Innovation | 06.07.18
Banks Embrace Financial Technology as More Evolutionary Than Revolutionary
The rise of digital commerce is not right around the corner — it’s here. The world economy is being transformed by financial technology (fintech), a large category which includes blockchain — a new technology with potential massive implications for currency and banking — and artificial intelligence. All business sectors face potential disruption but at the same time boundless opportunity. Banks are just one part of the financial industry poised for a rapid technology transformation.
For now, large banks are trying to keep abreast of what might happen, eyeing the fintech space with an open, experimental mind, letting an array of smaller steps — as opposed to bold leaps — guide the way. However, the pace of change is sure to accelerate as the banking sector comes under assault from nontraditional competitors wielding fintech innovation and abetted by venture capital backers.
Just one blockchain startup recently raised over $4 billion.
A buzzed-about incremental step toward the future came recently when a British startup, Revolut, an “app-only” personal finance platform, revealed plans to apply for a banking license in the United States. It intends to launch services such as automated investment advice (commonly known as “robo-advice”), commission-free stock trading and even small business loans, but to do so, Revolut will be looking at potential partners, according to Reuters. Meanwhile, Twitter’s payment company, Square Inc., is also seeking a banking license. So is Varo Money, which calls itself a digital bank catering to a new generation of consumers who have proven to be early adopters of mobile payments. A study, cited by PwC, revealed roughly half of millennials have said they prefer to pay for items, reimburse peers and track spending via their phones. “By 2020 consumers will need banking services, but they may not turn to a bank to get them,” PwC said.
“There’s serious pressure on financial institutions to incorporate fintech into their platforms,” said securities attorney Ben Marzouk of the law firm Eversheds Sutherland. “Robo advisers and online investing platforms are actively being acquired by large banking institutions whose thinking seems to be, 'If you can’t beat them, buy them.'”
Dance Cards Filling
A look at the top 10 banks shows robust investment activity over the past few years, as they snap up fintech companies doing basic things most commonly associated with banking, such as lending. Global pacesetter Goldman Sachs put stakes in more than two dozen such companies, including Marcus (personal loans), Neyber (employer-to-employee loans) and Financelt (point-of-sale loans).
A number of banks have invested alongside one another in the same companies, such as R3, designed to be a consortium, a safe space for banks to experiment as a community of cohorts with blockchain to see how far its applications can go.
After two-plus years’ worth of research, R3 — which is backed by $120 million raised from most of the large banks — headed straight to the one area considered an absolute no-brainer for blockchain-enabled transactions: the realm of trade finance. The sector is essentially a short-term loan from one party to another, guaranteeing that a large shipment of commodities (soybeans, for example) will find a home should the buyer become financially disabled during the period it takes for the shipment to arrive. That way, the seller and the freight carrier don’t get stuck with a cargo hold filled with undeliverable soybeans. The guarantor who underwrites the financing knows that if the deal goes south, there is at least a physical commodity to be claimed. Banks take in billions of trade finance revenue each year, and the space is notoriously archaic with paper documentation (letters of intent) at its heart.
HSBC recently used R3’s blockchain platform, Corda, to carry out a trade finance transaction. The blockchain, or shared ledger, trade was done for Cargill, and it involved a shipment of soybeans grown in Argentina and sent to Malaysia. Investors stepped in to provide parties a backstop, earning some short-term yield, and the multiparty trade was executed by a major bank using fintech. For R3 and Coda, it was an important proof of concept as they hope the platform can be used not only for trade finance but also for a host of other transactions. A new venture capital fund, Adroc, is now investing in initiatives to accelerate the pipeline of new Corda applications. However, those who follow fintech closely say we’re still in the early days.
"Trade finance was just about the lowest hanging fruit out there — it’s still entirely paper based,” said Josh Steiner, a managing director at Hedgeye Risk Management. “It was ripe for disruption.” Steiner cautions that it is too soon to talk about traditional banks being supplanted as fintech takes hold. “In such a heavily regulated industry as banking, it’ll be very difficult to supplant the ultimate deposit holder.”
Steiner explained that truly smart banks will be those that make strategic partnerships with a wide array of fintech companies hailing from different areas. And as for all the hype surrounding Bitcoin and Initial Coin Offerings (ICOs) — cryptocurrency is largely underpinned by blockchain technology — it’s interesting to note that there was only one new external blockchain investment made by a big bank in 2017. Citi invested $2 million into Axoni, which had technology aimed at the credit-default swap market.
Perhaps a more relevant and timely investment can be found with Goldman, Wells Fargo and some others putting money into Visible Alpha, which uses data science to improve equity research offerings. It’s fintech. It’s conceivably a game changer, but, notably, it’s not blockchain or crypto.
R3, which is blockchain, does count a number of the largest banks as backers, but it is telling to note that Goldman, JP Morgan and Morgan Stanley all subsequently dropped out of the consortium last year, according to CB Insights.
Rich Blake A veteran journalist based in New York City, Blake has covered the financial world for numerous publications, including Institutional Investor, ABCNews.com and Reuters. Blake was a co-founder and executive editor of Trader Monthly magazine. The Buffalo native is the author of three nonfiction books, including “The Day Donny Herbert Woke Up,” which is currently being adapted into a motion picture. In 2004, Blake was nominated for a National Magazine Award in the Reporting category for Institutional Investor.