Banking on Change
Perhaps more important, fintech
innovations are complementary; progress in one enhances the
effectiveness of another and opens the door to further applications.
The first automobiles were essentially old-fashioned carriages with engines
strapped on; it took years for pioneers like Henry Ford to design a vehicle
specifically adapted to the new internal combustion engine. Looking back,
those early machines seemed to awkwardly straddle two eras. But such hybrids
are typical of periods of rapid technological change, when it’s not entirely
clear what products or services will emerge.
Today, financial services are in this transitional phase. On the one hand,
paying credit card or utility bills online is quick, easy, and cost-free.
(Although in some countries, online banking means emailing pictures of paper
checks!) On the other hand, cross-border transactions remain costly,
time-consuming, and cumbersome. But pioneers wielding new technologies
adapted to the financial sector—fintech, for short—promise to propel the
financial industry firmly into the digital era, just as similar trailblazers
revolutionized communications, media, and photography.
Consumers—whether people shopping for home loans and insurance policies or
companies paying for foreign inputs to production—benefit from faster,
cheaper, and more reliable services. New firms enter the financial services
industry, while incumbents face competitive pressure that forces them to
embrace the new technologies or go the way of the horse and buggy.
Policymakers must adapt existing regulations, or design new ones, as they
seek to bolster financial stability and prevent fraud, money laundering, and
The challenge for policymakers is to harness the benefits of fintech and
minimize the risks without stifling innovation, which calls for
international cooperation. Other questions worth considering, but not
tackled here, include the impact of fintech on access to financial services
in poor and remote locations, as well as its effect on the transmission of
Fintech embraces a broad array of innovations, including artificial
intelligence, biometrics, encryption, cloud computing, and distributed
ledger technology, or blockchains—which power virtual currencies such as
bitcoin. Technology, of course, has already had a big impact on financial
services; the first ATMs were installed in the late 1960s, and online
banking has become widespread where high-speed Internet connections are
But today, the pace of change seems to be accelerating. One reason is that
technologies themselves have recently benefited from significant
breakthroughs. For instance, 90 percent of the data available today was
generated in the past two years, reports IBM. In May 2017, an artificial
intelligence program defeated a Chinese grand master at the ancient board
game Go, surprising the many observers who thought that day of reckoning was
Perhaps more important, fintech innovations are complementary; progress in
one enhances the effectiveness of another and opens the door to further
applications. For instance, artificial intelligence combined with the
explosion of available data could automate credit scoring and allow consumer
and business borrowers to pay interest rates more representative of the
likelihood a loan will be repaid on time. So-called smart contracts,
benefiting from encryption technology and artificial intelligence, could
automate sale of investors’ assets according to predefined market
conditions, which would enhance market efficiency.
Investors are betting the new technologies will pay off. Total global
investment in fintech companies soared from $9 billion in 2010 to more than
$25 billion in 2016, according to a report by the accounting firm KPMG.
Market valuations of public fintech firms have quadrupled in the decade
since the global financial crisis, outperforming other financial sector
firms. Meanwhile, the public has taken a keen interest, judging by the
frequency of online searches for fintech keywords.
To see how new technology could transform the industry, consider why
financial firms exist in the first place. Most—such as banks, providers of
interbank messaging services, and correspondent banks clearing and settling
transactions across borders—are intermediaries. They stand between
counterparties such as borrowers and depositors to facilitate transactions.
They provide information on the counterparties, monitor them, and help
spread out the fixed costs of engaging in transactions, including the costs
of information technology and regulatory compliance.
The challenge for policymakers is to harness the benefits
of fintech and
minimize the risks without stifling
innovation, which calls for international cooperation.
New technologies could reduce the need for intermediaries. For instance,
registries of standardized customer information available to regulators,
along with customers’ digital identities, could lower the cost of customer
due diligence. And new technologies could offer more information on
counterparties, as in the earlier example of more tailored and precise
credit scoring, for instance. In both cases, intermediaries would become
Those that remain—and many will—are likely to change the way they are
organized. Much will depend on who owns and has access to customer data.
Currently, large financial institutions invest heavily to obtain information
on customers—such as their creditworthiness and transaction histories. That
information makes it easier to offer customers tailored services, from
payments to credit and investment advice. This encourages the one-stop-shop
model of banking offering a variety of financial services.
However, the amount of new data, and who owns it, could change that model.
End users—whether individuals or firms—could own the data they generate in
their transactions and business endeavors. In this scenario, customers would
be much freer to switch between financial service providers and to use
services of multiple providers. Another possibility is for new players to
enter the financial sector. Social media, large online retailers, online
entertainment companies, and Internet service providers increasingly control
data about our habits and preferences, and to some extent about our wealth
and transaction history. Will they partner with existing financial service
providers or venture into this space themselves? It is hard to predict, but
access to, and ownership of, data will give them significant leverage.
Barriers to entry will also evolve. The lower cost of offering financial
services—as a result of automated back-office tasks, including invoice
reconciliation—is likely to encourage entry.
But aspects of the financial sector will continue to favor a small number of
large firms, though not necessarily those operating now. Trust will be
vital; without it customers will never turn over their wealth, transaction
requests, and personal data. Customers must still trust the security and
stability of services, even if providers lose out to networks, markets, and
algorithms. Building trust, though, requires money—often lots of it.
Investment in brand recognition, information technology security and
stability, and regulatory compliance can be substantial and could dissuade
Network effects will also remain prominent. In finance, as in other sectors,
the ability to connect with other members of a network is especially
valuable. A credit card, for instance, is more attractive if the payment
network is extensive. But new entrants will have a hard time attracting
customers if they are excluded from existing networks. Regulation can help
by mandating some degree of interoperability between networks, as is the
case among cellular network providers.
Fintech will also pose numerous issues for regulators whose job it is to
buttress financial stability, protect consumers, and prevent monopolies.
Take algorithms, or machine learning. Relying on them to trade financial
assets could expose investors to the risk that all buyers and sellers will
engage in similar behavior, thereby amplifying price movements. They could
also fail or be compromised in a cyberattack. Any of these events could
undermine financial stability. Will regulators have to be software engineers
who can check the computer code that underlies the algorithms?
Protecting customer data is another challenge. New technologies such as
biometrics should theoretically make personal data safer by replacing easily
compromised passwords with unique human characteristics, such as
fingerprints or retina scans. But this approach presents new risks: a
compromised retina scan cannot be changed the way a compromised password
can. This is one reason Citigroup recently dropped plans for biometric
verification of customer identity at ATMs, according to The Wall Street
Journal. Nevertheless, new security approaches continue to be explored.
The availability of vast amounts of data also calls for the right balance
between privacy and transparency. New rules may be needed to protect
consumer privacy from cyberattacks. Regulators must also be on guard against
money laundering and terrorism financing—particularly when it comes to
virtual currencies, which can be designed to hide the identity of
transacting parties. There are questions about which data can be used to
tailor financial services—and how. Can financial institutions make those who
live in poorer neighborhoods, purchase alcohol, or listen to the “wrong”
music pay higher mortgage rates? Would this not amplify, rather than dampen,
The entry of companies such as Apple into the fintech market has blurred the
traditional definition of a financial services provider. Regulators may need
to respond by focusing on activities rather than well-defined entities such
as banks and brokerage firms. But regulating activities is not
straightforward if the related entities are quickly evolving. On whose door
must regulators knock to inspect business practices? Will they just have to
wait for users to lodge complaints to learn of new relevant institutions?
Will new technologies be invented to help automatically assess online
activities and service offerings?
Finally, even a well-designed domestic regulatory regime must have
international cooperation to remain effective. Technology knows no borders;
many services can easily migrate to less regulated jurisdictions. Greater
harmonization between national regulatory frameworks would help level the
playing field and facilitate the adoption of new technologies on a global
A recent IMF study, “Fintech and Financial Services: Initial
Considerations,” takes a close look at cross-border payments. This is an
area that appears ripe for disruption, given the trouble and expense of
sending money across borders. These shortcomings reflect the limitations of
existing technology, to some extent. Without an international central bank,
most payments are cleared and settled by private correspondent banks, which
incur costs but also benefit from significant market power. Some fintech
companies are nevertheless making inroads; one, for example, has been given
a pan-European banking license that enables it to process cross-border
payments directly for its business customers, bypassing banks, according to
Electronic tokens could have the biggest impact on market structure and
regulation. These tokens, which replace sensitive personal data with a
unique string of numbers, could eliminate the need for the cumbersome system
of bookkeeping banks use to complete electronic transactions—which requires
costly identity verification, accounts, liquidity and risk management, and
clearing and settlement services.
For now, cash is the only alternative to this costly system, but its
simplicity is offset by the danger of loss or theft. That could change with
the introduction of the electronic token, which can easily and safely be
transmitted across any distance. Tokens can be issued by private
institutions or potentially even central banks (which would make it a
digital currency rather than a virtual one). When tokens are exchanged, the
transaction is verified by, and broadcast to, a network—with or without
information on the parties involved. Tokens eliminate the possibility of
double spending (not reporting a payment to one party, in order to pay
another with the same funds) and reinforce the stability and safety of the
Networks for token exchange could bypass large commercial banks with the
press of a button and eliminate the need for separate messaging services
among banks. Just as email eliminated the distinction between sending
letters domestically and internationally, cross-border payments could be
greatly simplified using tokens.
Such networks may never take off. Trust is one reason. Will users trust new
digital wallet providers with their life savings? Though the transfer and
storage of tokens is relatively safe, they are still subject to fraudsters
who could instruct the digital wallet to undertake transactions in their
favor. And will the value of tokens remain stable over time, relative to the
fiat money issued by governments? For now, it does not seem so, but new
solutions are constantly being explored, and not all governments can be
trusted with the stability of their currency.
There is a good chance that a decade or two from now current financial
services will be seen as part of an awkward transition phase that was soon
to be superseded.