Financial intermediation as we know it is morphing at an accelerating pace, fueled by innovative modern technology.
Whatever our definition – or understanding – of fintech, it now seems obvious that the future of financial services is being increasingly forged at this intersection of financial intermediation and digital technology. Most people would likely agree that this is now the cutting edge of finance, an area that is generating more excitement than any of the more established segments of financial services.
Not only is fintech attracting some of the brightest minds in the industry, but it also holds rapidly growing appeal for investors in search of the innovative ideas of tomorrow. But fintech also holds considerable promise for dramatically improving the efficiency and customer focus of financial services delivery.
It could well become the friendly – or friendlier – face of finance after a decade that did a great deal to ruin the reputation of banking and bankers that earned – rightly or wrongly – the stigma of being the main authors of the global financial crisis.
The rise of fintech is due to a combination of factors. But chief among these are the broad-based digitisation of modern economies and the structural challenges faced by financial services since the onset of the global financial crisis.
Digital technology has clearly emerged as a key element of the infrastructural of our early 21st-century economy. It is transforming processes of production and value chains across the full spectrum of economic activities.
Financial services is no exception. The trends that arguable started with the rise of ATMs and internet banking is now permeating virtually all aspects of financial service provision. Key elements of the 20th-century banking paradigm are rapidly retreating from view as evident, for instance, from the rapid decline in the number of conventional bank branches.
These trends are receiving further fuel from the digitisation of modern consumer culture. Especially among younger consumers, mobile devices are now the preferred communication platform and thus the most effective way of reaching and engaging them. Hence, digital communication and service delivery is no longer even optional but an absolute necessity is banks wish to remain competitive in the new market environment.
But by connecting with consumers in novel ways, fintech can also potentially reinvent the service experience and relationship in ways that at this point may be difficult to fathom. For instance, experiences and services may with time be bundled in ways that blur conventional sectoral demarcation lines.
But the rise of fintech is no less important due to structural factors reshaping the financial services sector. The growing burden of regulatory requirements over the past decade has led to a dramatic erosion of margins, indeed to a point where the rate of return achieved by financial institutions frequently falls short of the cost of capital.
Digital technology allows many of these compliance requirements to be met more cost-effectively. But it also enables banks to combat the margin erosion in other ways, for instance by delivering their services in less labor-intensive ways. This is gradually beginning to reshape the business models of banks and there is a growing consensus that the future of the sector will be characterised by value chain fragmentation.
At the same time, some scalable support services look likely to be delivered by utility-type companies that can cater to the needs of multiple institutions. Elements of the old universal banking paradigm are now likely in reverse, although it is probably too early to tell how far this process will go. Efforts by the Trump administration and others to loosen the regulatory burden may somewhat ease the margin pressure in certain areas but is unlikely to reverse these trends.
Until recently, the GCC region was a fairly peripheral presence on the global fintech landscape. This is now changing at a transformative pace.
In contrast to their counterparts in the West, financial institutions in the GCC were until recently able to achieve robust grow thanks to fairly “conventional” drivers. The region has benefited from internationally rapid population growth. At the same time, the economic diversification agenda, along with a massive infrastructure pipeline, has delivered rapid growth in the regional banking market. Until the oil price correction of late 2014, even the regional liquidity environment was internationally enviable. All of these factors meant less intense pressure of margins and established business models than was the case in many western markets.
More recently, however, the Gulf region has achieved dramatic progress in making up for lost time. A number of initiatives – some of them government-led, other purely private – have been launched to enable and encourage fintech investment.
Among other things, financial regulators in Bahrain and the UAE have set up regulatory sandboxes to give fintech entrepreneurs a low-cost and low-risk way of developing and trialing their ideas. Fintech-related events have become commonplace. In recognition of the value of creating communities of entrepreneurs, the region has seen investments in fintech incubators and comparable facilities, led by Bahrain’s FinTech Bay which was launched in February.
The work is typically benefiting from more general efforts to foster digitisation, ICT, and innovative start-up entrepreneurship. This has engendered a growing universe of bespoke physical spaces and funding vehicles targeting new technologies.
The potential of a sweeping fintech wave is immense. The regional financial institutions can naturally all derive benefit from more efficient technology. However, fintech can also be a powerful driver of financial inclusion by helping create new funding mechanisms, such as crowd sourcing. This should be of particular value in bridging the funding gap faced by SMEs, especially innovative start-ups.
Fintech can also support the underbanked and unbanked by offering more cost-efficient payment systems and helping better manage costly process such as KYC (know your customer) requirements. While these needs are of importance in the purely domestic context, they also hold particular appear for regional financial institutions operating in other parts of the Middle East or Asia, including jurisdictions where large parts of the population are outside of the remit of formal financial intermediation.
Fintech can potentially provide particular exciting applications for Islamic financial institutions seeking to grow and achieve a greater impact while remaining true to their principles of social responsibility and genuine risk-sharing. In essence, fintech might enable Islamic financial institutions to become “more Islamic” than has been possible to date.
Fintech is an inherently global industry, attracting talent and capital from all corners of the world and devising service solutions that – subject in some cases to regulatory constraints – can be delivered across borders. By positioning itself right in terms of investor-friendly regulation and openness to talent, the GCC region can turn the fintech boom into an important driver of its broader financial sector growth and rejuvenation. It can become an important tool for leveraging the region’s human capital, locational, and connective advantage, thereby putting an erstwhile laggard on the forefront of fintech innovation globally.
About the author
Jarmo Kotilaine is chief economist at the Bahrain Economic Development Board