Even though the digital age finds its root in the 1950s with the rise of computers, we had to wait until the mid 1990s and the rise of the internet to witness a first wave of tectonic shifts and the creation of what many defined as the New Economy. Innovation, characterized by the application of technology to productive means and resulting in driving down costs relentlessly over time, was hard at work. This first wave did not escape the rule and we saw the cost of “discovery” plummeting. By discovery I mean the ability to find any type of data. Google benefitted from this trend and built an empire based on hyper efficient search. We also benefitted from another wave that saw the cost of “communication” dropping and the rise of various forms of connecting between humans. Facebook can be viewed at the intersection of discovery and human connections. Apple benefited from the connection/communication wave. Finally, Amazon mined the decreasing cost of discovery in the e-commerce field.
More recently, we have benefitted from the wave of “personalization” where a myriad of applications have unbundled past needs, uncovered needs we did not know we had, or disintermediated needs that were poorly serviced. Again, this wave resulted in the cost of personalization plummeting.
Crucially whenever costs plummet, demand grows in both expected and unexpected ways. The New Economy and our demand have certainly exploded.
It is interesting to observe that the financial services industry did not immediately espouse these waves, nor did it find itself materially impacted by them, or at least it appears so to the naked eye. For example, banks were not particularly diligent in their internet banking efforts at that time. Even though new technology companies won the early stages of the New Economy and even though the financial services industry did not register any “win”, we also can categorically state that banks or insurance companies did not lose. They still command, to this date, market share and dominance in all five sectors – lending, capital markets, insurance, asset management, payments – in every geography.
The fintech movement, in its first two phases, the “direct to consumer” phase and, once that first phase failed, the “partnership pivot” phase were essentially driven by the necessity to play catch and for the financial services industry to capture the lower costs of “discovery” and of “connecting” with users. Much needs to be done as most participants have not completed their digital journey. Even though startups and incumbents alike are still mostly focused on digitizing front end processes – on-boarding, distribution, sales, underwriting amongst others – we have now seen a broadening of the digitization movement towards middle and back office processes.
Still this has not resulted yet in a dramatic lowering of costs in financial services and an increase in demand. To be clear, the cost of lending will never “decrease” below an incompressible cost of capital. The cost of delivering a loan should decrease, and in other sectors, the cost of of a payment (be it domestic, p2p, mobile, cross border, b2b) has yet to decrease across the board.
Meanwhile, the technology world is busy reinventing itself and as the waves of discovery, communication, connection and personalization are flattening, new waves are engulfing us. I will focus on two technologies which I believe are the leading candidates to usher the next wave – again characterized by reduced costs and demand explosion: Artificial Intelligence and AR/VR
Artificial Intelligence holds the promise of bringing our decision making to the next level. Any of the AI vectors – machine learning, deep learning, nlp/nlg/nlu to name a few – will drive down the cost of “decisioning”. By decisioning I mean the ability to arrive at optimal decisions via superior analysis of mountains of disparate data and in the absence of clarity. Most technology companies are locked in an epic arms race hiring the right talent, developing their own AI tech stacks and applying their technology breakthroughs to their fast evolving business models. The next wave may indeed see the rise of cognitive enterprises and cognitively enhanced individuals.
AR/VR holds the promise bringing our interaction with the world to the next level. I understand there are differences between AR and VR and for the purpose of this post will assume them away. AR/VR will drive down the cost of “immersive discovery”. By immersive discovery I mean discovery in action, using the full capabilities of our bodies in movement, in our three dimensional world; as opposed to the discovery we have done to date from behind a laptop or a smartphone. Given the explosion of supply and demand ushered by the plummeting cost of “discovery”, I leave you to imagine what this wave may be able to bring about.
Although it seems AI holds a slight edge over AR/VR currently based on maturity and traction, I do not definitively know which wave will be dominant first at scale, either in the enterprise or retail world. Suffice it to say that either wave will pose unique challenges to the financial services industry. Challenges inherent to customizing, designing, implementing and integrating each new technology paradigm. Challenges inherent in making use of and making sense of these new technologies with the right human skills. Finally, competitive challenges in the face of what we can only assume will be renewed pressure from non financial services enterprises ever more willing to capture poorly defended margins in lending or payments.
Although threats from fintech startups or tech companies have not been successful in eroding meaningful market share yet, many industry analysts believe that up to half and sometimes more of incumbents’ revenues are under threat. I believe this analysis does not fully include the implications of the lower cost of “decisioning” or “immersive discovery”. As such financial institutions may be under even more threat than we realize.
Be that as it may, a reasonable and well educated practitioner will healthily push back and raise two objections to the demise of financial institutions at the hand of the potential dislocating effects of the above digital waves. One is articulated around regulation, the other around core systems.
Regulation is tedious, complicated and costly and serves as a defensive moat. In some instances it can be a drag as financial incumbents cannot act as flexibly or nimbly as non-regulated entities. Still, regulation acts as an effective digital fire retardant. Regtech not only holds the promise of lowering the cost of compliance, it also holds the promise of lowering the cost of developing and disseminating regulation to the market. Should regtech lower the cost of compliance to such an extent that fintech startups become more competitive or non-regulated tech companies become less averse to regulation, then regulated financial institutions will come out weakened, all else being constant. I am not predicting this will happen, yet the likelihood should not be discounted altogether
Core systems in the market today are cumbersome, expensive to build, expensive to maintain. Even though financial institutions – banks or insurers alike – dislike their vendors with the intensity of a thousand suns due to the woeful inability current core systems exhibit operating in a digital world, the fact is not everyone can afford core systems. Imagine a world where the cost of building, provisioning or deploying a core system would plummet and you are one step closer to another incumbent competitive advantage vanishing.
Although the future of regtech and core systems is more difficult to predict than a presidential election, the trends clearly point towards cost and complexity reduction and even though the full effects of either the lower cost of “immersed discovery” or “decisioning” are still be be felt, they cannot be avoided. These new digital waves hold the potential to drastically lower the cost and complexity of “building a bank” or “building an insurance company”. Obviously, regulatory capital, liquidity and solvency issues will still hold, but picture a world where building a core stack will be as easy as building a web site and where the cost will be a fraction of what it is now – to the dismay of the entire value chain of third parties currently feasting on any implementation, from consultants to systems integrators – and you can start grasp the monumental changes afoot. Digital waves keep coming and most financial institutions are still standing. How will they respond to the coming waves is an important question to ask. How will incumbent service providers cope is equally intriguing. How fintech startups exploit gaps will be fascinating to witness.
ps: no blockchain was harmed while writing this post.