David and Goliath: Is Fintech a Threat to the Financial Behemoths?
Emma Ractliffe, Dartmouth Business Journal
Can you remember those miserable days before Venmo came around? The hassle and confusion that inevitably arose every time you and your friends split a cab and everyone had to figure out who owed whom? For millions of Americans (Venmo will not disclose exactly how many users they have), Venmo has become such an integral part of daily life.
Started in 2009 by two University of Pennsylvania students, Andrew Kortina and Iqram Magdon-Ismail, Venmo is now a must-have app that allows people to seamlessly and effortlessly pay back a friend for a drink, a meal or a wild night out. A bank account, debit card or a credit card is linked to your account, which you can then use to transfer money to anyone- even those without a Venmo account. At the tap of a finger, one can also request money, which can then be rolled back into a bank account.
Venmo, which was acquired by PayPal in 2013, is currently one of the fastest growing apps in the world by dollar volume. In the third quarter of 2015, it processed $2.1 billion dollars, triple the amount in the same quarter in 2014 and up from $1.6 billion in the previous quarter. In a bid to turn Venmo into a moneymaker, PayPal announced in its third quarter report this October, that it would allow merchants to accept payments through the service, charging merchants the same 2.9% transactions fees that Venmo’s sister, PayPal, charges.
Venmo is just one of many financial technology companies – now fashionably referred to as fin-tech companies – that have revolutionized the way money changes hands. Long seen as a highly regulated field dominated by a few corporate giants, finance is now riding an entrepreneurial wave. Whether it be payment, peer-to-peer lending, crowd funding or wealth management, a new generation of startups is harnessing software and the power of the internet to take aim at the heart of the industry and a pot of revenue Goldman Sachs estimates at $4.7 trillion. Although the fintech industry remains small and many of the most talked about startups – including Venmo- have yet to turn a profit, pundits predict that Fintech will reshape finance in profound ways.
The Economist suggests that fintech disruptors, unburdened by the same amount of regulation, legacy IT systems and branch networks, will be able to cut costs and improve the quality of financial services. Lending Club, a peer-to-peer lending company headquartered in San Francisco, has expenses of about two percent of its loan balance versus an average five to seven percent for conventional lenders. IPOed in 2014, Lending Club operates as an online platform that allows borrowers to obtain loans and investors to purchase notes backed by the payment made on the loans. With lower operating costs for small loans, new peer-to-peer lending companies such as Lending Club can therefore offer better deals to borrowers and lenders.
Similarly, the Economist reports, other startups are improving the quality of financial services. Funding Circle, operating around the clock, receives half of its loan applications outside of normal business hours, improving the ease with which small businesses are granted loans. TransferWise, on its side, allow people to transfer money across borders at a fraction of the cost banks would levy for the same service.
Until recently, lending to individuals or small businesses was typically based on a single credit score and a meeting between a banker and a client. The cost inherent to this traditional form of relationship lending encouraged lenders to chase only big borrowers at the expense of small borrowers. With the advent of new data-driven and digitalized lending platforms, however, young borrowers who were previously on the fringes of the banking system are for the first time being given easier access to funding.
Prosper, another lending company, relies on over 400 data points including factors such as the applications relationship with suppliers, shipping companies and credit card processors, e-commerce activity and cell phone records to underwrite loans. Similarly, OnDeck has loaned over 2 billion to small businesses across 700 industries in the United States and Canada evaluating creditworthiness through a proprietary method that allows them swiftly process loans within a day. Affirm, Kabbage and Earnest are just a few more of a multiple of startups that have come up with clever new ways to compile vast sources of data to come up with more accurate assessment of borrowers riskiness.
The data these startups rely on, Steve Lohr from the New York Times reports, go substantially beyond credit history, and include subtle predictions about the borrowers’ behavior gleaned from a vast array of online and offline sources. It is not farfetched, Lohr believes, that bankers of the future may forego observing traditional metrics, and look to see if potential customers use only capital letters when filling out forms or the amount of time they spend online reading terms and conditions (metadata analysis has determined that these attributes are correlated with the likelihood of default) What does this mean for you? Don’t upload Facebook posts of you and your friends doing shots – it might not be good for your credit score.
Finally, automated investment services, frequently called “robo advisors” have been revolutionizing the field of wealth management. Built on the premise that many of the activities performed by a Registered Investment Advisor can be performed by software, these new technology backed advisors have drastically cut costs by providing automated, algorithm based portfolio management advice without the use of human financial planners. By eliminating the middlemen and cutting costs, robo advisors have widened the reach of the industry – traditionally reserved for the wealthy – making it for the first time accessible to anyone with an Internet connection.
Over the past few years, these robo advisors have been enjoying astronomical growth. Betterment and Wealthfront, both of which build and manage personalized investment portfolios with customized asset allocations based on an individuals risk score and account tax status, have grown to manage 3 and 2 billion respectively in just three years.
It goes without saying, that traditional wealth management divisions at many of the big banks are watching the emergence of the robo advisors with a heavy dose of unease. In the best case scenario for current wealth managers, robo advisors will merely put downward pressure on management fees, while in the worst scenario, robo advisors will make traditional wealth managers obsolete.
Financial advisors are finding it progressively harder to effectively market themselves, particularly to younger generations. Millenials, soon to become the largest client group, have a particularly strong distrust towards financial institutions, Deloitte noted in a recent report. As such, Deloitte predicts money management is going to be disrupted and reinvented in significant ways. Betterment, Wealthfront and tech driven personal finance startups, who have enjoyed particular success among younger generations, stand to benefit tremendously.
“Without a doubt the era of fintech is upon us” Dominic Broom, Head of Treasury Services at BNY Mellon wrote, in a 2015 report. Indeed, global fintech financing has dramatically increased from just 3 billion in 2013 to 20 billion in 2015. While there has been a lot of debate about the tech bubble bursting in 2016, many pundits see bright prospects for the fintech subsector. Dartmouth grads and MBAs who dream of a lucrative future at the traditional behemoths like Goldman or JP Morgan might want to have a plan B. Forty years ago, working at IBM and Xerox were dream jobs too.