Cheaper. Better. Faster. We hear those words so often they become a cliché. But in the world of financial technology (or FinTech), they represent a future that is on the one hand already here, and on the other hand, continues to evolve.
The Great Recession spawned by the global financial crisis of 2007, has affected the way many consumers, particularly millennials, think about traditional banking. Not only are we seeing a trend of workers who are less tied to traditional work, but they are also less likely to trust traditional banks and financial institutions.
This is also a generation that would prefer online contact and social media to direct human contact. They are a generation that has been raised on and embraces, a technology which is having an impact on our society is still struggling to digest. One of the ways that technology and distrust towards financial institutions are playing out is in the way this generation has moved away from traditional banks and is finding other applications that meet at least their basic financial needs.
From sending money to each other to using mobile apps to send invoices and receive payments, there is a changing mindset over the role of, and the need for, traditional banking. And with an increasing number of FinTech companies entering the space, consumers are finding more reasons to skip the banks.
How the FinTech industry shakes out will be one of the more fascinating developments of the next decade. One of the questions will be if large technology companies like Google (NASDAQ:GOOGL), Apple (NASDAQ:AAPL), or Amazon (NASDAQ:AMZN) will jump into the FinTech space. This is already happening in China. But the regulatory environment in China makes it easier for that to occur. Plus, with the increasing focus – even among younger consumers – on the blending of technology and security, it’s easy to see why this may not happen overnight.
And what of traditional banks and financial institutions? Will they find a way to divert customers back to their products and services? Or will they form some uneasy alliances as may already be happening with companies like Google which is partnering with Citigroup to allow customers to open traditional checking accounts.
One of my favorite quotes is attributed to Mark Twain who allegedly said, “History doesn’t repeat itself but it often rhymes”. In the aftermath of the Great Depression (and probably before it if we’re being honest) many Americans took to stuffing money in their mattresses. They may have done it because they distrusted the banks. Or they were the gig workers of their day who had unpredictable and/or unreliable income that made traditional banking unavailable to them.
Today, traditional banking is coming under attack in a more stealthy fashion. Many younger workers have not – and have no intention to – use a traditional bank. They have grown up on PayPal (NSYE:PYPL). To them, Venmo is a verb as much as it is an app. The reality is, in part due to mobile phone apps and online transactions, these workers have a variety of options to service their basic financial needs.
This application of technology into traditional financial service is known as Financial Technology (or FinTech). In some form or fashion, FinTech has been around for a long time. In its most basic form, FinTech refers to the technology used on the back end by banks and other financial institutions to lower costs, add convenience and prevent losing customers to new startups.
But just as technology continues to grow, so do the opportunities and applications in this growing area. FinTech is not a sector in itself, but it touches many of the other investing sectors such as health care, banking and retail. In this article, we’ll explore the meaning and evolution of FinTech. We’ll look at how the area may still evolve as well as its current - and potentially future - impact on traditional banking.
What is FinTech?
FinTech is a culturally shortened derivation of the words Financial Technology. It refers to the use of technology that is used to automate and provide innovation to, financial services. Financial technology started out as technology used at the back-end of financial institutions (think electronic statements, online bill pay, etc.). But today, the term is used to describe the fundamentally different ways that consumers are choosing, and in some cases, expecting to manage their personal finances.
How big is the FinTech market?
According to Accenture, the global investment in FinTech was $55 billion in 2018. That number is only expected to rise as the industry continues to evolve to incorporate advancements in digital experiences, artificial intelligence (AI) and distributed ledger technology (i.e. blockchain).
FinTech and the “gig economy” are a perfect pair
The “gig economy” refers to the movement by workers to choose self-employment (in the form of short-term contracts or freelance work) in place of a traditional nine-to-five job. The passage of the Affordable Health Care Act has made employer-sponsored health care less of a need for younger workers and workers of all ages who are relatively healthy. Exactly how many workers are involved in the gig economy is unclear. However, the Gig Economy Index, a part of pymnts.com says that nearly 40% of the workforce makes at least 40% of their income from gig work.
Since one of the considerations traditional banks use in determining a customer’s suitability for different financial products is a regular deposit history, gig economy workers can find it difficult to avail themselves of the tools they need to help their business grow. That’s the case even if, as the Gig Economy Index reports, some 55% of gig workers maintain full-time jobs in addition to their gig work.
Gig workers have banking needs that are not easily met by the traditional financial institution, including:
- Inconsistent and/or unpredictable income
- Access to credit
- Health insurance
- Tax requirements and compliance
Will FinTech make traditional banks irrelevant?
Traditional banks still have an important advantage in that the deposits that are held in a bank are the only ones that are insured by the Federal Government. Now younger consumers – who have been deeply scarred by the global financial crisis - may question the “safety” of that insurance. And with savings rates continuing to be near all-time lows, the allure of “receiving interest” on their money is virtually non-existent. However, for high-income earners who have a significant amount of liquid savings, a traditional bank may be the best way to protect those savings.
Another advantage for traditional financial institutions is they are still the way for many people to have funds deposited. According to an October 2018 survey by the American Payroll Association, 96% of U.S. employees have their paycheck direct deposited. For that to happen, employees need a relationship with a traditional bank.
Or are they? One of the appeals of FinTech is its perceived security over a bank. Millennials have been the catalyst for these services. Their generation has more innate trust in technology. In other words, they’re less concerned about “insuring” their deposits as they are about having access to their funds. In that way, many FinTech applications are making it easy for consumers to have access to their money.
However, because so many FinTech companies are in their infancy it remains to be seen if they can offer products that are truly better than what banks offer? Can they integrate with the wide variety of other services available? Are their offerings scalable?
For their part, many banks are already trying to blunt the effect of companies such as PayPal and Venmo by integrating Zelle, a payment tool, into their banking applications.
However, here again there is some evidence that FinTech companies are evolving
Already PayPal (NASDAQ:PYPL) offers business customers access to their PayPal Working Capital program. This program can help small business owners who may not qualify for a traditional bank loan to have access to capital. The combination of using non-traditional lenders and approvals that are based on the revenue a business generates (which is easily tracked by PayPal) makes approval easy and done without a credit check. Repayments are done as a percentage of their outgoing invoices.
Will this replace traditional lending? Not likely. And as businesses grow, the question of scalability will certainly arise. But for single proprietor businesses, this is a solution that is far more convenient.
Another example of the evolution of FinTech is Robinhood which has already disrupted the traditional brokerage firms. Robinhood offered commission-free trading that became so popular many traditional brokerages such as Charles Schwab and T.D. Ameritrade had no choice but to eliminate their practice of charging fees for trading. These companies, which recently announced a merger, and other brokerage firms are now essentially ceding the ability to monetize trading and are moving to a wealth management model. That’s the definition of disruption.
Blockchain and the future of FinTech
Distributed Ledger Technology (DLT) or blockchain technology represents the future of financial services. Whereas many of the existing FinTech services merge technology and convenience, the technology they are based on makes transparency and security key issues. To make a long story short, the existing digital architecture was never designed with security first. Additionally, operational processes can be streamlined which will shorten settlement times for traditional banks (a key benefit of FinTech right now).
Already traditional financial institutions such as Bank of America, Goldman Sachs, and American Express are competing with companies like eBay, Amazon, and IBM for blockchain patents that will give them the ability to be first-to-market with innovative tools for customers. The companies that can quickly pivot to this space are likely to define the future of FinTech.
The final word on FinTech
FinTech is disrupting the role of traditional banking. Fueled by a generation that has cut their teeth with technology and views traditional banking as inconvenient and perhaps even unethical, FinTech is becoming more than just a way to send money from one person to another. Already traditional brokerages are changing their business model to adapt to the emergence of Robinhood, which allows commission-free trading through their subscription service. And many workers in the gig economy are already fully immersed in FinTech companies who, in turn, are expanding their offerings to keep these customers from turning to traditional banking.
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