The Future is Fintech

The Future is Fintech

by Dominic Broom, Head of Treasury Services EMEA, BNY Mellon

“Fintech will radically redefine the payments landscape, and has the potential to leave banks behind if they fail to react.”

So concludes BNY Mellon’s pioneering new report, Innovation in Payments: The Future is Fintech, which is launched at Sibos 2015. A confluence of technology innovation, increasing interest and investment in financial technology (‘fintech’), new consumer trends and industry-wide developments has sparked a period of momentous change for the payments business, affecting not only the mechanisms, but even the concept of what constitutes a payment. As new payment capabilities come to the fore, innovative technology is transforming how we initiate and process transactions. This is no longer just a case of new currencies or faster payment methods, but an entire rethinking of transfers of ‘value’ (monetary or otherwise) and how these are undertaken.

The emergence of new players

Over the past few years, we have seen a surge of interest from non-bank players in global transaction banking, particularly payments. The foreign exchange (FX) market is already rife with non-bank participants, particularly at a retail level, with a similar trend in trade finance. Historically, however, payments have been purely the domain of banks, not least due to their complexity, and the need for both a network and clearing system access. This is changing, however, with a host of new entrants vying to win a share of the payments market with attractive, user-friendly solutions. Fintech start-ups, for example, are looking to leverage technology to bring advancements to the payments space.

Meanwhile, established non-payments industry operators, such as Facebook and Apple, are seeking to improve the payments experience of their customer base in order to support their core (non-payments) business. These new competitors are playing a leading role in exploring opportunities that have the potential to transform payments processing in terms of speed, convenience, efficiency and multichannel accessibility.

Constraints and opportunities

An obvious question is why non-bank participants are playing such an important role given banks’ supremacy in this area in the past.

Firstly, it is important to emphasise that banks have been instrumental in driving radical change in the payments space over the past few years, with a marked change in culture from competition to collaboration. For example, in the wholesale and corporate payments sector, industry-wide initiatives such as SEPA and TARGET2 have served to increase payment harmonisation and establish market standards. However, despite such progress, some banks are currently underprepared in embracing and harnessing a new generation of payments technology, creating a greater opportunity for non-banks to enter the market.

A major reason for banks being less equipped with state-of-the-art technology-driven solutions is that they have a range of competing priorities, of which compliance with new regulations that have materialised since the global financial crisis is perhaps the most onerous and complex. Banks consequently operate in a more constrained environment than their non-bank participants, such as the need to perform rigorous know your customer (KYC) approvals and meet anti-money laundering and sanctions screening requirements. With a range of pressures on resources and investment dollars, banks are therefore in less of a position to focus on innovation than aspiring market participants that are not subject to the same constraints. However, high standards of regulation mean that banks are able to provide much greater levels of security and risk mitigation than non-bank players, which is likely to become a more compelling issue in the future as non-bank solutions become more mainstream.

Conversely, fintech companies that are more nimble and less constrained by regulation, are keen to tap into the potential profitability of the payments market. Increasingly, payments are not a physical exchange, such as cash or cheque, but a transfer of value driven by data on the originator, beneficiary and transaction details. The data-led nature of a payment is highly attractive to both fintech companies and larger non-bank operators that are looking to add payments to their wider offering, as this is typically the area in which they excel.[[[PAGE]]]

Moving up the value chain

The nature of payments innovation that is emerging is obviously taking different forms according to the profile of the market participant. The most significant changes so far have been seen in retail payments, to some extent resulting in the ‘unbundling’ of a range of financial services. Transaction speed and convenience is key to the success of these initiatives, just as non-bank providers in the FX market have been able to take advantage of the cost-saving opportunities that can be offered to clients through innovation in transaction speed. For the historically under-served small and medium-sized enterprise (SME) sector, an array of new capabilities is providing businesses with a wider range of options and tools for receiving payments, managing the payments process, and for gaining access to all-important capital.

The corporate market remains the most challenging, due to the complexity, volume and multinational, cross-border requirements of larger businesses. Corporations have greater sensitivity to security issues than some other market participants, and it is more difficult to integrate new payment mechanisms into existing processes and infrastructure. However, as companies become more focused on working capital, and treasurers and CFOs become more accustomed to secure, convenient and rapid payments on a personal level, corporate expectations are changing. This in turn is likely to drive innovation that aims to transform the corporate payments environment beyond the existing focus on retail and SME payments. Indeed, digital currency-based solutions and the potential they hold in terms of settlement mechanisms and exchange of value in particular are likely to represent a disruptive force in the wholesale payments sector as various fintech start-ups launch their offerings in the medium to long term.

Banks are increasingly seeking to partner, invest in and mentor emerging fintech players

The power of partnerships

In recognition of the growing aspirations of fintech companies in corporate payments, banks are increasingly seeking to partner, invest in and mentor emerging fintech players, including through venture capital investment and accelerator/incubator programmes. By doing so, these banks can harness technologies within, rather than outside the banking domain, and therefore protect their role in supporting corporate customers. In addition, they can impart their own knowledge of security, high volume processing, and the specific nature of corporate payment requirements to convert good ideas into viable business solutions.

As heightened demand for enhanced user-friendly payment experiences filters through from the retail space into the wholesale and corporate sector, banks of all sizes and in all regions need to position themselves to tap into exciting fintech developments and leverage the creativity and flexibility of non-bank players. Failure to do so brings the risk of being outmanoeuvred by more nimble competitors, who will be quick to leverage the numerous opportunities that will emerge in a new payments landscape.

Indeed, the buzz around fintech is growing ever stronger, with investment into fintech innovation rising dramatically. In the past 12 months, for example, fintech investment has almost tripled in the US, expanding from US$3.4bn in 2013 to nearly US$10bn in 2014 (source: Accenture [NYSE: ACN] and the Partnership Fund for New York City, June 2015). This is not a straightforward process for banks that are already investing heavily in regulatory compliance, but those that can reverse their reputation from being somewhat slow to adapt, and implement swifter responses and decision-making practices, are likely to be those that survive and thrive in a new digital age.