Information technology made significant strides in the first decade of the twenty-first century, most notably with the rise of the internet. Even you can see how most global industries are modernizing through the use of technology, and the financial sector is no exception to that trend. As the economy developed and social networks began to become popular, information technology applications such as a new wind were expected to change the outdated and slow operation of traditional financial services. Since then, the concept of Fintech was born to become a challenge to traditional financial institutions. However, you may not completely grasp what Fintech is or why it can pose a threat to the long-established banking system, therefore this article attempts to answer these issues.
| KEY TAKEAWAYS
_ Fintech is an acronym for Financial Technology, it was defined as the application of information technology to financial services. _ There are three main types of Fintech services: lending, deposit, and capital-raising; payment; investment management. _ Fintech businesses are completely qualified and capable of competing with conventional financial institutions. |
What is Fintech?
Surely, you can easily recognize that Fintech is an acronym for Financial Technology, it is a combination of two fields of finance and technology. Even still, many people mistakenly believed that Fintech was merely the application of modern technology to financial operations, but the issue was more complex than that. A brief historical overview is necessary for a clearer understanding of the distinction between Fintech and the usual use of technology to the financial industry.
In the 1980s, when the first online banks were established, information technology was initially applied to banking. Banks only utilized IT at that time as a risk management tool to assess financial goods using mathematical models[1]. After that, people overused these techniques themselves and had complete faith in the outcomes they produced. And according to Barberis and others, this was the crisis’s initial cause, as the incorrect belief that information technology could completely eliminate the dangers to the banking sector that led to the 2007–2008 crisis[2]. As a result, it is clear that there has been a long history of co-development between information technology and finance. However, the term “Fintech” gained popularity only after the 2007-2008 crisis. After the crisis, the flaws in the conventional banking system were revealed, and authorities swiftly produced several regulations and legal frameworks to tighten banking operations and provide the bare minimum of safety for the economy. This has turned into a significant benefit for the growth of non-traditional financial institutions, which, along with the rapid advancement of technology, has encouraged the creation of new participants in the finance industry[3]. This new player is “Fintech”.
One of the original definitions offered by Arner et al. (2016) emphasized that Fintech was defined as the application of information technology to the financial services, it was a group of organizations that used technology to provide financial intermediary services that were previously only offered by traditional financial institutions. Fintech takes advantage of technological developments to create new products, business models or applications related to the provision of financial services[4].
Nonetheless, despite having entirely separate concepts—Fintech and TechFin—the two terms are frequently confused. Because they are both made up of the two words technology and finance, TechFin and Fintech are sometimes mistaken with one another. But in essence, TechFin are basically technology firms that focus on creating software or apps for use in the financial sector. These companies, unlike FinTech, can serve as suppliers or partners to develop and provide technology products for traditional financial intermediaries instead of being in direct competition with them[5]. Whereas Fintech are companies in the financial industry, they see technological software as merely a tool to help them deliver exclusive financial services.
Types of Fintech Services
Fintech companies operate very widely with many different types of financial products, within the framework of this article, we can divide them into three main types of services:
_ Lending, deposit, and capital-raising services
_ Payment services
_ Investment management services
Lending, Deposit and Capital-raising Services: Prominent products in this form of service are digital microcredit, peer-to-peer lending and crowdfunding.
Digital microcredit is a well-liked type of lending in developing nations; these loans sometimes have brief periods, tiny loan values, and particularly excessive fees and interest rates. Loan durations might be from one week to several months, and the maximum borrowing amount is around a few hundred dollars[6]. However, interest rates for digital microcredit are quite high; according to one study, they can range from 24 to 174 percent, with 12 to 621 percent notably being the average in Kenya[7]. Fixed costs are also included in the interest rate, and this is usually a fixed rate of interest calculated on a daily, weekly or monthly basis. Most digital microcredit products are connected via mainstream mobile phones, using SMS, SIM cards or Unstructured Supplementary Service Data (USSD), and it is now available on smart phones or phone apps. Digital microcredit developers apply automated credit scoring with alternative data to quickly process loans (it can happen instantly or take a few hours)[8]. Alternative data sources could include social media activity, mobile money transactions, or mobile phone activity. Algorithms would then assess this data to decide whether to approve a loan proposal.
Peer-to-peer (P2P) lending is one of the most well-known and earliest business models in the Fintech industry. The P2P Lending model creates an online marketplace that can link lenders and borrowers directly without going through any banks or credit institutions, and this online marketplace is the Internet platform developed by Fintech companies. Credit granting activities of P2P Lending are different from traditional banks because of the source of credit financing. While traditional banks raise deposits from the public and lend them out, loans from P2P Lending platforms come directly from investors. Borrowers and lenders will connect with each other through the means of communication on the web. Investments, credit ratings, loan requests and contact information are all handled on the web[9].
Crowdfunding is also one of the most popular and attractive models in Fintech services. Crowdfunding is swiftly developing into an alternative financing option to help small firms or organizations in the age of technology overcome financial challenges. Fintech firms offer a direct connection platform for investors and enterprises or organizations seeking funding. There are several varieties of crowdfunding, and they are classified based on the type of return each type provides to investors: donation-based crowdfunding, reward-based crowdfunding, equity-based (investment) crowdfunding, loan-based crowdfunding (P2P Lending).
Payment Services: This is the first service that kicks off the technological revolution in the financial industry, the number of Fintech companies competing in this sector is now the highest among Fintech services. Payment services primarily offer two product lines: e-wallets and Mobile-Money.
In terms of e-wallets, there is not much to say; the basis of an e-wallet is an enhanced version of a standard payment card. E-wallets are linked to your bank account to be able to pay for online transactions.
Mobile-Money is not as popular as e-wallets, but it has the potential to become a rival and grow in the near future. Europe has made significant advancements in mobile money, but developed nations largely disregard and pay it little attention. However, it has also expanded significantly and become quite well-liked in developing nations where banking services are not yet completely accessible. With the help of Mobile Money, users can make payments when purchasing and selling goods and services online without requiring cash or a bank account. Mobile Money is an intermediate service that offers online payment solutions through mobile devices[10]. Mobile Money service providers (often telecommunications companies) set up an electronic account for consumers (registered based on their mobile subscriptions), and the customer deposits money into that account in order to be able to perform payment transactions[11].
Investment Management Services: Technological improvement has also changed investment products and services. This is a new service that appeared recently and has not been really popular yet, the potential of this service is also great. Because of its significant danger, its advantages are still debatable in modern times. Robo Advisor is the most prominent platform among investment management services. Digital platforms called Robo Advisors to offer automated financial planning services based on algorithms with little to no human oversight[12]. We may now answer questions online and have Robo Advisor define investing goals rather than having to physically visit financial counseling firms for face-to-face consultations.
New Challenge to Traditional Financial Institutions
Fintech businesses, as was said in the article above, are completely qualified and capable of competing with conventional financial institutions. Credit, payments, and investment management were formerly the sole domain of banks, but fintech companies have since created competitive financial product lines in all three areas. With the continuous development of technological innovation, the battle between Fintech businesses and traditional banks will intensify. Traditional financial institutions’ organizational structures still place a significant emphasis on manual processes by maintaining a high level of intimate customer contact. This approach takes too long to handle client requests, necessitates a huge workforce to do several tasks, and ultimately drives up both the bank’s costs and its customers’ interest rates. And now, this strategy is being battled against the low-cost products created by Fintech companies using algorithms and big data.
Lending, Deposit, and Capital-raising Services
One of the key benefits of financial technology is that it provides greater financial inclusion. Financial inclusion is the process of ensuring that all people, organizations, and businesses have access to the financial sector and removing obstacles that stop people from using financial services to better their lives[13]. Although most fintech products can expand financial inclusion, three services—crowdfunding, peer-to-peer lending, and payment services—have the biggest effects on this development. It is a truth that a significant percentage of the population lacks access to financial resources. With the purpose of maximizing profits, financial institutions only focus in places with a high population density, ignoring rural areas, in many developing or even developed countries. In addition, many individuals cannot meet the conditions to be able to get a bank loan, or if they are reluctant to meet those conditions, they also have to bear high-interest rates.
As previously mentioned, crowdfunding will make it possible for small firms to access new sources of funding from a wide range of potential investors via Fintech platforms. Firstly, due to their reputation, small size, insufficient records, and lack of mortgages, small firms have an extremely difficult time accessing finance sources. Banks and angel investors lack the confidence necessary to support these companies. Crowdfunding can be used by firms of any industry, with weak growth potential, unclear profit direction, small size and age, and even inadequate assets to find an investment source[14]. Secondly, because of the Internet, investors from all over the world can donate money to projects that are offered on crowdfunding platforms, saving businesses the time and expense of tracking down each investor. Even that, everyone using the crowdfunding platform simply needs to spend 10 dollars to become an investor; there is no cap on the amount you want to contribute[15]. Thirdly, one of the advantages of crowdfunding is that it may be used as a marketing strategy by companies with a tight budget. If many people are interested in investing money in a business idea, they can help raise interest in the company’s product or service throughout the online community[16]. One of the best examples of crowdfunding is Dota2’s The International tournament. The International is held once a year. Every time a tournament is coming up, Valve (Dota2’s Producer) uses crowdfunding on their own game platform to call for donations from players around the world. Those donations are converted into prizes for the top teams at The International. From 2013 to 2021, the prize pool increased from $2 million to $40 million, making The International one of the biggest esports events in the world along with the League of Legends World Championship.
P2P lending is seen as a successful method of cash support and investment for both individuals and organizations, much like crowdfunding is for small and medium-sized businesses. P2P Lending is essentially a form of crowdfunding, but it also has its own advantages. First, P2P Lending can reduce the time-consuming and costly lending processes. In the conventional banking system, it typically takes a week or a month for the parties to get all the necessary loan documentation. Even if the borrower is far away from the bank, they still have to spend a lot of effort to move. However, P2P Lending can assist borrowers acquire loans on the same day without having to visit a bank thanks to technology; all they have to do is submit a request to the platform and wait for approval[17]. Second, one of the advances that P2P Lending and Fintech combined bring is big data, which can foretell client behavior and be used to develop strategies and risk-management techniques[18]. Banks frequently monitor clients continuously or ask them for a mortgage in order to make sure that customers pay their bills on time. P2P lending businesses now employ big data to track consumer behavior or pair high-risk clients with risk-averse investors. Since then, digital finance companies can reduce time and costs for customers, enhance risk management capabilities. Ultimately, P2P Lending is a solution to reduce injustice for both borrowers and lenders. Why the article makes such a statement, see the following explanations. At first glance, it seems that if the investor receives a high interest rate, it means that the loan interest rate is also high for the borrower. However, if assessed in general, P2P Lending helps borrowers and lenders transact directly with each other through the web platform, and it has eliminated a very high cost, which is the intermediary cost or bank operating costs. Banking costs include costs of premises, salaries for staff, costs of internal electronic systems. If the above costs are included in the borrower’s interest rate, they may incur an interest rate of 15%, whereas they will only receive an interest rate on their deposit of 1% at the same bank. It is an injustice[19].
Payment Services
In the section on payment services, the article will focus on analyzing the advantages of Mobile Money, simply because today’s e-wallets are still very dependent on banking services. In locations where people lack the prerequisites to open a bank account, mobile money services are a practical way to allow consumers access both non-cash payment methods and modern financial services. First of all, Mobile Money can serve all customers, including those in borders, remote locations, and islands; these areas still face many challenges because of unfavorable geographic locations that prevent banking services from reaching; these include areas with underdeveloped socioeconomic conditions, as well as traffic conditions[20]. In less developed areas, basic infrastructure such as electricity, roads and telephone lines are severely lacking, and banks do not provide their services to the majority of people in such areas. The primary cause of the above is the high startup costs associated with opening a branch or ATM for banks in places with poor infrastructure, as opposed to Mobile Money, which does not require a physical location for deposits and withdrawals. Second, Mobile Money is a straightforward, practical, and easy-to-use financial service. It is therefore perfectly appropriate for the environment of many countries today, where the degree of intellectual development is not very high and the banking system is not sufficiently large. In the meantime, most of the country is covered by the mobile network, and the number of subscribers keeps growing. The Mobile Money service is now accessible to everyone with a phone and an active mobile subscription[21].
Nguyen Tran Viet. All rights reserved
[1] Douglas Arner and others, “The Evolution of Fintech: A New Post-Crisis Paradigm?” [2016] SSRN Electronic Journal
[2] Douglas Arner and others, “FinTech, RegTech, and the Reconceptualization of Financial Regulation” [2017] Northwestern Journal of International Law and Business
[3] Mohammed Khair Alshaleel, “Regulating Financial Technology – Opppurtunities and Risks” (dissertation2019)
[4] Financial Stability Board, “Financial Stability Implications from FinTech, Supervisory and Regulatory Issues That Merit Authorities”
[5] Cristiana Schena and others, “The Development of Fintech. Opportunities and Risks for the Financial Industry in the Digital Age – with Preface to the Fintech Series” [2018] SSRN Electronic Journal
[6] “Consumer Risks in Fintech: New Manifestations of Consumer Risks and Emerging Regulatory Approaches” [2021] World Bank Group
[7] Michelle Kaffenberger and Patrick Chege, “Digital Credit in Kenya: Time for Celebration or Concern” <https://www.cgap.org/blog/digital-credit-in-kenya-time-for-celebration-or-concern>
[8] “Consumer Risks in Fintech: New Manifestations of Consumer Risks and Emerging Regulatory Approaches” [2021] World Bank Group
[9] Clara Naidji, “Regulation Of European Peer-To-Peer Lending Fintechs Regulatory Framework To Improve SME’s Access To Capital ”(thesis2017)
[10] Decision No. 316/QĐ-TTg [2021]
[11] Trung Duong Nguyen, “Completing the Law on Mobile Money Service” [2022] JOURNAL OF LEGISLATIVE STUDIES
[12] Paolo Sironi, “FinTech Innovation: from Robo-Advisors to Goal Based Investing and Gamification” [2016] Wiley Finance Series
[13] Marek Hudon, Marc Labie and Ariane Szafarz, “A Research Agenda for Financial Inclusion and Microfinance” [2020] Edward Elgar Publishing
[14] Yannis Pierrakis and Liam Collins, “The Venture Crowd: Crowdfunding Equity Investment into Business”
[15] Paul Belleflamme, Thomas Lambert and Armin Schwienbacher, “Crowdfunding: Tapping the Right Crowd” [2012] SSRN Electronic Journal
[16] Ibid
[17] Clara Naidji, “Regulation Of European Peer-To-Peer Lending Fintechs Regulatory Framework To Improve SME’s Access To Capital ”(thesis2017)
[18] Cristiana Schena and others, “The Development of Fintech. Opportunities and Risks for the Financial Industry in the Digital Age – with Preface to the Fintech Series” [2018] SSRN Electronic Journal
[19] Rashed Jahangir, “Peer To Peer (P2P) Lending” (Istanbul Sabahattin Zaim University 2019)
[20] Trung Duong Nguyen, “Completing the Law on Mobile Money Service” [2022] JOURNAL OF LEGISLATIVE STUDIES
[21] María Paula Subia and Nicole Martinez, “Mobile Money Services: ‘A Bank in Your Pocket’ Overview and Opportunities” [2014] ACP Observatory on Migration
