Chapter 2 of 5. Read the full report here.
The fact that finance is one of the last industries to be disrupted by technology, behind industries like telecoms, music, and retail over a decade ago, and transport and tourism more recently, is testament to one thing. How hard it was going to be. The industries that technology has taken longer to impact such as finance, health and education share a few traits.
For example, they’ve been around for longer and so have built up a legacy of both domination and trust - with regulation for the most part created by the incumbents for the incumbents to the exclusion of newcomers and with relationships built up with consumers over decades and generations. What’s more, they are formed around significant building blocks of our lives that are fundamental in our hierarchy of needs rather than modern-day additions.
For the financial sector, the barriers to entry were huge because of both the regulatory framework and the relationship of the consumer not just to the incumbent but also with money itself. The - historically - blind trust that we as consumers had in the banks is the main reason that it has taken longer in this sector than in others for disruption to take hold. That, coupled with consumer inertia in financial services, have always been the banks’ most valuable assets. The rise of financial technology disruptors has finally come about over the last five years primarily as the result of five key developments that laid the foundations for change. Alone they may not have been enough. But together they provided enough impetus for the first wave of companies like TransferWise, Lending Club, Funding Circle, Betterment and Nutmeg to gain traction.
Creating the perfect storm: the five conditions for change
1. The loss of trust: the global financial crisis of 2008
Most importantly, the banks lost our trust. Financial services have always been about trust. Perhaps the biggest barrier to entry for new entrants has been getting new customers to trust an unknown brand or service and that’s particularly true with digital disruptors who lack a physical presence with no bricks and mortar on the local high street. The financial crisis of 2008 created a seismic shift in the dynamics of trust in financial services. The initial shock was bad enough, but over the past seven years, twenty of the world's biggest banks have paid more than $235bn (£151.71bn) in fines and compensation for breaching a variety of financial regulations during and before the crisis.
The banking industry has never regained that trust. According to Edelman’s Trust Barometer, financial services as an industry ranked second to bottom in trust, below historically disliked industries like Big Pharma, Oil & Gas and Big Tobacco. Fintech would have happened without the global financial crisis - but it would have taken much longer.
2. Expectations of better
As other verticals have been disrupted, consumers are now used to a better experience - one that’s faster, cheaper, more convenient… and we’re used to more choice. Our experience in everything from communication to music is now enabled by tech. By comparison, financial services look and feel outdated and restricted.
3. The rise of the millennials
The rise of the millennial created a new demographic whose expectations are very different. Millennials are the largest generation in world history and will soon command the largest wallet power as well. It’s estimated they’ll be spending $200 billion annually by 2017 and $10 trillion over their lifetimes as consumers in the U.S. alone. They do not have the same legacy relationship with their banks. In the US, 18% of millennials have switched their primary bank within the past 12 months—compared to 10 percent of customers aged 35 to 54 and just 3% of people 55 and older. The growth of fintech has been driven by adoption across age groups but the demand from the millennial generation to innovate and think about financial services differently has been a catalyst for change.
4. The rise of the mobile internet
With a smartphone, we have a supercomputer in our pocket and are always connected. The way we bank is changing as part of this macro trend. Traditional banks have made the move from branch to online - and more recently, to mobile. Our expectations of how and where we can do our banking have changed. By 2011, more than 65% of US adults were using online banking and by last year that number had risen to 74%. In the UK, online banking usage rose by 40% in the four years from 2009 and by 2013, customers used online banking 7 billion times over the course of the year. Additionally, the last five years have seen an explosion in mobile banking with nearly two thirds of Americans between 18 and 29 using mobile banking in 2014 and over a third of all UK adults using mobile banking.
5. Regulation that truly looks after the rights of the consumer
The financial sector is tightly regulated and rightly so: consumer protection must always be the priority. But regulation can encourage innovation at the same time as protecting our rights. In some countries, the regulators are more approachable, more flexible and have responded faster to the advent of financial disrupters. For example, in the UK the Financial Conduct Authority (FCA) set up Project Innovate in 2014 to work with innovative businesses, an approach which others such as Singapore and Australia have followed. But in other countries, a company is required to be a ‘bank’ to do a whole range of financial services, even if it’s restricting itself to one activity such as payments. This makes it harder for challengers to enter the market. In contrast, the approach taken in the UK is to actively encourage non-banks to compete in payments. In April 2015 a new Payment Systems Regulator launched with an objective of broadening access to the UK’s payment systems. As more non-banks use payment systems more directly, consumers will benefit from increased competition and better services on offer. Regional regulatory agreements eg in the European Union can also encourage innovation. The EU is a large internal market: there’s only one set of rules for payments - just one Member State authorisation is required that enables a business to ‘passport’ into all Member States. It’s no coincidence that there are a number of new payment companies that have come out of Europe. Crucially, flexibility is still accompanied by high standards. For example in the UK, all companies must meet the standards set out by the FCA for the services they want to provide to consumers. This is an important factor as it ensures continued consumer trust in the sector - whether people use an incumbent or a new tech provider.