What’s Driving FinTech’s Growth?
FinTech is emerging as a powerful theme in 2018, driven by the rapid adoption of cutting edge technologies across the financial services industry, such as digital payments and money transfers, financial software and automation, and alternative lending and funding platforms. In this piece, we look at the major trends that are propelling FinTech’s growth, including:
- The digitalization of financial services
- The rising number of payment options at retailers
- Tapping into the emerging markets’ middle class
- The expansion of FinTech beyond traditional financial services
Digitalization of Financial Services
Digitalization has changed how financial services firms interact with their customers and conduct their back-end operations. Historically, customers consolidated much of their financial needs at a single financial firm’s local branch where they worked with the bank’s staff to conduct deposits, loans, mortgages, and investments. With digitalization, customers now frequently access automated versions of these services online, allowing for more convenient and seamless experiences. According to a survey by PWC, 49% of consumers now conduct their banking primarily on their desktop or smartphone.1 At the same time, the number of bank branches in the US has already shrunk by about 8% from their peak, and some analysts expect the number to fall by another 20% through 2027.2
Digitalization presents two key challenges for traditional financial firms that are significant opportunities for FinTech. First, developing intuitive websites and apps in addition to automating many services and back-end operations requires banks to spend billions of dollars each year on technology. IDC anticipates global financial services IT spend will be $440 billion this year, rising to nearly $500 billion by 2021.3 While a portion of this spending is directed internally by hiring IT employees and developing proprietary software platforms, a significant portion is expected to be spent externally with enterprise software providers in the FinTech space. These firms build specialized software for market data and analytics, trading and portfolio management, mortgage and loan processing, risk analytics, and regulatory software, among other areas. For many financial services firms, engaging with these enterprise software providers is now a basic requirement to survive in the digital age.
The second challenge is that digitalization substantially increases competition within the industry. Consumers are no longer limited to the handful of firms with local branches, but instead can shop for the best pricing or services among dozens, if not hundreds of companies online. While this opens the door for more traditional firms to compete against each other, it also allows entirely new firms with unique business models to enter the space, such as digital-only banks and insurance companies, as well as peer-to-peer lending and crowdfunding platforms. While these FinTech firms often lack the scale of more traditional firms, they seek to leverage their nimble structure and expertise in technology to actively disrupt the status quo. Many consumers are incorporating these FinTech services into their financial lives, with EY estimating that 33% of the global digitally active population has already adopted FinTech.4
Rising Number of Payment Options
These days even the corner coffee shop needs to offer in-store as well as desktop and mobile ordering options to customers, while accepting physical payment in cash, credit, debit, gift cards, as well as digital payments from mobile wallets on phones and wearables, money transfers from apps, and sometimes even in a variety of cryptocurrencies. Take, for example, the payment methods accepted at Starbucks, according to their website: Gift cards, Starbucks Mobile App, Chase Pay, Apple Pay, PayPal, Visa Checkout, Credit Cards, Cash (listed in that order!).5 All of these forms of payment need to occur instantaneously, while ensuring security, reliability, and integration across the business’s other accounting, inventory, and order fulfillment systems. For many firms, offering such a complex web of payments options requires working with third-party FinTech firms that offer point-of sale hardware, cloud-based software solutions, and payments infrastructure to facilitate these transactions. The end result is that payments firms are entrenched as an essential component of retail business operations around the world.
Tapping into the Emerging Markets’ Middle Class
FinTech firms with digital-only strategies enjoy highly scalable platforms because the majority of their costs are in the initial software development and infrastructure buildout. Each additional customer on the platform contributes little incremental cost and likely comes with positive effects such as diversifying the customer base, revenues, and sources of risk. Take for example, tax preparation software. The cost of adding a new client is essentially zero since the software is already built no matter how many clients there are. Perhaps there is a nominal cost to hosting additional servers and storage, but in the digital age these costs are de minimis. Compare this to a traditional tax prep firm where enough additional customers requires setting up a new, fully staffed branch of tax advisors and bringing on additional back-office help to set up accounts.
What does this have to do with the emerging markets’ middle class? Previously, many financial services firms, from banks, to investment houses, or even tax preparers, had no desire to spend the money required to extend their services to this group. The expected revenue simply could not cover the incremental costs. FinTech firms, however, are uniquely positioned to serve them. Given their highly scalable platforms, adding a middle class banking customer with a few thousand dollars in savings or who requests a loan for a few hundred dollars may still be profitable. Factoring in the size and growth of the emerging markets middle class, tapping into this group could meaningfully accelerate FinTech’s growth. In China and India, the number of middle class consumers is growing at 6% per year, compared to just 0.5% growth in developed markets. Globally, the middle class is adding approximately 160 million people each year.6 In all, Accenture believes there is $380 billion in potential revenue from extending financial services to the unbanked.7 In our opinion, FinTech firms are the best-positioned to capitalize on this opportunity.
Expansion Beyond Traditional Financial Services
Many FinTech firms are exploring new technologies and services to complement their core offerings. One area receiving considerable attention is blockchain and crypto-assets. Currently, companies representing one-quarter of the Global X FinTech ETF (FINX) are actively involved in some way on blockchain or crypto-assets.8 Many of these firms view blockchain/crypto as a disruptive, high growth potential technology and are leveraging their expertise in programming, payments, or market structure to help advance this field. Some FinTech firms are also entering into areas more tangential to their core business, such as payments firms offering marketing, operations, and human resources software. Given their large customer base, expertise in software development, and understanding of small business needs, these firms believe they are well-positioned to offer a broader range of products to help manage a business.
While the FinTech industry consists of a diverse set of firms, business models, and areas of focus, we believe it is well-positioned to experience outsized long term growth. The financial services industry is in a state of transition as it moves towards a more digital and scalable structure. This is ultimately creating significant opportunities for firms at the intersection of finance and technology, whether they are looking to compete with traditional financial firms or help empower them in the digital age.
FINX: The Global X FinTech ETF seeks to invest in companies on the leading edge of the emerging financial technology sector, which encompasses a range of innovations helping to transform established industries like insurance, investing, fundraising, and third-party lending through unique mobile and digital solutions.