Issue: Fintech Fintech - By: Victoria Finkle - SAGE Business Researcher
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Issue: Fintech
Fintech
By: Victoria Finkle
Pub. Date: September 12, 2016
Access Date: January 21, 2022
DOI: 10.1177/237455680218.n1
Source URL: http://businessresearcher.sagepub.com/sbr-1775-100731-2748617/20160912/fintech
©2022 SAGE Publishing, Inc. All Rights Reserved.
©2022 SAGE Publishing, Inc. All Rights Reserved.
Will financial technology startups disrupt traditional banking?
Executive Summary
The surge of financial technology startups—or “fintechs”—is improving the speed and quality of customer service of lending, money
transfers, wealth management and much more in the banking industry. As these firms become more prominent in the financial services
sector, banks and regulators will have to adapt. Banks already are beginning to integrate these new services by investing in or partnering
with fintechs and by developing similar technologies on their own. Regulators are rushing to understand the nature of these new firms and
the potential benefits and threats they pose to the financial system. As the financial sector debates the future of fintech, here are some of
the issues under consideration: Will fintech replace traditional banking? Are alternative lenders reshaping how people borrow? Is
government capable of regulating the emerging fintech industry?
Overview
Lending Club’s banner hangs on the New York Stock Exchange façade for its IPO in December 2014. The alternative lender
embodies both the promise and perils of fintech. (Don Emmert/AFP/Getty Images)
James Song realized he needed access to some fast cash. A lot of it.
It was 2007, and Song was building the first plastic recycling plant in Uganda, where he had traveled on a Fulbright scholarship after
graduating from Harvard University two years earlier. His goal was to reduce the spread of malaria, a mosquito-borne virus. Plastic bags
littered Uganda’s streets and blocked sewers, creating pools of standing water that are a breeding grounds for the pests.
The only problem? Song was out of money. He had started building the plant with money he had raised from friends and family, but he
needed $25,000 to finish the project. The most obvious solution, turning to a bank, seemed like a long shot.
“I was absolutely not optimistic about getting a bank loan,” says Song, who now runs Faircap Partners, an investment management firm
focused on development in Myanmar.
Not to mention, he was running out of time before the machinery he ordered would arrive.
Dejected, Song was surfing the internet at a café in Uganda when he came across an intriguing opportunity. A new company called
Lending Club was offering fast loans of up to $25,000. Song says requesting a loan through the fledgling site was a “no-brainer,” given his
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SAGE Business Researcher
©2022 SAGE Publishing, Inc. All Rights Reserved. situation. To his surprise, Song’s loan was funded in a matter of days, at an annual rate of just over 11 percent. He paid off the loan in three years without missing a monthly payment. “It saved the business, and I ended up creating the recycling infrastructure in Uganda over the next few years,” Song says. At the time, Lending Club offered what’s known as peer-to-peer loans, in which individuals posted loan requests and others funded them directly. Song notes that a single person funded almost half his loan. The site then operated solely as a Facebook app, though its reach quickly spread. Lending Club said it facilitated half a million dollars’ worth of loans within two months of opening for business in 2007. 1 Today, Lending Club is one of the biggest players in the alternative lender community, having originated more than $20 billion in loans since its launch. Borrowers most commonly use the loans to pay off or refinance existing credit card debt, while others tap the funds to pay for major one-off expenses like a wedding, business expansion, medical treatment or home improvement project. 2 Wall Street players, including hedge funds, asset managers and big banks, make up a growing share of the company’s lending base. 3 But the same company that provided a vital financial lifeline to Song and other borrowers has faced its own riptides. Recent allegations surrounding the firm’s faulty internal controls and the questionable actions of founder and former CEO Renaud Laplanche have shaken the company, and also served to illustrate the perils that accompany the promise of “fintech,” the hottest trend in banking right now. The rapid expansion of tech-driven financial startups has positioned them to challenge the supremacy of traditional banks; this quick growth has also saddled the newcomers with growing pains and some doubts about their long-term viability. At the same time, the fintech boom is compelling the established banking industry to think about how it too can harness technology to better serve its customers through ongoing investments in new products and partnerships with startups. Fintech is an umbrella term that describes a wide range of new digital services that are transforming the banking industry. They include online loans, crowdfunding platforms such as Kickstarter, digital currencies such as bitcoin, algorithm-based wealth management firms such as Betterment and mobile payment companies such as PayPal and Square. Fintech also encompasses new online remittance services for sending money internationally, personal budgeting software such as Mint and digital wallets such as Apple Pay. “You’re dealing with money and a computer—now, almost everything could fall under the definition of fintech,” says Edward Mills, a policy analyst at FBR Capital Markets, an investment banking and advisory firm based in Arlington, Va. Investment in fintech companies has exploded in recent years, with more than $50 billion in financing going to more than 2,500 fintech firms around the world since 2010. 4 Global investment grew 75 percent to more than $22 billion in 2015 alone. 5 Separately, Goldman Sachs estimates that the total amount of revenue at stake in the competition between the traditional banking industry and fintech companies involved in crowdfunding, payments, wealth management and lending is $4.7 trillion. 6 A host of factors has shaped fintech’s rise. For example, stricter rules for banks after the 2007-09 financial crisis created an opening for nimbler upstarts, while the spread of mobile phones and digital access has changed how consumers can run their financial lives. Younger and wealthier consumers seeking quicker access to a wide variety of financial services are driving the trend. 7 Page 3 of 24 Fintech SAGE Business Researcher
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A sign in a Berlin pub reflects the growing interest in the digital currency bitcoin and other “cryptocurrencies.” (Sean
Gallup/Getty Images)
“The fintech providers are carving out a position in the market as being the fastest, most responsive players,” says Ron Shevlin, director of
research at Cornerstone Advisors, a financial consulting firm in Scottsdale, Ariz. “For a growing percentage of younger consumers, it’s
more about speed and how easy is the experience. And that’s a growing threat that I don’t think a lot of banks really appreciate today.”
How big a threat this will ultimately pose for traditional banks, large and small, remains to be seen. In some cases, such as with the use of
digital currencies like bitcoin, widespread adoption could one day be revolutionary for traditional banks, regulators and fintechs alike.
Central banks around the world already are exploring potential uses of the technology, which removes the “middleman” from financial
transactions. 8
“It does this by taking the all-important role of the ledger-keeping away from centralized financial institutions and handing it to a network of
autonomous computers, creating a decentralized system of trust that operates outside the control of any one institution,” wrote Wall Street
Journal reporters Paul Vigna and Michael J. Casey in their book The Age of Cryptocurrency. 9 “At their core, cryptocurrencies are built
around the principle of a universal, inviolable ledger, one that is made fully public and is constantly being verified by these high-powered
computers, each essentially acting independently of the others.”
In other cases, such as in the online wealth management space, major brokerage players like Charles Schwab are scrambling to compete
with the startups. Firms including Betterment and Wealthfront are now managing billions of dollars in assets of consumers who can’t afford
or don’t need a personal wealth adviser, but can benefit from the new algorithm-based investing services, also called robo-advisers. 10
Meanwhile, online money transfer companies like PayPal and Venmo (which is owned by PayPal) are making it easier for customers to
make purchases online and share money with each other.
But the fintech industry is facing its own challenges and competitive pressures. Laplanche, Lending Club’s founder and a pioneer in the
industry, stepped down as CEO in May 2016 after an internal investigation found that several loans had been mishandled and that
Laplanche had encouraged the firm to invest in another company without disclosing his own stake in it. 11 A month later, the company
announced that Laplanche and some of his family members took out loans in the company’s early days to help give the appearance of
growth and that the firm had improperly valued some internal private investment funds. 12
On top of that, Lending Club, along with rivals including Prosper and Avant, announced significant layoffs over the summer, raising
questions about the viability of the online lending business if the economy were to dip into another recession. 13 The industry’s troubles
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may be starting to spook hedge funds and other institutional investors that have been backing the alternative lenders, which could force the
companies to seek capital elsewhere. Prosper CEO Aaron Vermut told a conference in April that funding challenges represent the most
significant enduring issue facing the industry, and that his firm and others should focus on finding long-term investors. 14
Over time, online lenders and fintech firms of all stripes are likely to face some of the same hurdles as their more entrenched peers,
including heightened oversight from regulators. They also will need to increasingly contend with concerns about cybersecurity and data
protection as they gather larger swaths of consumer information. (See Short Article, “Fintech Firms’ Cyberdefenses Called
Underdeveloped.”)
More broadly, questions remain about whether the fintech sector can continue to grow at its current rate,
and what will happen if—and when—the economy begins to cool.
“I think you’re going to see some consolidation of the medium and bigger-sized fintech companies, where
they buy up the smaller ones that have good ideas or a better algorithm, and incorporate them,” says Marc
Hamud, a banker at Wells Fargo and an adjunct professor at the University of Southern California’s
business school, where he co-teaches one of the first fintech courses in the country. 15 “I definitely see
consolidation coming down the pipeline, very soon actually.”
As entrepreneurs, banks and regulators consider the growth of fintech and what it means for the financial
services industry, here are some questions under debate:
Weighing the Issues
Lending Club founder Renaud Will fintech replace traditional banking?
Laplanche was ousted after an
internal investigation. So far, banks have taken a mixed view of the fintech market’s fast growth.
To understand this ambivalence, an observer doesn’t have to look further than the recent comments and
actions of Jamie Dimon, chief executive of JPMorgan Chase, one of the world’s largest banks. In April 2015, he famously warned in a
letter to shareholders that “Silicon Valley is coming.”
16
“There are hundreds of startups with a lot of brains and money working on various alternatives to traditional banking,” Dimon wrote.
By the end of the year, JPMorgan Chase had partnered with OnDeck, an online lender to small businesses, in an effort to boost the bank’s
own small-business lending. By working with the startup, the bank has been able to expand its reach into that market, in which borrowers
typically request less than $250,000—an amount previously too small for the large bank to handle profitably. 17
“It costs JPMorgan the same to underwrite a loan for $100,000 as it does $1 million, and they’re obviously economically incentivized to
focus on the million-dollar loan,” says Isaac Boltansky, director of policy research at Compass Point Research & Trading, an investment
banking firm in Washington.
In March 2016, Dimon had a more circumspect view of the challenges fintech firms pose for the traditional bank industry.
“It’s nothing mystical,” Dimon said of fintech lenders in an interview with Bloomberg. “But they’re very good
at reducing the pain points. They can underwrite it quicker using—I’m just going to call it big data, for lack of
a better term: ‘Why does it take two weeks? Why can’t you do it in 15 minutes?’ ” … Can we [JPMorgan] do
something like that? Of course we can.” 18
Fintech’s future is likely to be some mix of traditional and avant-garde banking. While some startups may
grow large enough to compete on their own, others will partner with existing financial institutions. Still others
will fail or get bought out by stronger rivals. Meanwhile, the banks themselves will continue to acquire
technology through investments in high-tech companies or by developing their own internally.
The potential models are numerous. Citigroup is building an experimental fintech unit inside of its consumer
bank, while the Spanish Banco Santander has begun a $100 million venture capital fund for fintech
startups. 19 Goldman Sachs recently started its own online-only retail bank to court new customers, small-
time savers and borrowers as opposed to the large corporate clients the bank is known for servicing. 20
Some in the industry say this could mean a wholesale transformation in the banking business.
JPMorgan Chase CEO Jamie
“Most of the products we’re used to seeing in banking will completely disappear—credit cards, debit cards,
Dimon: “Silicon Valley is
saving products in the traditional sense,” says Brett King, founder of Moven, a mobile-based banking
service based in New York City. coming.”
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©2022 SAGE Publishing, Inc. All Rights Reserved. For others, however, it’s more likely that fintech and banking may begin to look like one and the same. “The conversation shifts from one where everyone is out to disrupt traditional banks to one where there is a willingness to improve traditional banking,” says Boltansky. As banks make investments and adopt new technologies, absorbing some of the work of fintech players, “I actually think we see it slowly all shift back into the banking system.” Part of the issue stems from the size advantage of banks, especially the largest ones. Lending Club originated more than $8 billion in loans in 2015, a significant sum. 21 But that figure is dwarfed by the more than $700 billion in outstanding credit card debt in the United States. 22 “For the most part, the banks are going to let the little guys beat themselves out and consolidate from the very bottom—and the big banks will take the winners,” says USC’s Hamud. “For them to buy even a $5 billion company is a drop in the bucket.” Regional and community banks are warier, however. “Everyone’s fighting for a small customer base, and if you are a community lender and you’re in a middle part of the country in a suburban area, the traditional source of getting a loan would be going directly to a bank,” says James Ballentine, executive vice president of congressional relations and political affairs for the American Bankers Association, which represents banks of all sizes. “That certainly poses an issue from a competition standpoint, because there are increased players in the area.” At the same time, Ballentine says that the association continues to promote collaboration between banks and technology providers and to explore ways to make that happen. “We’re big into partnerships,” he says. But even collaboration is likely to take different forms. “Everybody else is going to be talking about partnering between banks and fintech providers and how that’s the future—and they’re dead wrong,” says Shevlin of Cornerstone Advisors. “A partnership is a one-to-one agreement between two players that often involves shared risk and shared reward. And the simple reality of the world is, even the largest banks simply don’t have the resources to go out and partner with as many fintech partners that they would need in order to have a meaningful impact on their bottom line.” Instead, he predicts a model in which fintech companies can “plug in” to the bank’s existing technology, much like those selling products on Amazon do today. “I sell my books on Amazon. Do you think they enter into a negotiated contract with me? No way,” he says. “The banks need to have a platform that enables these fintech providers to easily plug in, integrate and take advantage of the incoming traffic that the bank is going to create by bringing consumers on to manage their financial lives—and that is the real change in direction that’s going to happen.” Top Fintech Adoption Rates, By Country Hong Kong leads in users adopting financial technology Page 6 of 24 Fintech SAGE Business Researcher
©2022 SAGE Publishing, Inc. All Rights Reserved.
Note: Ernst & Young surveyed more than 10,000 digitally active people in Australia, Canada, Hong Kong, Singapore, the United Kingdom and the
United States for this data.
Source: EY FinTech Adoption Index, http://tinyurl.com/zu8x256.
Hong Kong has the highest rate of financial technology adoption, with 29 percent of digitally active consumers
using fintech products. The United States, although second in fintech adoption, came in significantly lower at 17
percent. For complete data, download the file above.
In line with this approach, some alternative lenders might change their models and choose to license their technology to traditional banks
to limit their own downsides, such as the high cost of finding new customers and the challenges of dealing with future regulation.
“A lot of companies might end up realizing that their highest and best use to shareholders is not to be a company that does the lending,
analysis and servicing—their best bet is to be a technology platform that licenses itself to the big banks for fat yearly or monthly fees,” says
Brandon Barford, a partner at Beacon Policy Advisors, a regulatory and legislative consulting firm in Washington.
Are alternative lenders reshaping how people borrow?
Fintech is evolving in many forms, through the payments system, virtual currencies and digital budgeting tools. But one of the sector’s
foremost advances is the growth of online lending.
“When you first say the word fintech, what pops into mind are the online lenders, because they’ve been getting the A1 coverage,” says
Mills of FBR Capital Markets.
Even within the field of alternative lenders, there’s a surprising amount of variation in how businesses raise or generate cash to fund their
loans and the types of borrowers they target. Many startups, for example, specialize in either consumer or business lending, with Lending
Club, Prosper and Avant in the first camp and OnDeck and Kabbage the latter.
Some lenders simply provide a “marketplace” for investors and borrowers to connect, while others underwrite loans with funds they’ve
raised or a line of credit from a bank. Still others partner directly with a bank. Lenders offering personal loans to consumers must have a
bank license to lend from their own balance sheets, while those lending to small businesses can do so with just a commercial license. In
small-business lending, a growing number of so-called merchant cash advance firms are active; loans they extend to a company are
repaid based on the borrower’s cash flow.
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SAGE Business Researcher©2022 SAGE Publishing, Inc. All Rights Reserved. Crowdfunding platforms that offer backers an equity stake or revenue-sharing option provide another loan alternative, especially for entrepreneurs starting a business. “There’s something very democratic about the revenue-sharing model that I think is very appropriate for crowdfunding,” says Sara Hanks, co-founder of CrowdCheck, which helps investors and small businesses meet legal requirements in crowdfunding, including new rules by the Securities and Exchange Commission. “And that is obviously going to be more attractive than a bank loan, to the extent you could have even gotten a bank loan or a Small Business Administration loan in such early days.” Funding choices aside, startups hold several advantages over traditional banks in the online loan process, including the ability to provide faster service. “When customers experience good service and instant approvals, they will refuse to put up with banks’ bad customer service,” says Barford. “The online lenders have changed the standard, and as more people get exposed to that and they have good experiences, they will demand more from banks.” Fintech lenders also are able to use a wider array of metrics for evaluating creditworthiness and provide faster service than a bank, because they are—at least for now—subject to considerably less regulation. Banks can charge different rates to borrowers with different credit histories, but they are limited in the kinds of information they can request and have stricter parameters about how they can set those rates. “When a small business borrows from an online lender, they will ask you for traditional information—what’s your bank balance, and so on. But they may also want to see your UPS shipping receipts to learn how much inventory are you shipping out to customers. Traditional applications didn’t request this type of info,” says Scott Talbott, senior vice president of government affairs at the Electronic Transactions Association, a group based in Washington that represents banks and online small business lenders. “They are looking for additional data points to help evaluate the ability of the small business to repay the loan. If the small-business borrower has a business Facebook page, the online lender can look at that and see the number of ‘likes’ and complaints.” But alternative lenders also face some headwinds. Loan delinquencies are rising; they increased from 0.56 percent to 0.75 percent between January and December 2015, according to the analytics firm Orchard Platform. 23 Moreover, it’s unclear whether there are enough borrowers for the online players to continue to grow at their current pace. 24 Several large firms have recently cut their staff to prepare for leaner times. Total Revenue of Global Mobile Payments Market, 2015-2019 Revenue is projected to steadily increase over the next three years Page 8 of 24 Fintech SAGE Business Researcher
©2022 SAGE Publishing, Inc. All Rights Reserved.
Source: “TrendForce Says Global Mobile Payment Market to Reach US$620 Billion in 2016 with Apple and Samsung Staking Large Claims in the
Ecosystem,” TrendForce, Feb. 1, 2016, http://tinyurl.com/zp4hbs4.
The global payment market got a big upgrade with major smartphone brands Apple and Samsung entering the
business. The total revenue of the worldwide mobile payment market reached $450 billion in 2015 and is
estimated to reach $620 billion by the end of 2016. Data for 2017 through 2019 are future estimations that
could arrive at upwards of $1 trillion.
The departure of Lending Club’s CEO also has cast a pall over the industry. “It’s never good when the industry leader and its bellwether
has a near existential crisis, especially with a CEO who in many ways created the industry,” says Compass Point’s Boltansky.
Others worry that in the race for new business, fintech lenders will begin making riskier loans.
“We just lived through a horrible financial crisis a few years ago triggered by sloppy credit practices playing fast and loose with lending,”
Camden Fine, president and chief executive of the Independent Community Bankers of America, a trade group representing smaller
banks, told CNBC. “There’s no shortcuts in lending. Everybody should play by the same rules.” 25
Is government capable of regulating the emerging fintech industry?
As fintech companies continue to grow and expand, regulators in Washington are sitting up and taking notice. So far, they have focused
on allowing innovation to develop.
“It’s not an issue of punishing or subjecting someone to a regulatory regime,” Thomas Curry, comptroller of the currency, said at a Wall
Street Journal conference in June 2016. 26 “Internally, we are looking at how we can be responsive to both sides of the question—both the
banks and the fintech firms and what the relative advantages and disadvantages are of existing regulations.”
King, the Moven founder, dismisses any doomsday scenarios, such as the threat that regulators will become interested in establishing
rules that would severely curtail or endanger the growing industry.
“Maybe two or three years ago, there was some concern about the regulators,” he says. “If you’re in the U.S. or U.K. or Germany, or Hong
Kong or Singapore or China or Australia, where I’ve met with regulators in each of those countries, every regulator is telling me the same
thing: For our economy to be competitive, we have to encourage fintechs to grow and to flourish, and we have to figure out a way for that to
be done safely so that consumers are not at risk. But I’ve never heard a regulator talk about fintechs as if, we’ve got to stop these or make
it harder for them to operate.”
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Part of the issue for regulators and the industry alike is finding a balance where consumers, borrowers and participants are protected, but
the startups have room to maneuver. The White House has been active in promoting the use of technology within the Obama
administration and the private sector, but has also been a strong backer of the Consumer Financial Protection Bureau (CFPB), the new
agency dedicated to protecting consumers from confusing or predatory financial products.
“What to me is fascinating is the push and pull that’s going on in D.C. between embracing innovation—the Obama administration has
been all about innovation and using technology—but at the same time, making sure there’s adequate consumer protections,” says Mills of
FBR Capital Markets. “That push and pull between embracing innovation, but ensuring consumer protections, is the biggest hurdle.”
Still, a recent survey found that nearly half of fintech founders and investors cited regulatory hurdles as the most significant challenge to
growth in 2016. 27
At the same time, fintech startups have benefited from new regulations imposed on banks in recent years. The banking industry has faced
a host of new regulations, including the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in the wake of the 2008
financial crisis. Dodd-Frank caused banks to pull back on innovation and anything potentially deemed risky behavior, which in turn
contributed to the success fintech startups have enjoyed thus far, says Boltansky of Compass Point.
“The pace of tech innovation was hastened by this rush caused by regulatory arbitrage,” Boltansky says. “The banks were facing a plethora
of regulatory programs, which provided the nonbanks an opportunity to fill the void the banks left.”
Currently, the banking regulators have more limited authority over financial technology startups and aren’t able to provide the kind of up-
close examinations they conduct of banks.
But as government regulators, including the CFPB, the Federal Trade Commission (FTC) and others begin to scrutinize fintech more
closely, the industry’s advantages may dim and its regulatory costs may continue to grow.
“What Silicon Valley is finding out, for better or worse, is that there’s a ton of regulation anytime you get into dealing with money and into
banking,” says Mills. “In many ways, the arbitrage that these guys had was the lack of regulation, and if they don’t actually have that
arbitrage, what is the profitability?”
Mercedes Tunstall, a Washington attorney who specializes in consumer finance, says banks—particularly big ones—have been frustrated
that they’ve had to pull back on innovation in recent years because of heightened oversight, when they are used to being at the forefront of
technological innovation in the field. Partnerships with fintech companies give them access to some of that activity, such as experimenting
with new ways to lend, without assuming the same levels of risk that a full-fledged bank program would entail.
“They are really interested in some of these ideas and having a front-row seat.
Partnerships help because they don’t have to bear the full risk themselves,”
she says.
For alternative lenders, one of the biggest questions is, what constitutes fair
lending? Government officials have so far put considerable focus within the
fintech sphere on the online lending market, and Congress is beginning to
hold hearings on the subject. 28 Banks have always had discretion to turn
down loan applications that don’t meet their standards based on financial
metrics, such as a person’s credit history, or impose higher interest rates, but
the issue gets sticky when it comes to whether those decisions affect certain
groups more than others. The Consumer Financial Protection Bureau has
been leading the charge against auto lenders and others over concerns about
disparate impact, the idea that lending decisions can lead to indirect racial
bias or other forms of discrimination. 29
“If you’re in the business of lending, generally speaking, you have to lend to
everyone,” Mills says. “Where the regulation is going to be focused is, to the
extent that your business model is cherry-picking certain loans—that was the
regulatory arbitrage—if you’re disproportionately lending to people of certain
demographics, that’s a potential problem.”
Down the line, other fintech ventures are also likely to face increased scrutiny.
When it comes to virtual currencies, for example, questions remain about how
the anonymity such currencies can provide complicates efforts to root out
terrorist financing or other illegal operations.
“Policymakers are understandably hesitant regarding cryptocurrency,
especially in an environment where there’s incredible discomfort with anything
Isaac Boltansky: “The conversation shifts from one where that can be vehicle for terrorist financing,” says Boltansky.
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Isaac Boltansky: “The conversation shifts from one where
everyone is out to disrupt traditional banks to one where there Ultimately, the debate over fintech regulation is just heating up. “One of the
is a willingness to improve traditional banking.” issues that comes up with fintech is, if you want me to come up with the list of
possible regulations, it’s almost unending,” says Mills.
Background
Early Advances
Although the term “fintech” wasn’t popularized until recently, the banking and technology sectors have always been interwoven. In some
ways, currency and the creation of formal financial records were technological breakthroughs. Those advances and others also were
central to the advancement of human civilization.
“Far from being the work of mere leeches intent on sucking the life’s blood out of indebted families or gambling with the savings of widows
and orphans, financial innovation has been an indispensable factor in man’s advance from wretched subsistence to the giddy heights of
material prosperity that so many people know today,” wrote Niall Ferguson in “The Ascent of Money,” his history of finance. “The evolution
of credit and debt was as important as any technological innovation in the rise of civilization, from ancient Babylon to present-day Hong
Kong.” 30
The first money constructed out of metal dates back to 1000 B.C. in China, while the first modern coins made from precious metals
appeared about 500 years later in what is modern-day Turkey. The Persians, Greeks and others copied the concept, as did the Romans.
The first paper money appeared in China in the A.D. 800s, although as the supply of currency grew, so did inflation. 31 It wasn’t until the
late 1400s that merchants created the double-entry bookkeeping system, a method of recording all transactions with at least two columns
or accounts, that underpins the structure of financial records today. An Italian monk named Luca Pacioli recorded the system in his math
encyclopedia, and word of the process quickly spread. 32
In the modern economy, financial technology began to take off in the 19th century. The telegraph was first used for commercial purposes in
1838 to send messages using electric impulses (Morse code), and workers laid the first successful transatlantic cable in 1866, providing
the basis for “the first major period of financial globalization,” according to a history of fintech published by law professors Douglas Arner,
Jànos Barberis and Ross Buckley. 33
By the 1890s, thanks to the Industrial Revolution, the use of commercial credit spread. Whereas credit had previously been considered
“much more personal and more local”—something merchants extended only to those they knew—it was employed as a business tool by
the end of the century. 34
“Large retailers and companies such as Singer Sewing Machine rarely had personal connections to their customers—hadn’t grown up
with them or belonged to the same organizations; didn’t know whether or not they came from a family that always repaid its debts; and
often didn’t even live in the same community,” the Federal Reserve Bank of Boston wrote. 35
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Heavy machinery on board the vessel Great Eastern was used to lay the first successful transatlantic telegraph cable in 1866,
helping usher in “the first major period of financial globalization.” (SSPL/Getty Images)
Oil companies and department stores offered consumers what were called proprietary cards, which they could use only when doing retail
business with the issuing company. Even traveling to another region of the country limited use of the cards. 36
Still, many consumers remained at the mercy of pawnshops and loan sharks. It wasn’t until 1919 when General Motors introduced a
37
financing program for the middle class that installment credit, in which borrowers repay a loan in fixed increments, began to catch on.
Tech Takes Hold
By the late 1940s, the consumer credit market was in store for a number of technological breakthroughs. Brooklyn, N.Y., banker John
Biggins introduced the first bank credit card in 1946, called the Charg-It. When customers used the card, the bill was forwarded to the
bank. A few years later, in 1951, New York’s Franklin National Bank produced its own credit card for its customers. 38
Around that time, businessman Frank McNamara came up with the idea of the Diners Club, a cardboard card to be used for travel and
entertainment purposes. The company signed up hotels and restaurants, and diners could use the card for a fee, then pay the bill for their
purchases at the end of the month starting in 1950. A few years later, Bank of America launched the predecessor of Visa, and Chase
Manhattan Bank introduced the precursor to MasterCard. 39 American Express, which had specialized in travelers checks and money
orders, joined the pack with its own card in 1958. 40 One year later, MasterCard tried out the idea of the revolving balance, in which
customers would not have to pay their bills in full every month. 41
Card technology continued to advance in the following years. In the 1960s, IBM engineers began experimenting with the use of a magnetic
stripe on the cards to hold data.
“Our first cards were actually pieces of audio tape wrapped around the cardboard to simulate the bank card,” said Jerome Svigals, who
helped develop the technology, soon adopted by American Express. 42
Still, it wasn’t until 1967 that bank customers had ready access to cash, when the British bank Barclays unveiled the first automated teller
43 44
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machine, or ATM, in front of an excited crowd. 43 It was called a “robot cashier.” 44 As the machines became ubiquitous in later decades,
former Federal Reserve Chairman Paul Volcker in 2009 called the ATM “the most important financial innovation that I have seen in the
past 20 years” because it “really helps people and prevents visits to the bank.” 45
As the use of mainframe computers began to expand in the 1980s, more developments in the financial industry followed. Michael
Bloomberg, the media titan and former mayor of New York City, made his fortune with the introduction in 1982 of the Bloomberg terminal,
a computer monitor and keyboard that hooked up to the company’s mainframes and provided financial data and stock prices to banks
and traders. The terminals’ underlying technology is still used widely on Wall Street, although the devices have been replaced by a
subscription service providing data, analytics and news, accessible with a personal computer. 46
“Certainly, by the late 1980s, financial services had become largely a digital
industry, based on electronic transactions between financial institutions,
financial market participants and customers around the world,” wrote Arner
and his co-authors. 47
By the mid-1990s, the financial services industry overtook all others as the
single largest spender on information technology, a position it maintains
today. 48 And as internet access spread to households across the country,
online banking began to take hold. Citicorp, the predecessor to today’s
Citigroup, first used the term “fintech” in 1993 to describe a research project it
was undertaking, later known as the Financial Services Technology
Consortium. 49
“I think fintech has always been there, and in fact we called it that, but nobody
grabbed onto the name for probably 20 years,” says Chris Feeney, president
of BITs, the technology policy division of the Financial Services Roundtable, a
Washington trade association for large banks, insurers, asset managers and
credit card companies. “The firms have always looked at technology as a way
to enable business—both business growth and operating efficiency—and
certainly to offer better products to consumers and clients.”
In 1994 Stanford Federal Credit Union of California was the first financial
Michael Bloomberg introduced his eponymous terminal that institution to offer internet banking to all of its customers; the first successful
provided financial data to banks and traders in 1982. online-only bank, NetBank, opened two years later. 50
Fast forward to 2001 and online banking had become commonplace—19
million Americans were accessing their account information online, and eight U.S. banks had more than 1 million digital users. 51
According to Arner and his colleagues, “by the beginning of the 21st century, banks’ internal processes, interactions with outsiders and an
ever increasing number of their interactions with retail customers had become fully digitized, facts highlighted by the significance of IT
spending by the financial services industry.” 52
New Frontier
Fintech in its current form is the product of several societal trends in the late 2000s.
There was the financial crisis and the response from Congress and regulators, which placed new rules and restrictions on banks of all
sizes, especially under the Dodd-Frank Act, signed into law in July 2010. But the crisis’ timing and its fallout also aligned with a consumer
shift—in both demographics and demand. As these changes unfolded, it opened the door for innovative startups to find ways to fill
financial needs more quickly and cheaply than traditional banks.
“The birth and rise of FinTech is deeply rooted in the financial crisis, and the erosion of trust it generated. People’s anger at the banking
system was the perfect breeding ground for financial innovation,” wrote Rébecca Menat, director of communications at The Assets, a
Paris startup that helps businesses to trade assets. “Good timing, because digital natives (a.k.a. millennials) were becoming old enough
to be potential customers and their preferences pointed to the mobile services they understood and mastered, instead of bankers they
could not relate to. In this favourable landscape, FinTech providers came in, offering new and fresh services at lower costs, through well-
designed platforms or mobile apps.” 53
Millennial Online Payment Methods
Electronic banking and payments are becoming widely used by Millennials
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Source: “The Unbanked Generation: A Guide to the Financial Habits of Millennials,” First Data, http://tinyurl.com/jza8dof.
Millennials are increasingly turning to online and mobile banking methods instead of cash and checks.
Approximately 47 percent of Millennial consumers have transferred money to someone electronically, and 43
percent find online banking a valuable part of their day-to-day banking experience.
Pioneers in the online lending business, such as Lending Club, Prosper and OnDeck, along with crowdfunding platform Indiegogo and
mobile payment company Square, were early to the game, but the industry really took off around 2010. Investment in private fintech
companies has skyrocketed from less than $2 billion a year in 2010 to $19 billion in 2015. 54
“The T-shirt-wearing whizz-kids and their backers reckon that newcomers will do to JPMorgan Chase, [the London-based bank] HSBC
and the rest what e-mail has done to post offices and Amazon to bookshops,” The Economist wrote last year. “So far bankers have simply
failed to notice that their sprawling firms will become tomorrow’s low-margin utilities. Finance, all bits and bytes, is at heart a tech problem,
… [Silicon] Valley believes, and will be solved by tech companies, not the lumbering banking gerontocrats.” 55
Current Situation
Expanding Partnerships
As the number of fintech startups continues to grow, banks are beginning to bring companies under their wings early, through a variety of
relationship models. A number of banks, including JPMorgan, Wells Fargo and Barclays, have created their own incubator programs for
budding firms. 56 Others, including Spanish banks BBVA and Santander, are starting venture funds to support select startups. 57
Elsewhere, banks are banding together to experiment with new technologies that can compete with the startups. Some of the largest U.S.
banks recently announced their own mobile-payment platform, clearXchange, which allows customers to send money to each other
instantly, a rival to startup services like Venmo. 58
At the same time, the new crop of fintech firms is benefitting from an exodus of executive talent from the traditional banking industry. 59
Blythe Masters, a former executive at JPMorgan, is now CEO of Digital Asset Holdings, a blockchain company that works with the
underlying ledger technology employed by bitcoin. Mike Cagney, co-founder of online lender SoFi, which specializes in student loans and
other personal loans, started his career in banking before moving into financial technology. 60
The consulting firm Accenture estimated that investment in collaborative startups, those focused on enhancing bank performance, rose
138 percent between 2014 and 2015. Such investments now represent 44 percent of the more than $18 billion in total annual fintech
investments, with the remainder going to competitors that seek to directly challenge the offerings of traditional banks. 61
“[W]hile there is still more investment going into competitive fintech companies, there is a clear and growing appetite, from both sides, to
collaborate,” an Accenture report said. 62
But the report also noted that banks themselves remain minor players in backing fintech startups, both competitive and collaborative. They
invested $5 billion last year, less than 10 percent of the value of all the deals that took place. 63
There is some evidence that the trend is moving even further toward partnerships between banks and fintech firms, where banks can
benefit more directly from the innovations taking place.
“Banks are partnering to keep in the game and keep relevant,” David Gibbons, a managing director at Alvarez & Marsal, a consulting firm
64
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64
in New York City, told CNBC.
Regulatory Scrutiny
This summer has been an active one in the regulatory sphere. The Office of the Comptroller of the Currency (OCC), an independent body
of the Treasury that oversees national banks, the Federal Trade Commission and the White House all held fintech events focused on the
changing dynamics of the industry and what they mean for oversight. Because discussions are in their early stages, a fintech players have
the opportunity to shape the narrative about them in Washington.
“Technology has always been an integral part of financial services—from ATMs to securities trading platforms,” Adrienne Harris, special
adviser to President Obama on economic policy, wrote in a blog post about the White House event. 65 “But increasingly, technology isn’t
just changing the financial services industry, it’s changing the way consumers and business owners relate to their finances, and the way
institutions function in our financial system.”
The OCC is developing a regulatory framework for fintech companies, although knowledge of the details is limited. 66 Regulators are
considering a charter that would impose greater regulations on fintech firms but allow them to operate nationally more easily because they
could follow one set of provisions instead of various state laws. 67
In June the Financial Stability Oversight Council, an interagency body of bank regulators focused on rooting out threats to the financial
system, listed fintech as a possible area of risk.
“Financial regulators will need to continue to be vigilant in monitoring new and
rapidly growing financial products and business practices, even if those
products and practices are relatively nascent and may not constitute a current
risk to financial stability,” a council report warned. 68
The alternative lenders remain a central focus for the banking agencies. The
Treasury Department released a highly anticipated white paper in May that
made several recommendations, including stronger protections for small
businesses that borrow less than $100,000 and greater transparency
surrounding loan data and securitization.
The white paper also called for regulators to monitor how online lenders
perform if economic conditions deteriorate or more borrowers start falling
behind on repayment.
The report noted that “new business models and underwriting tools” underlying
the growth of online lending “have been developed in a period of very low
interest rates, declining unemployment, and strong overall credit conditions.” It
added that it “will be critical to monitor” how online lenders test and adapt
models if credit conditions become weaker. 69
The Federal Deposit Insurance Corp., which oversees state-chartered banks,
has also weighed in with guidance for financial institutions considering online
Square’s mobile payment devices plug into a tablet or lending. 70 The Securities and Exchange Commission, meanwhile, has
smartphone, facilitating acceptance of credit cards by small helped to write rules governing sales of securities in equity crowdfunding
businesses. deals. The rules took effect in May. 71
Elsewhere, the Bank of England, under Mark Carney, the bank’s governor,
has been at the forefront of promoting innovation in the financial industry. The United Kingdom’s central bank announced the launch in June
of an “accelerator”—a program to nurture development—for companies in the mobile payment and cybersecurity sphere to develop
blockchain technology, the underlying ledger technology used by bitcoin.
“Fintech should neither be the wild west nor strangled at birth,” Carney said at the announcement. “The Bank is devoting considerable
resources to ensure whatever develops is sustainable, not ephemeral.” 72
Legislative and Judicial Oversight
As the banking agencies consider next steps for fintech oversight, alternative lenders are carefully watching a case wind its way through
the courts. The Supreme Court declined to hear Madden v. Midland in June 2016, sending it back to a District court to proceed. The
plaintiff, New York State resident Saliha Madden, has argued that the interest Midland Funding tried to collect on overdue credit card debt
violated the state’s interest rate cap a nonbank owned the debt. Bank of America, which was not subject to the usury cap, had sold the
loan to Midland after writing it off as delinquent. A lower court had ruled that the bank’s legal right to collect interest above the state cap did
not transfer to Midland.
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While the case involves a bank and a debt collector, it could have implications for online lenders. A federal
appeals court ruled in Madden’s favor in May 2015, raising questions about how much interest online
lenders can charge in New York, Connecticut and Vermont, which fall under the jurisdiction of the court that
made the ruling. Future cases could potentially extend the reach of the decision to other states. 73
“It’s probably going to take a long time for effects to truly be felt,” says FBR Capital’s Mills.
Congress also is watching the case. Rep. Patrick McHenry, R-N.C., introduced legislation in July that would
allow debt buyers, including online lenders, to apply the same interest rates as the financial institution that
wrote the loan. The measure is part of a series of bills McHenry is backing called the Innovation Initiative. 74
The House Financial Services Committee’s Subcommittee on Financial Institutions and Consumer Credit
also held a hearing in July, chaired by Rep. Randy Neugebauer, R-Texas, on the state of online lending.
The Senate is starting to ask more questions about the development of the fintech market. Democratic
Mark Carney: Under his Sens. Sherrod Brown of Ohio and Jeff Merkley of Oregon wrote to bank regulators in July asking what the
leadership, the Bank of agencies are doing to ensure that fintechs, including payments firms, blockchain technology companies,
England launched a program to online lenders and others, are properly monitored.
nurture development of “These companies are changing financial services, and it is vital that the regulators and Congress
blockchain technology. understand all the impacts and take actions as appropriate,” the senators wrote. 75
Earlier, in April, the two senators and Sen. Jeanne Shaheen, D-N.H., requested that the Government Accountability Office, the
investigative arm of Congress, update its analysis of the fintech sector. Its first report on the topic was published five years ago.
“As we saw during the 2008 crisis, gaps in understanding and regulation of emerging financial products may result in predatory lending,
consumer abuse, or systemic issues,” the lawmakers wrote. 76
Looking Ahead
Transformational Change
Ultimately, the future of fintech—and what its rise means for the banking industry—depends on how both startups and traditional
institutions respond to economic and demographic changes in the coming years and decades, industry analysts say. The internet has
transformed the book industry (Kindle), transportation (Uber) and shopping (Amazon), and banking is already following suit.
“The way we think about banking products and services today, you come to a bank branch, you sign a piece of paper, we give you this
plastic card—every part of that process is being undermined and changed as a result of technology,” says Moven’s King.
But Ballentine, of the American Bankers Association, argues that relationship banking will still have a role in a digital world.
“A bank is more than just a lender in a community; they’re a partner in the community, they fund the Little League club. That can’t be
duplicated through a keystroke or algorithm,” he says. “One thing that can never be replaced is, if you’re having difficulty with your loan,
going to the bank to work that out. If you are familiar with a bank and the bank’s familiar with your business and the type of business that
you’re trying to open, those things are extremely important for customers.”
At the same time, as technology continues to advance, regulators too are likely to harness more-powerful computing systems to better
police the financial industry.
“I have a dream. It is futuristic, but realistic. It involves a Star Trek chair and a bank of monitors,” said Andrew Haldane, chief economist at
the Bank of England, in 2014. “It would involve tracking the global flow of funds in close to real time (from a Star Trek chair using a bank of
monitors), in much the same way as happens with global weather systems and global internet traffic. Its centre piece would be a global
map of financial flows, charting spill-overs and correlations.” 77
The question still to be answered is how well traditional banks and regulators can keep up—and how effectively they can integrate the
technologies and advances that industry newcomers are uncovering.
About the Author
Victoria Finkle is a freelance journalist based in Washington, D.C., who focuses on business, banking and public policy. She has written
for the New York Times, Inc. magazine, Bloomberg BNA and Washington Monthly, and previously worked as a staff writer for the American
Banker newspaper, covering Capitol Hill and consumer finance. Her previous report for SAGE Business Researcher was on behavioral
economics.
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Chronology
Ancient and Money and the foundations of the financial system begin to develop, as humans move away from a
Medieval bartering system.
Worlds
1000 B.C. The first primitive metal coins are exchanged in China.
500 B.C. People in Lydia, or modern-day Turkey, construct the first coins out of precious metals.
A.D. 800s The first paper money begins to be exchanged in China.
1494 Luca Pacioli, an Italian monk and mathematician, describes the double-entry bookkeeping method in a math
encyclopedia.
1800s–1940s The global financial system starts to coalesce and consumer credit is adopted.
1838 The telegraph is introduced for commercial purposes.
1866 A British ship named the Great Eastern lays the first permanent transatlantic cable, providing the foundation for the
rapid transmission of financial data overseas and the development of a global banking system. The project is financed
in part by City Bank of New York, now part of Citigroup.
1890 The use of credit expands as the U.S. industrializes, although pawnshops and loan sharks are also common.
1919 General Motors offers the first widespread installment payment plan for the middle class.
1946 John Biggins of Flatbush National Bank in Brooklyn, N.Y., introduces the first “universal” bank card, called Charg-It.
1950–2007 Credit cards, ATMs and digital banks point to the future of banking.
1950 Frank McNamara, an executive at Hamilton Credit Corporation of New York, introduces the Diners Club card, which
allows patrons to pay with a cardboard card instead of carrying cash at certain restaurants and hotels. They are sent
the total bill at the end of the month.
1960 IBM engineer Forrest Parry first uses a magnetic stripe to store data on a card.
1967 British bank Barclays unveils the first automated teller machine (ATM), called the “robot cashier” by some observers.
1970 The New York Clearing House Association, made up of New York City’s leading commercial banks, establishes the
Clearing House Interbank Payments System, allowing some of the largest banks in the world to electronically transmit
and settle payments.
1982 Businessman and former investment banker Michael Bloomberg sells the first Bloomberg computer terminals for
accessing stock prices and other financial information.
1993 Citicorp coins the term “fintech” to describe a bank research project.
1994 Stanford Federal Credit Union of California offers Internet banking to all its customers, the first in the country to do so.
1996 The first successful online-only bank, NetBank, opens for business.
2006 Prosper, the first online peer-to-peer lending firm, becomes available to the public; the company connects borrowers
and lenders through its website.
2007 Lending Club, an online lending company, opens for business, initially as an app on Facebook.… Apple launches the
first iPhone, providing new opportunities for digital firms in the financial technology space to reach their customers.
2008–Present The fintech boom begins to take off in the wake of the financial crisis.
2008 The financial crisis hits and Lehman Brothers files for bankruptcy on Sept. 15; banks severely constrict consumer credit
in the wake of the crisis and the ensuing recession.… Betterment and Wealthfront (then called kaChing) begin offering
online wealth managements services; also known as robo-advisors, the companies offer algorithm-based portfolio
management.
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