Fintech: a digital (r)evolution in the banking system

5 September 2019

Fintech is a recent phenomenon that is challenging the traditional financial and banking system. The first challenge that the system is facing is to find a unique definition, that might be shared by the entire economic community. After hundreds of research in the field, the common definition is that “Fintech is a global digital phenomenon, where technology is used to support and implement financial services”. The technologies that have supported the growth of the phenomenon are cybersecurity, data analytics, blockchain, peer-to-peer and robo-advising. The established areas of Fintech such as payments and lending still grow and in the last years the number of investors and the volume of the investments’ themselves have increased. Furthermore, businesses are now focusing on the development of areas of Artificial Intelligence and Data Analytics.

The real challenge for the traditional system lays in the fact that financial and banking sectors are highly regulated, consequently they tend to be quite sticky and adapt slowly to changes. The traditional system is challenged by the pace of Fintech development, which is really fast and by its effect, which are disruptive for the system. Indeed, Fintech is a source of opportunities for already established systems and for start-ups to reach a sustainable, long-term development. The main challenge is not being able to adapt the business model to this structural change and being left out of the market. The main opportunity for the system is the increase in speed of financial and banking transactions and the decrease in the costs of the transactions themselves. Indeed, Fintech might bring to a more efficient and interconnected financial system. Fintech is undoubtedly a source of value creation.

Nevertheless, Fintech is facing four challenges: trust, credit risk, innovation risk and regulation. Although the great potential and benefits that Fintech might bring to the financial system, these four elements might impede its success. Trust is fundamental among economic actors and technology cannot replace the role of trust. However, transparency and verification can be a replacement of trust, indeed Fintech is a trump card in financial and banking services where calculations or record keeping are involved. However, trust is partly sustained by proper regulation. Because of the nature of financial banking services, Fintech needs the support of regulation and governments to increase transparency and, consequently, trust. Regulation strengthens the relationship among consumers, investors and business, since with the right regulation they all feel protected in transactions.

Therefore, regulation is an instrument for the safeguarding and trust in the relationship between economic actors. Although many virtuous countries, such as Estonia, Gibraltar, Hong Kong are working hard in order to implement the right regulation and attract investments, many countries are struggling in finding a common point for the development of the appropriate regulation. By the way, United States and European Union are now making a few steps towards the creation of apposite regulation. Especially in European Union the focus on the development of regulation is leading to an increase in investments in Regtech companies, i.e. companies that monitor and advise firms to make them compliant to regulation. Then two other main risks are innovation risk and credit risk. Innovation risk is directly stemming from the lack of regulation. Indeed, Fintech can be successful only if the system is able to support it; therefore, innovation risk is the risk that originates from a mismatch between the innovation and the infrastructure supporting it, which is one of the risks underlying Fintech implementation, but if governments collaborate with each other can be overcome.

Credit risk is the risk that the borrower does not payback the future payments to the lenders. When considering P2P platforms credit risk must be considered. P2P platforms such as Lending Club or Prosper are working hard, in order to decrease credit risk, basing the choice of funding on objective measures, concerning the risk profile of an individual or business considering different characteristics of the demander of credit.
Fintech is fascinating because of the potential enclosed in it and the huge influence that has on financial and banking sectors. If the financial system manages to overcome the challenges and to implement fully Fintech services, protecting consumers, investors and business, then the value creation stemming from Fintech might be really huge and it would be able to create value that would have not been created otherwise.

This complex framework demonstrates how traditional financial institutions and Fintech startups are increasingly in need of new professionals, in order to make digital transformation a competitive advantage: it comes into contact with the didactic coordinator of our Master in Finance and Fintech to become an actor key to this process.

Author: Daniela Arzu

PHD Student at Alma Mater Studiorum Università di Bologna