Are we resigned to a future where disruption rather than stability is the new normality? We saw what Amazon did to record shops and booksellers. We are seeing Uber decimate the cab industry. This fate, presumably, awaits every industry and every occupation.
An efficient finance industry is at the core of a productive economy. But the finance industry has many critics, who might well argue that finance needs disrupting. Fintech is the label we give to the explosion of disruptive innovation in finance. This critique provides a useful framework for thinking about its role.
Four broad functions of the finance industry
1. Facilitate payments and transactions processing, which is crucial for trade and economic life more generally
2. Safekeep assets and the creation of capital
3. Enable the sharing of risk through insurance and pooling
4. Intermediate savings, investment and capital raising – getting money from where it is the way it is needed.
There have been three broad areas of concern about the finance industry. There is continuing concern about what the finance industry did to the global economy in 2008 and whether it could happen again, that is, the concern about systemic risk. There is a belief that some people are not getting the financial services they need, for example, limited access to banking in the developing world, such as the financing gap faced by SMEs. Finally, there is a view that financial services are too costly.
In a recent paper, Thomas Philippon from New York University finds the annual cost of financial intermediation in the US, which is roughly 2%, is the same now as it was in the late nineteenth century. This leads him to conclude that the US finance industry has showed no efficiency gains at all over 130 years.
Philippon’s 2% is a neat peg for everyone with concerns about finance to hang their hat on. But Philippon’s study is a macro one and he doesn’t tell us where the deep pools of cost are in the finance industry. For sure, not all of the financial services industry can be characterised in this way. This calls for much more research.
Will fintech solve these problems? Finance has always been an energetic early adopter of information technology. Remember tickertape? No, I don’t either, but it was surely transformative at the time. So the question is whether fintech will reach places that earlier technological innovation didn’t.
Can fintech take us further?
There are reasons to think it will. Fintech automates complex processes, enabling disintermediation. It brings the intensive use of data and analytics giving the customer much better information, visibility, and access to choice. Fintech thrives on relatively low barriers to entry and, mostly, has low capital requirements, suggesting there will be much greater competition in some areas.
Already, in terms of value added, one of the most important fruits of fintech has been the marriage of finance and mobile telephony that is bringing the most fundamental financial services – reliable payments and safekeeping – to the developing world. Payment systems are subject to a lot of fintech activity everywhere. The lower cost technology will win, though the value proposition of the Bitcoins of the world is arguably less compelling than that of the Mpesas.
Peer-to-peer is an exemplar of what fintech does well – beautifully designed software puts savers directly in touch with borrowers, informing the decisions of each in a transparent information environment, disintermediating incumbent banks, and helped, initially at least, by light regulation.
But the evolution of peer-to-peer is informative. Uptake is perhaps slower than expected. Some, like Lending Club, have stumbled. Most significantly (the more agile) incumbent banks are responding by embracing the technology and the start-ups that are driving it. So peer-to-peer may keep its promise to transform SME financing, while leaving the institutional landscape not so changed as we might expect. This, after all, is what has happened in retail. Some retailers have disappeared and are continuing to disappear, but others have adapted and are stronger for it.
Fintech has the ability to drive cost out of the finance industry and efficiency in: but to what extent? Be careful what you wish for – after all, Philippon’s transactions costs are people’s salaries and jobs.