The convergence of finance and technology potentially represents a major disruptive force that will necessitate a response from banks and other financial services providers.
The face of finance is changing rapidly. Once dominated by traditional retail and commercial banks, the industry has expanded significantly to now include a host of FinTech providers.
FinTech is a term coined to describe a rapidly growing industry segment that is aiming to deliver financial services more broadly, efficiently, and innovatively using powerful online technologies, enabled by “Big Data” and cloud computing.
Initially arriving on the scene in the form of online-based payment services, FinTech enterprises are now offering access to credit, insurance, and investments.
Today, FinTech potentially represents a major disruptive force that will necessitate a response from banks and other financial services providers, as well as from regulators.
But it also represents a growing investment opportunity.
Dramatic growth of e-commerce has brought with it the need for easy-to-use, online, secure payment services. Couple that with huge, underserved populations around the world with little-to-no access to banking services or credit and you have the perfect storm.
FinTech has also been driven by the massive amounts of data available from e-commerce transactions, social media, and internet searches. This data allows FinTech companies to determine what financial services to offer to which person, as well as how to price that product. Data has become more important than collateral for these providers.
Lastly, a lag in regulations for these new entrants is allowing FinTech businesses to innovate aggressively, and perhaps take risks that their customers are not fully aware of, while restraining incumbent financial services companies, which are regulated, from competing head-on with these new entrants.
For underserved populations, FinTech’s most dramatic impact is opening up access to credit and offering digital cash transfer platforms. We explore two of those new offerings here:
Digital cash transfer platforms are now widely used worldwide. These can be particularly beneficial to migrant workers, whose families—often unbanked—rely on receiving money from abroad.
According to the World Bank, funds sent back to the home country are an important source of income for several developing countries, representing a non-negligible four percent of GDP in Mexico, for example, and up to an eye-watering 27 percent of GDP in Nepal. Global remittances in 2019 exceeded $700 billion, with over $500 billion flowing to developing nations. The International Monetary Fund estimates that remittances sent through traditional channels are subject to fees that average 10 percent but can be as high as 20 percent for small remittances of under $200, which are typical for poorer migrants.
FinTech can also help improve access to credit for small and medium-sized enterprises and provide services in remote areas through alternatives to traditional lending methods.
Examples of this have included apps providing credit facilities and enabling consumers and merchants to borrow money sourced from banks on their smartphones. In some cases, these apps are able to assess borrowers’ creditworthiness even if they lack the repayment track record required by traditional banks, and to tailor the financial terms of a loan to suit each borrower based on the particular risk profile.
Beyond these, FinTech offers a wide range of services, and we highlight four key segments.
When paying with a credit card, consumers use a bank-issued card that’s linked to a global payment network. The merchant, in turn, works with a merchant processor who manages the credit card transaction process and is an intermediary between the merchant and the financial institution involved, authorizing transactions and helping merchants get paid on time by facilitating the transfer of funds.
Global payment networks enable consumers and merchants to smoothly conduct commerce on a global scale and to utilize digital mobile devices, opening up new opportunities for merchants. They can also enhance overall efficiency and working capital management for businesses of all sizes by digitizing business-to-business payments.
Digital wallets allow an individual to make electronic transactions and bypass traditional banks. According to market data provider Statista, digital wallets accounted for 44.5 percent of all global e-commerce transactions in 2020. Solutions within a consumer digital wallet can include merchant payments, peer-to-peer payments, international money transfers, bank accounts, lending, and cryptocurrency trading.
Merchant processors can have a large impact for small merchants by enabling them to accept electronic payments so they do not have to handle cumbersome cash and checks.
Unlike other FinTech segments, this one is not dominated by a handful of key players. A myriad of companies of all sizes offer their technological expertise. Technology providers enable small-to-midsized financial institutions to digitize their ecosystems so they can provide banking services to consumers and businesses more efficiently and cost-effectively.
The proliferation of FinTech providers and the disruption they are creating in the financial services industry is a trend that likely won’t abate anytime soon. But in that chaos, there lies opportunity.
Those new providers who innovate and monetize their products successfully offer investors some interesting potential growth stock opportunities. But investors would be wise to concurrently keep an eye on the incumbent players in the sector, too. They will have to adapt in order to fend off the approach of newcomers into their territory.
This article is part of our SusTech series, which explores the confluence of sustainability and technology and why this concept matters as an investment theme.
Read more from the series:
Source - RBC Wealth Management, World Bank’s Global Findex Database
With contributions from Jason Deleeuw, CFA, U.S. Equities Portfolio Advisor, RBC Wealth Management Portfolio Advisory Group – U.S. and Stephen Chang, CFA, U.S. Equities Portfolio Advisor, RBC Wealth Management Portfolio Advisory Group – Equities, RBC Dominion Securities Inc.
Stephen Chang, an employee of RBC Wealth Management USA's foreign affiliate RBC Wealth Management Portfolio Advisory Group – Equities, RBC Dominion Securities Inc., contributed to the preparation of this publication. This individual is not registered with or qualified as a research analyst with the U.S. Financial Industry Regulatory Authority (“FINRA") and, since they are not associated persons of RBC Wealth Management, they may not be subject to FINRA Rule 2241 governing communications with subject companies, the making of public appearances, and the trading of securities in accounts held by research analysts.
RBC Wealth Management, a division of RBC Capital Markets, LLC, registered investment adviser and Member NYSE/FINRA/SIPC.
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