The ways people undertake financial transactions are undergoing disruptive changes today, with the rise of financial technology (FinTech) innovation. In a nutshell, FinTech is understood as an application of innovative technologies, such as blockchain, to financial services and processes.
Thus, the FinTech promise to modernize the financial sector is highly appealing, reaping active support from banks, policymakers, and regular end-users due to its promise of broader financial inclusion and greater efficiency, effectiveness, and resilience of the global financial system. Here we review the benefits of FinTech for the payments sector and examine how the integration of FinTech improves the financial transactions' efficiency on a practical level.
What is FinTech?
Fintech is a term defining the technology used to improve and automate the delivery of financial services. Most FinTech startups now utilize blockchain technology to create FinTech solutions due to its security and immutability vital for securing financial transactions among participants. Initially used to describe back-end systems of established financial institutions, FinTech has evolved into a broader umbrella term covering blockchain applications for education, retail banking, fundraising, cryptocurrency, investment management, etc.
FinTech is yet another sphere in which blockchain has found a beneficial application, apart from its rising use in the insurance industry and supply chain management, among other domains. Most financial sector players are highly optimistic about the future of FinTech, with over US $112 billion in investment in 2018 and expected market growth by over US $309 billion by 2022. Even despite the COVID-19 pandemic outbreak, the pace and magnitude of FinTech startups did not slow down significantly, suggesting that the technology thrives across the globe and enjoys high demand.
Why is FinTech popularity booming?
The secret to FinTech's popularity is the way it democratizes payments and gives universal access to a wide variety of financial services to people who previously were underserved or unserved by the mainstream financial sector. The spheres of FinTech application in finance include:
- Cryptocurrencies, blockchain, and ICOs
- Peer-to-peer lending and microlending
- Mobile financial services
- Financial regulation technology (regtech)
- Robo-advisors and wealth management
- Supply chain-related finance
First, the reason for FinTech's popularity is in the broader technological progress characterizing our era. In these conditions, technological changes cannot help touching upon every domain of human activity, finance included. The global community witnesses a massive transition to cloud-based solutions, which are much more scalable and cost-effective than offline, land-based operational models. New technologies also transform how data is stored, processed, and made sense of, generating "big data" that also finds its application in FinTech. Thus, the benefit of FinTech lies within better information management.
Second, FinTech gets increasingly popular as it follows the digitization trend worldwide. With so many services going digital, the financial sector also needs to keep pace with digital service adoption. Digital finance adoption rates are the highest among fast-growing middle-class populations and previously unbanked people. Thus, the ability of FinTech to deliver high-quality services without relying on dedicated physical infrastructure and the absence of a central controller become the critical drivers of FinTech adoption.
FinTech innovation and payment efficiency
FinTech-enabled financial services possess greater automation and are more user-oriented than traditional finance. Correspondingly, the users can expect better efficiency from such services due to their underlying innovative technology and the user's convenience in mind. Here are the key contributors to FinTech payments' efficiency:
The fundamental principle behind entrusting one's money to a bank or another financial service is trust. This is what decentralized financial solutions may be lacking, in contrast to officially licensed and certified banks and credit organizations. However, the FinTech industry has resolved the issue of security and trust with an effectively integrated feature – an ability to use smart contracts with all transaction validation details stipulated in them. In this way, both the sender and the recipient of funds are protected, completing the transaction on their side only upon seeing that the transaction's conditions are met. Such a feature eliminates the need for engaging a central controller (like a bank or auditor) without sacrificing any security measures.
The times of transaction completion in the bank's offices are long gone, with more and more people using desktop or mobile apps for transacting funds and assets online. As a result of broad FinTech adoption, users have gone further in their payment accessibility, enjoying risk-free transaction opportunities for personal and commercial transaction completion. Besides, with FinTech, payment solutions have become more automated and less intrusive, with little to no sensitive personal data required to open a wallet and complete the transfer.
FinTech is the Holy Grail for underserved and unbanked populations with a poor credit history or no loan track record at all. Based on the conventional scorecard principle, banks don't provide loans to people without a credit history. So, students or entrepreneurs planning their first startup have limited access to loans, having fewer business growth possibilities. FinTech applies more flexible, AI-driven methods of user creditworthiness analysis and avails many microfinancing and peer-to-peer lending tools to increase access to finance, thus giving broader business development potential to users.
The issues of identity verification, user validation, KYC, and anti-money-laundering practices adopted in traditional financial institutions serve as limitations for larger categories of users, hindering their access to financial services or complicating the process of financial transactions. FinTech is much more geared to user convenience, thus eliminating many barriers associated with centralized financial control. FinTech users serve as peer controllers (nodes) within the blockchain system, so they do not require external identity or transaction validation. Such an advanced level of automation thus guarantees decentralization without any security and asset integrity risks.
FinTech products are more flexible and user-oriented due to the use of AI and ML algorithms for big data analysis. Such analytical findings give a much better understanding of the services their clients need, user preferences, and the best timing and packaging of services so that they become the best fit for the target users. Loan credit risk is also calculated more flexibly, with AI algorithms giving better scoring to individuals without credit history based on their earnings potential.
Types of payments you can make with FinTech
While the ability of FinTech to transform how payments are made is well-known, few users understand the whole spectrum of transactions this change can touch upon. Here is a brief breakdown of the payment types and changes expected with greater FinTech adoption.
The consumer and retail payment sector is the financial service segment enjoying the quickest growth. With the advent and broader integration of FinTech alternatives, users worldwide have obtained the following opportunities:
- Mobile wallets enabling instant payments via smartphones
- P2P mobile payments
- Foreign currency exchange without the use of banking networks
- Real-time global payments
- Digital currency (asset) products
FinTech is adopted much slower in corporate finance, primarily due to safety and standardization concerns. Yet, there is still much potential for this technology in the wholesale and corporate sectors because of the broader trend toward digitization and financial modernization.
- Harmonization of national and international financial transactions, with the removal of nationally- and regionally-specific limitations. Like the ISO 20022 and XML and ASN.1 standard introduction for better international payment processing, FinTech can stimulate further harmonization and processing efficiency improvement.
- New lending options. FinTech enables much more flexible peer-to-peer lending and microfinance opportunities for SME growth.
- Implementation of Bank Payment Hubs (BPHs). The latter serves as a more optimized version of payment infrastructure, eliminating the complex bureaucracy, improving payment flows, and enhancing finance management.
- A new approach to supply-chain finance. FinTech solutions can help address the everyday challenges of global supply chains by adding transparency, user trust, and payment flexibility.
- Use of digital currencies in corporate and wholesale finance. Crypto assets and tokens are penetrating all areas of finance as more users see them as stores of value and means of ensuring instant, secure, and frictionless payments.
FinTech and mainstream finance
A rule of thumb suggests that FinTech solutions are initially designed as a threat or challenge to conventional banking services. They do so by offering greater accessibility and affordability coupled with similar privacy protection and asset security levels. Thus, users choosing FinTech are gradually distancing from traditional banking and finance in favor of more optimized, more automated, and more accessible financial solutions.
However, even given the rising popularity of FinTech software development and the growing use of such solutions among financial service users, one should not speak of the "either-or" scenario as the only possible solution. Evidence suggests that banks also adapt to the changing financial technology landscape by adopting innovative products and tools. Thus, their evolution takes place simultaneously with FinTech, enabling a more significant number of avenues for further fusion. At present, the scenarios of the banking sector's development in alliance with FinTech include:
- Improvement of traditional banking services with innovative integrated technology (better automation, user-friendly client interfaces, digitization of services, mobile payments, more flexible loans)
- The emergence of new banks to provide digital and enhanced digital customer experience (e.g., Neo-banks)
- Evolution of distributed banks based on the combination of traditional banking, FinTech, and Bigtech services
- Relegated banking services involving a fusion of incumbents, Fintech, and Bigtech in the financial service aggregator form
- Disintermediated banks (FinTech-only services)
FinTech and financial inclusion
The critical advantage of FinTech for large numbers of underserved populations is the increasing accessibility of financial services, such as financial transactions at home and abroad, microfinance, peer-to-peer lending, loans, mobile payments, etc. The promise of FinTech is global financial inclusion, which is good news for the unbanked population. Inclusion is primarily achieved with the help of mobile payment systems, implementation and delivery of financial services for the poor, and financial literacy initiatives. Besides, FinTech startups are targeted at enhancing the micro-entrepreneurial capabilities of the underserved population and empowerment of traditionally marginalized populations (e.g., women in some communities, impoverished populations, etc.).
Is the future of finance about FinTech?
As the analysis of FinTech adoption in payments shows, the payment sector is experiencing large-scale, far-reaching innovation today. The introduction of digital innovation disrupts the way payments are done and changes users' preferences and choices in this area.
FinTech has faced broad acceptance because it managed to address the major bottlenecks of conventional banking services, such as limitations for marginalized populations, high commissions, high entry barriers (KYC, identity verification), and slow, cumbersome processing of transactions. FinTech draws on blockchain technology to solve the most widespread payment problems and gives people broader access and higher affordability of transactions coupled with enhanced security and privacy.
The future is cloudless for FinTech, with traditional banking giving way to innovative alternatives. However, it is too early to talk about the demise of traditional finance as banks are also responding to the challenge of change proactively. With banking services evolving to incorporate the latest innovations and striving to incorporate broader user categories into their service coverage, FinTech is likely to remain a healthy alternative or even an integral component of the evolving banking sector.