Future of Financial Services
A Look At The Forces Shaping The Future of The $163 TN Global Banking Industry
“Giants are not what we think they are. The same qualities that appear to give them strength are often the sources of great weakness.”
― Malcolm Gladwell, David and Goliath: Underdogs, Misfits, and the Art of Battling Giants
The Financial Services Industry was always a bastion of incumbents with very high barriers to entry. Silicon Valley has given birth to many disruptions meant to upend the world of finance. However, along with other forces, what is upending finance today is a product of anonymity — a cryptocurrency created by the ‘Banksy of the Blockchain’ world — ‘Satoshi Nakamoto’. Although mathematics disrupted finance through financial engineering and created complex, derivative instruments such as swaps, Collateralized Debt Obligations (CDO’s), nobody foresaw cryptography upending finance using Blockchains as the decentralized networks of the future. Just as an anonymous creator is reshaping finance through Bitcoin’s underlying technology, forces such as demographics, the need for financial inclusion, advent of technologies such as Blockchains and Artificial Intelligence (AI), reduced barriers to entry and regulatory support are giving birth to new entrants into the $163TN (by value) world of banking and finance. This article examines finance of the future and provides an overview of powerful forces disrupting finance. Read this article to understand who the new Goliaths of finance could be?
Establishing The Framework
I vaguely remember the day I created my twitter account. Jack Dorsey, twitter’s co-founder hails from the same city I live in today. However, I must admit the purpose of twitter as a large group SMS was very alien to me. Think of how many bankers used to think Blockchain technology is from Mars. However, I clearly remember Marc Andreessen, the founder of Netscape and Andreessen Horowtitz — a$4.2 billion Venture Capital (VC) firm, tweeting more than any other user on twitter. His first six months on twitter were epic. Then, there was an interview with Bloomberg Markets in 2014 which contain the famous excerpts:
“We have a chance to rebuild the system. Financial transactions are just numbers; it’s just information. You shouldn’t need 100,000 people and prime Manhattan real estate and giant data centers full of mainframe computers from the 1970s to give you the ability to do an online payment.
“You would not today, starting from scratch, invent any of these financial businesses in the same way. To me, it’s all about unbundling the banks.”
These statements ring true today as Blockhains of all types-public and private are taking over the world of finance. Smart Contracts, as Nick Szabo (father of Bitgold-Bitcoins predecessor) are thought of as replacements of all modern contracts. Artificial Intelligence (AI) algorithms are meant to take over wealth managment and digital channels are slated to dominate client acquisition. Thus, the unbundling that Marc referred to in the interview has progressed fairly quickly. Personally, I do agree with a lot of what Marc says except that I want to put a human face to the argument. Ultimately, who does the world of financial services serve? humans, right? So, why do we talk about re-invention of finance with a lesser emphasis on improving client experience through proper context.
Let me explain- a couple walks into a bank branch for a mortgage. It is one of the biggest liabilities they will assume but it is also their dream to own a house. Today, it is almost impossible for bots or AI to understand context and read between the lines as a loan officer (human) would. A nod exchanged or a wince can be interpreted by the loan officer as the couple indicating non-verbally it’s agreement or dislike. The loan officer can then quickly adjust his conversation to proceed or to inquire about the factors stopping the couple from proceeding.
This is a very simple example but there are millions of situations where context is incredibly important in delivering a superior client experience. That is precisely why the sales profession is hard to automate completely. Financial advisors who can educate clients on complicated financial terminology using plain English provide a service that is hard for bots to do. How many of us have had a bad experience with a speech recognition bot or a contact center agent that does not understand our accent while redirecting the call? I am guessing many.
However, besides educating humans on finance, understanding non-verbal communication and guessing what’s on the minds of clients, a lot of the other processes in finance are ripe for automation and for reasons well understood by many.
Need for financial inclusion
Perhaps, the strongest moral and human argument for advancement of FinTech is the need to bring the unbanked population into the financial mainstream. There are many negative consequences of being left out including exploitation by loan sharks. A recent report by the Oxford University which studied income inequality across the globe states that the population living in extreme poverty i.e. “World Bank’s $1.90/day extreme poverty threshold has fallen drastically, from 35% in 1990 to 11% in 2013. Despite a major expansion in world population, the number of people in extreme poverty has fallen dramatically from 1.85 billion to under 800 million.” While this is a positive trend, 800 million people under the poverty threshold is still a staggering burden by any standard.
This report also observes that while inequality in developing countries has closed the gap with that in developed nations, inequality within developing countries has widened. Countries such as India and China which reaped the benefits of globalization have seen inequality increase within the country.
However, as India’s demonetization experiment demonstrates, no change can be implemented on a nationwide basis without pain, chaos and decrease in economic activity. But then, very few changes have worked unless there is a compulsory diktat to change or risk having your wealth reduced to nothing. While there are arguments on both sides, it is upto a global coalition to decide whether cash stays or fiat currencies become digital at the flip of a switch creating chaos and shocking the current economic system into submission.
Irrespective of the outcome, bringing the unbanked into the financial system remains a noble cause propelling the growth of financial technology:
Depositing cash in an ATM or a mobile ATM (ATM mounted on a moving vehicle) using advanced AI for the unbanked is a relatively cheaper way to bring them into the fold. Second order AI to process and understand all native languages in remote villages will be needed to inspire trust, provide needed education and remove friction. ATM’s with video capabilities that allows a banker to talk to the unbanked and walk them through the benefits of inclusion will be needed. It goes without saying the mandate has to come from the government but the infrastructure has to come from the private sector.
The advancement of Artificial Intelligence needs a diversity of approaches. While the backbone of deep, machine learning is a breakthrough called back propagation:
Vector Institute based out of Toronto, Canada is using Geoffrey Hinton’s 2012 research paper and his understanding of back propagation to drive commercialization of Artificial Intelligence (AI) driven by investments from Google, nVidia and Uber. Geoffrey Hinton is widely regarded as “the father of deep learning”. A recent article in the MIT Technology review explains that “A 2012 paper by Hinton and two of his Toronto students showed that deep neural nets, trained using back-propagation, beat state-of-the-art systems in image recognition. “Deep learning” took off. This is one approach to training machines to learn.
The other approach is using probabilistic models and systems neuroscience to create an advanced form of AI — the coveted Artificial General Intelligence (AGI). Founded by Dileep George, Vicarious is developing AGI for robots. Vicarious is funded by Mark Zuckerberg, Jeff Bezos, Marc Benioff amongst others. Many in the field of AI research believe the answer could lie in combining machines with human tissue. Many also believe that mimicking the brain’s million plus neurons is nearly impossible.
A lot of the revenue generating activities such as wealth management, deposit taking, lending, opening and operating digital wallets including the ones used to store crypto currencies have been simplified and automated. Smart contracts could someday take over listings of equity and debt instruments with Blockchains for recording transactions.
Regardless of the approach, AI is still far away from understanding context, reading facial expressions perfectly to predict emotions and read between the lines and reaching the same cognitive capability as a human. The new Goliaths of financial services will need to master AGI to differentiate it’s approach to client service
With the easing of regulations, the new goliaths could bring some usual and some unusual suspects.
Many regulators have gone from a state of stasis on Blockchain and FinTech to gradually begin incorporating these new technologies and entrants into the mainstream thereby reducing barriers to entry in financial services. The regulatory framework across the globe is moving at varying speeds but the direction is more uniform i.e. a greater accomodation of FinTech players and Blockchains into the mainstream. An accomodative regulatory environment is a clear warning sign to incumbents.
While regulations in the US could possibly allow firms such as Walmart, Google, Apple or Amazon to open their own financial services business, FinTech players such as SoFi have already applied for banking licenses.Mexico is contemplating regulations to open bank API’s to FinTech player much like the establishment of sandboxes in the UK, Singapore and India.In January 2018, Europe will enact the Payments Service Directive 2 (PSD2) designed to open Bank API’s to FinTech players.
ICO’s have halted their advance in countries such as China because of their role in creating giant Ponzi schemes.
While FinTech landscape which is valued just shy of a trillion dollars and is home to the usual suspects disrupting finance, the unusual suspects could come from the world of commercial businesses such as Walmart or Google. While this is conjecture, the regulatory environment opening up financial services for competition is not.
Reduced Barriers to Entry
Banks have traditionally been protected by many of the barriers of entry shown below:
Today, it is easy to setup Blockchains. All you need is a powerful computer and programming tools and prowess. Any individual sitting in a basement could launch an ICO and create his own token.
Gathering deposits was considered the essence of banking. It was also the only element that differentiated banks from other non-banking finance companies. However, with easing regulation and rapidly advancing technology, gathering deposits is becoming easier and the cost of client acquisition is dropping to zero.
Raising capital also is not an issue with billions of dollars of ‘dry gunpowder’ i.e. capital sitting on the sidelines waiting to be deployed.
With deposit taking and capital raising becoming easier, scale is not out of reach. In fact, if tech giants decide to setup a financial services business, there is little stopping them. If you consider the money exchanging hands through WeChat and AliPay in China, there are already some commercial firms leveraging scale to their advantage.
While the above discussion focuses on competitive advantages of new entrants into financial services, there are many factors such as inspiring trust, capital available for acquisitions and an alert mindset that may work to the adavantage of incumbents. In short, there is no clear answer.
Makings of A Goliath
If all technologies i.e. AI, Blockchains, Smart Contracts, Digital identities, Augmented Reality (AR) become ubiquitous, democratized and easy to implement, what then will create the Goliaths of the future?
Finding factors of differentiation, therefore, will become key to survival and growth. Inevitably, the search for differentiaion, which is another name for delivering a great client experience, will result in the re-humanization of technology.
One area where humans will be needed is creating context within AI algorithms. The better the AI at understanding contex, the superior the client experience. Context will improve education of clients by AI systems which is difficult today. Imagine a scenario where not only can AI systems explain and complete a mortgage application with incredible nuances but it can also study facial expressions and read between the lines to understand and respond to human behavior as a human would. Therefore, the first consortium, approach or entity that breaks the code and leaps into AGI will nevertheless have the keys to an unlimited expanse including financial services.
Another factor of differentiation will be alliances with other service providers. If you could use your banking relationship to seamlessly perform a myriad of lifestyle activities such as booking exclusive experiences and discovering new activities (based on AI anticipating what you will like even before you do and recommending) across the globe, it would make your life much easier and exciting.
The third factor is delivering education that is adaptive, understands languagues and dialects and guides a transaction from start to finish without human intervention.
The reason I refer to ‘Goliaths’ is because there will always be a nimble David that brings in disruption. That is the essence of change or as they say:
In With The Newest, Out With The Newer