Fintech comes of age: invest in the future of finance
The financial technology sector covers areas ranging from digital payments in emerging markets to bolstering high-street banks’ crumbling IT infrastructure. Years of strong growth lie ahead, says Stephen Connolly
“Fintech”, short for financial technology, is often dismissed as yet another buzzword – a way for companies to market themselves and raise money. But there is a great deal more to it than that. Think of it as a sector bringing together money and new technologies to improve financial services. It is closely linked to major technological advances in several other areas.
One is artificial intelligence, which can help financial services companies make decisions about loans, for instance, or help customers by installing robo-advisers to answer questions. Blockchain, the electronic ledger that underpins bitcoin, can help manage transactions more efficiently; data storage and processing advances help companies achieve more scale for less cost; and internet connectivity, through cloud computing, means they can embed their services in everyone’s daily lives across all their devices.
The stockmarket sees the potential
Equity investors certainly see plenty of potential in the sector. It has generated near-10% returns this year while some markets, such as the S&P 500 in the US, are just breaking even. This is due to both the compelling long-term outlook and short-term factors. In lockdown, people were forced to change their habits and turn to online shopping, payments and e-commerce to get by. Many won’t go back. All these areas of fintech were already growing; what the virus has done is accelerate the take-up. Throw in the structural tailwinds from various technologies and no wonder more and more investors think the fintech sector is a smart place to be.
Fintech was profitable before Covid-19 too. Investors have been getting a stellar 23% annual return, if averaged out over the last three years – and that’s just by investing in a benchmark and not being clever at choosing individual stocks. And most studies expect the sector to expand by more than 20% a year to 2025 and beyond.
Upstarts take on the old guard
A look at recent developments illustrates the potential. One source of growth is that big, established financial services groups need the expertise of fintech businesses to help them change and adopt new technology. At the same time, however, the internet allows fintech firms that can raise funds to enter the market themselves and disrupt the old guard.
An online presence means reaching a market without investment in bricks and mortar. And platforms can be built using other providers who can offer the transaction management, the data processing and the joined-up infrastructure. It is becoming increasingly straightforward for new players to enter the sector. A good example of an early disruptor is mobile-payments company PayPal, while online, “virtual” bank Monzo offers accounts in the UK without a single branch.
Fintech can be hyped as a “David versus Goliath” battle between small, plucky upstarts armed with attractive deals and services fighting to free us from the tyranny of evil bricks and mortar banks. This narrative has been tarnished this year, most notably with the financial scandal unfolding at German payments company Wirecard. While it would seem its demise is a case of fraud rather than faulty technology or a flawed business model, it’s a warning to investors and regulators. Visionary entrepreneurs, start-ups and disruptors are all well and good, but the desire to encourage them should not come at the expense of supervising them effectively.
Challenger bank Revolut, meanwhile, has lost several top-level employees this year and has been accused of having a dysfunctional work culture. Monzo, on the other hand, has been scoring highly in the customer-complaints league. The US online stockbroking platform Robinhood has had technological breakdowns locking people out of trading just as prices move against them.
Where it all began
It’s all a far cry from the fintech of old. In June 1967 nobody waiting in the crowd outside the Barclays Bank on north London’s Enfield High Street could have imagined they were about to witness a major milestone in the long history of financial technology. For them, the attraction was an appearance by Reg Varney. He is still just about remembered today as the star of ITV’s sitcom On the Buses. He was there to launch what was the world’s very first automated cash machine. And now, more than 50 years later, there are 3.25 million more cash machines globally.
The first cash machine built on previous advances. In 1866 the first reliable transatlantic cable was used to send foreign-exchange price data (hence the term “cable” to denote the exchange-rate between the pound and the dollar). The US Federal Reserve’s Fedwire system launched in 1918 and used the telegraph and Morse code to transfer money. Credit and charge cards were appearing in the US in the 1950s, while Barclays launched Britain’s first plastic card – the still surviving Barclaycard – in the 1960s.
It’s not just retail banking. Finance everywhere was sped up by the major breakthrough of the handheld calculator in the late 1960s (previously they were big and generally built into desks). Electronic share trading arrived in the 1970s with the world’s first digital stock exchange, America’s Nasdaq. The Swift system, a name that will be familiar to anyone who makes international payments, came soon after. This international code remains a very common way in which banks talk to each other as they move funds around the world. The 1990s saw online banking, and hence e-commerce, take off.
Towards a cashless society
Despite fintech’s rich past, the sector today is often associated most closely with innovations in how people pay for goods, especially online, and pay each other outside the traditional banking and financial system. Digital payment is a major theme globally and a significant driver of fintech. The world is shifting away from cash. Covid-19 has accelerated the trend. Suggesting people avoid cash to limit potential transmission of the virus has been a boon for traditional banks and credit-card companies, as well as other payment-system providers. According to the British Retail Consortium, even before the pandemic cash payments were in third place behind debit and credit cards. Retailers handed over £1.3bn in fees to payment companies in 2018. No wonder, then, that the share prices of PayPal and Square are up by 65% and 100% respectively this year.
Sweden, with a young, tech-savvy population, provides a glimpse into the cashless future. Cash usage has declined rapidly as people embrace paying electronically. At least 4,000 Swedes have even had microchips inserted under their skin allowing them to make payments with the wave of a hand. Italy, on the other hand, where cash payments are still relatively high at 86%, is actively promoting the use of cards in a bid to reduce tax evasion totalling an estimated €100bn a year by offering tax cuts for users of plastic.
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Stephen Connolly writes on finance and business, and has worked in investment banking and asset management for over 25 years (firstname.lastname@example.org)