officer of MAS’s FinTech and Innovation group was the Global Head of Consumer Innovation Lab Networks & Programmes at Citi

Blockchain:

Decentralization

• Blockchain has been the buzzword going around in

the banking and financial industry

• Why do banks care about blockchain?

• Is it just FOMO (Fear Of Missing Out)?

Blockchain:

Decentralization

• There may be pressure from consumers who got a

taste of freedom from banks via alternative FinTech

services

• Blockchain-enabled solutions will take that freedom bar

even higher via decentralization, peer-to-peer behaviors

• Blockchain startups may be chiseling at the banks’

business

• Banks risk becoming islands if they don’t catch up

Blockchain:

Decentralization

• Possibilities for efficiency and security

improvements in areas like payments and

securities handling through the use of the

blockchain

• The auditability of the blockchain is also appealing

• Any edits are embedded in the blockchain are forever

• Such an electronic audit trail could replace paper trails

and manual audits.

Blockchain:

Decentralization

• Any process that requires extensive recordkeeping

• For example, Property records and title transfers are

possible examples

• Title can be theoretically be transferred to another

person on the blockchain without the need for title

insurance

• Alot of work is still needed

• Inter-banking co-operation over new networks will not

be easy

R3CEV

• R3 is an innovation firm focused on building and

empowering the next generation of global financial

services technology

• With the intelligent application of cryptographic

technology and distributed ledger-based protocols

within global financial markets

R3CEV

Banks that have joined R3’s distributed ledger initiative

• 15th Sept: Barclays, BBVA, Commonwealth Bank of

Australia, Credit Suisse, Goldman Sachs, JP Morgan,

Royal Bank of Scotland, State Street and UBS

• 29th Sept: Bank of America, BNY Mellon, Citi,

Commerzbank, Deutsche Bank, HSBC, Mitsubishi

UFJ Financial Group, Morgan Stanley, National

Australia Bank, Royal Bank of Canada, SEB, Societe

Generale and Toronto-Dominion Bank

LASIC Principles

• L: Low Margins, attract and build critical mass

• A: Asset light, ride on existing infrastructure such

as E-commerce, Telecom companies

• S: Scalable, able to expand without exponential

increase in costs, technology has to allow for large

change in scale

• I: Innovative, innovative use of technology such as

social media to find untapped markets

• C:Compliance easy, work in areas where the

government is likely to support

Lee, David K.C. and Teo, Ernie G. S., Emergence of Fintech and the Lasic

Principles (September 30, 2015). Available at SSRN:

http://ssrn.com/abstract=2668049

The Economics of

Financial Inclusion

• The global emergence of mobile

technology will play a large goal in

enabling financial inclusion

• Through mobile and other smart devices

• Many unbanked and unbanked segments of

the world will be able to gain access to

financial services.

The Economics of

Financial Inclusion

Figure 2. Active mobile phone subscriptions

The Economics of

Financial Inclusion

Figure 3. Active mobile phone subscriptions per 100 inhabitants

The Economics of

Financial Inclusion

• The problem of financial exclusion does not just

exist in undeveloped countries

• 7.7% of US households are unbanked and 20% are

underbanked

• The underserved in the world turn to non-traditional

forms of alternative financial services such as those

provided by cheque cashers, loan sharks and

pawnbrokers

• For example, illegal workers in the US who cash

cheques via agents such as cheque cashing depots

or convenience stores

The Economics of

Financial Inclusion

• The global picture of the unbanked and

underbanked is even more skewed

• Only 50% of adults in the world have an individual

or joint account at a formal financial institution

(Demirguc-Kunt and Klapper , 2012)

• There are 2.5 billion adults in the world with no

formal bank accounts, most of them in developing

economies

The future of banking

and finance

• Financial inclusion is not just a worthy cause but

also opens a large pool of untapped demand for

potential financial institutions.

• The world of financial services is fast changing;

consumers want more personalized services that

increase convenience and yet retain security

• Through the use of internet and mobile technology,

this can be made possible

Mobile banking customers at the top 12 global banks

Forbes

rank Bank HQ location

Mobile

banking

customers

annual

mobile

growth

Online

banking

customers

Total

customers

Mobile

percentage

of

customers

1

Industrial and

Commercial Bank

of China

China 100 million + 49.5% 390 million 432 million 23.2%

2 China

Construction Bank China 117 million 38.9% 150 million 291 million 40.2%

3 Agricultural Bank

of China China 83.0 million N/A 110.9 million 320 million 25.9%

4 JPMorgan Chase USA 16.4 million 24% 35.0 million N/A N/A

8 Wells Fargo &

Company USA 12.5 million 23% 23.8 million 70 million 17.9%

9 Bank of China China 52.1 million 24.6% 101.1 million N/A N/A

13 Bank of America USA 14.4 million 19.8% 30.0 million 50 million 28.8%

14 HSBC Holdings UK 2.5 million N/A N/A 60 million 4.2%

16 Citigroup USA N/A N/A N/A 100 million N/A

24 BNP Paribas France 1 million N/A N/A N/A N/A

37 Mitsubishi UFJ

Financial Japan N/A N/A N/A N/A N/A

43 Banco Santander Spain 2.6 million N/A 11.6 million 106.6 million 2.4%

Source: Banks 2013 annual reports

Except JPM and WFC: Q1 2014 report. Via © mobiThinking

What can banks do?

• Act open

• Engage with external technology solutions early

• Open own IP to generate new ideas

• Collaborate

• Co-innovate

• Within industry: SWIFT, Mastercard

• Engage with startups: Fintech Innovation Lab

• Challenge: Organizational Culture

• Invest

• Venture investing in startups

Accenture (2015), “The Future of Fintech and Banking: Digitally disrupted or reimagined?”,

http://www.fintechinnovationlablondon.net/media/730274/Accenture-The-Future-of-Fintech-and-Banking-

digitallydisrupted-or-reima-.pdf

Questions?

Ernie Teo,

[email protected]