Fintech Sector: Vive la Revolution.

Bastille Day will be celebrated next month. Known formally in France as La Fête nationale it commemorates the beginning of the French Revolution with the storming of the Bastille, the symbol of the absolutism of the French monarchy, on 14 July 1789.

Much like the French Revolution, there is a new revolution in the works today with the rapid rise of the financial technology or FinTech sector, characterized as a battle between the old and new ways of doing business.

But what exactly is FinTech? The Wharton Business School FinTech blog defines it simply as an economic industry composed of companies that use technology to make financial systems more efficient.  

The explosive growth of the FinTech Sector is being fueled by a combination of innovative tech entrepreneurs (using disruptive business models) and billions in venture capital investments. Global investments in the sector exceeded $5 billion in 2014 according to Silicon Valley Bank estimates. 

The fintech space has reached the point where it is now considered competitive across all financial services categories: lending, personal finance, payments, retail investments, institutional investments, equity financing, remittances, consumer banking, financial research and banking infrastructure with well over 1,000 funded start-up companies in the sector.

Particularly vulnerable to such disruptive business models is the financial services industry including global and regional banks, investment advisory firms, financial information providers and securities brokers.

The Economist has defined the FinTech revolution as a wave of start-ups that is changing finance – for the better. They accurately observe that FinTech firms are not about to kill off traditional banks. But these start-ups will cut costs and improve the quality of financial services, unburdened by regulators, legacy IT systems and expensive branch networks.

Innovative data-driven lending will provide better ways to assess risk versus a single credit score or the meeting of a bank loan committee. Algorithms are more objective, and risk assessment using online information is better than a loan officer in a bank branch.

Barons boldly stated on a recent cover,“Meet Your New Advisor” that robo-advisors (using website backed by sophisticated software) will help put many investors into asset allocation models that meet their various financial goals. This change will bring high quality investment advice to the masses, for a fraction of what traditional advisors charge.

Two great examples here are Wealthfront and Betterment – which keep the process simple by asking users a few questions about their goals, risk tolerance and investment horizon. From there, algorithms provide an asset allocation, with zero human interaction. Brilliant.

The Wharton Business School's students observed the biggest obstacle to growth in the fintech sector will be psychological, as the financial services sector has long been dominated by big firms that are resistant to change, stalled by inertia.

But there is a blinding glimpse of the obvious here. The UX or “user experience” for small businesses and consumers with large money center banks and brokers is simply awful. It is expensive, impersonal and can be very unpleasant. Problem resolution is at times slow to non-existent.

David Reilly

While many large Wall Street firms have long chosen to ignore start-up (and develop software solutions themselves in-house) a number of firms are starting to take an interest. 

“We owe it to ourselves, our customers, our clients and our shareholders to cast a wide net and find new ways to solve existing and new challenges,” said David Reilly, a technology infrastructure executive at Bank of America. “Engaging with the start-up and venture capital community forces us to think about innovation in a different way, more revolution than evolution.”

Recently Goldman Sachs hosted a hack-a-thon featuring developers from Kensho, a firm that is out to shake up the $26 billion financial data industry,  dominated by Bloomberg and Thomson Reuters.

Kensho’s software gives the masses the type of complex, quantitative computer-generated data currently only available to top hedge funds like Bridgewater Associates. In essence, they offer a Goolge-type search for very complex investment questions, posed in plain English. Goldman was impressed enough by this cloud-based software data firm to invest $15 million late last year.

Daniel Nadler

Such an event reflects Wall Street’s growing recognition that the old-school view of ignoring start-ups may be short sighted. “There’s a certain cultural moment now that is quite palpable,” said Daniel J. Nadler, the 32-year-old chief executive of Kensho about the hack-a-thon and Wall Street's broader engagement with start-ups like his.

Fintech firms are using disruptive business models in their most positive sense – to cut costs, provide better / easier access to information, and improve the quality of customer service. And that formula will always attract new customers and drive long-term profitable growth. A fact that prescient venture capital firms have known about, and profited from for years.