Innovative disruption in the financial sector

Ladies and gentlemen, good day. I would like to extend my gratitude to the OECD for inviting me to this competition meeting to discuss the topic of disruptive innovation within the financial services sector.
I believe we can all concur that the pace of technological evolution has been, and continues to be, exceptionally rapid.
The world is progressively embracing digital solutions, with banking via smartphones and tablets now being the preferred method for customers to manage their finances. Mobile banking has surpassed traditional branch banking, and the internet stands as the most popular medium for banking in the UK. In 2015, customers conducted transactions worth £2.9 billion weekly through banking apps, a significant increase from the £2 billion in 2014.
Just last Wednesday, many of us from my generation couldn’t help but smile as it marked “Back to the Future day” – the date to which Marty McFly traveled forward in time from 1985. At that time, the hoverboard epitomized futuristic technology. Remarkably, the Lexus Hoverboard was conceptualized and brought to the market within a mere 18 months.
This prompts the question of whether the financial services industry is keeping pace with, harnessing, or being fundamentally reshaped by technological innovation. The first wave of the internet revolution ushered in online banking, much like online shopping offered a new platform for conventional services. However, the current wave of innovation is introducing a more diverse array of ideas, including peer-to-peer lending, where borrowers and lenders are directly linked via platforms without traditional intermediaries. This wave is often encapsulated by the buzzword “Fintech.”
Today, I aim to provide an overview of the Fintech sector in the UK and worldwide, elucidate the role of regulators within this landscape, and identify the disruptive elements witnessed so far.

Overview of the Fintech Sector

Global investment in Fintech tripled to $12 billion in 2014 compared to the previous year. The United States commands the largest share of this investment, but Europe, especially the UK and Ireland, is experiencing the most rapid growth.
The UK government has been notably supportive of fostering innovation in financial services, exemplified by the appointment of Eileen Burbidge as a special envoy for Fintech, tasked with advocating innovation in financial services on both domestic and global fronts.
Competition in retail banking and other financial services was already a concern pre-crisis, and the situation is even more precarious post-crisis, with increased concentration and the decline of former challenger banks. However, the emergence of Fintech in this landscape brings hope. Fintech is driving not only the new generation of challenger banks but also various businesses seeking to disrupt traditional banking in innovative ways, a much-needed shake-up.

Role of Regulators

This sets the stage for discussing the role of the Financial Conduct Authority (FCA) within this milieu.
The traditional role of regulators in innovation has typically been to “stay out of the way” and avoid favoring particular players. While we refrain from choosing winners, our mandate to promote competition gives us a role in this context. The FCA stands out among financial regulators for its competition mandate, which has been a statutory objective since April 2013. Consequently, our role centers on empowering consumers to make informed choices, encouraging new entrants, and nurturing innovation to enhance value in financial services.
Fintech companies often grapple with how to initiate conversations with regulators. In response, we established the Innovation Hub, a dedicated unit within the FCA tailored to collaborate with innovative businesses.
Like many other conduct regulators, we adopt a risk-based approach, allocating resources where the potential for harm is highest. This naturally leads us to focus on firms with a substantial customer base – the large incumbents – about whose outlook we have a fair understanding. However, our competition mandate necessitates that we consider the perspective of a different cohort – new entrants and challengers. We scrutinize how regulation affects their experience, whether our frameworks provide adequate protection, instill confidence in consumers, and foster an environment conducive to innovation.
To explore these issues, we launched Project Innovate in October 2014 and established the Innovation Hub within it. The Innovation Hub serves two primary purposes. First, it offers direct support to innovative firms, particularly Fintech companies that often grapple with aligning their business models with regulations designed for a previous era. Second, it fosters dialogue with the industry, probing for regulatory barriers hindering innovation and ensuring our frameworks evolve in sync with the changing landscape.
In this vein, we sought input from firms in June this year to understand the specific regulatory obstacles they encounter when innovating using digital and mobile solutions. The Innovation Hub is currently evaluating these responses, with the findings expected later this year.
Furthermore, the Innovation Hub is exploring the feasibility of a regulatory “sandbox,” a controlled environment where businesses, including newcomers and established players, can experiment with innovative products, services, and business models without immediately facing typical regulatory consequences. We will present the results of this feasibility study to the government later this autumn.
In its initial nine months of operation, the Innovation Hub provided ongoing support to 144 firms, with many more seeking assistance. We have established criteria for targeting our assistance, requiring firms to demonstrate innovation, conduct preliminary regulatory research, exhibit genuine need for support, and provide tangible consumer benefits – we do not endorse “innovative” tax planning!
Out of the 144 firms assisted, the Innovation Hub provided 51 informal steers. Unlike legally binding individual guidance, informal steers offer prompt and candid feedback on a firm’s regulatory considerations based on the information provided, though they carry their own risk.
The Innovation Hub also conducts themed events, like the recent three-day forum on the emerging robo-advice market. These forums facilitate dialogue with the industry, enabling discussions on innovative ideas and regulatory intricacies relevant to various segments of financial services innovation.

Payment Systems Regulator

I have discussed the FCA’s endeavors to promote innovation. However, it is imperative to mention the Payment Systems Regulator (PSR), a subsidiary of the FCA established in response to persistent challenges within UK payment systems. These issues primarily revolve around accessing payment infrastructure, particularly for new banks and challengers, as well as concerns regarding the slow pace of change.
The PSR is mandated to champion the interests of service users, foster competition, and promote innovation in payment systems. While the first two objectives align with typical regulator goals, the focus on innovation is unusual but pivotal.
The PSR’s innovation objective revolves around two key approaches. First, it aims to eliminate barriers hindering competitive innovation, ensuring that challengers can access payment infrastructure to facilitate fund transfers. Second, it emphasizes collaborative efforts that benefit all users of the payments system. When collaboration is essential for innovation, such as the establishment of messaging standards, it is imperative that these decisions consider the needs of all users, including challengers.
This bears substantial significance for the Fintech community, as payments innovation stands as one of the most active segments, with approximately 40% of the Fintech population operating within this domain.

What Does Disruption Look Like?

Now, let’s delve into what we are observing in the market in terms of disruptive business models. While it’s a diverse landscape, a common thread is that these models are technology-driven, well-branded, and committed to delivering a seamless customer experience, distinct from the traditional queue at a bank branch.
Allow me to commence with crowdfunding, including peer-to-peer (P2P) lending. The rise of crowdfunding stems from banks tightening lending practices, prompting small businesses to seek alternative avenues for borrowing.

Here are a couple of examples:

Funding Circle, one of the UK’s major P2P lenders, sources funds from savers and extends them to small businesses, claiming to eliminate most of the fees associated with traditional banks. Launched in 2010, the company has raised over £100 million in funding.
P2P foreign exchange platforms are eliminating intermediaries from currency conversion, offering mid-market or crowdsourced rates to customers and charging a flat commission rate of about 0.5% per transaction. Banks typically charge a margin of 1 to 5% on mid-market rates, in addition to transaction fees. Transferwise has gained traction in this market within the UK.
Recognizing the emergence of the crowdfunding/P2P market as something genuinely new, we adopted a tailored approach to regulate this sector, a model that other regulators globally are looking to emulate.
In banking, innovation is exemplified by Atom Bank, which aims to provide a complete online banking service without physical branches.
In the payments arena, we have witnessed innovations like digital wallets, contactless payments, and more recently, Apple Pay. It’s important to note that these innovations operate over existing payment infrastructure such as Visa/Mastercard and interbank systems. Thus far, we have not witnessed any substantial challenge to these systems at the infrastructure level.
Another innovation with transformative potential is blockchain technology, known for its use in Bitcoin, launched in 2009. Blockchain serves as a public ledger for virtual currency transactions and share trading. Virtual currency refers to digital representations of value not issued by a central authority but accepted as a means of payment, transfer, and storage.
To clarify, the FCA does not regulate virtual currencies, but we actively engage in discussions with regulators worldwide and the UK government, especially via the Financial Action Task Force on virtual currencies.

Conclusion

I have provided a comprehensive overview, although there remains much more to explore regarding innovation in financial services.
In my assessment, disruptive innovation has yet to pose a significant threat of expelling established incumbents from the financial services sector. Nonetheless, discernible benefits for consumers are beginning to emerge. I would like to highlight six key themes:

1. Cost Efficiency: Cheaper models, both through online-only provision and traditional banks optimizing multi-channel delivery, similar to the retail sector’s evolution.
2. Evolving Roles: Technology is reshaping the roles of human experts, extending beyond financial services to professions like education and healthcare. Machines are anticipated to outperform humans across various tasks, impacting markets such as financial advice.
3. New Markets: Firms like Aire in the UK are targeting previously underserved consumers, such as newcomers, by using data to create proxy credit records and facilitate credit scoring.
4. Simplified Payments: Beyond coffee shops, innovations like text micropayments and platforms like Justgiving make online donations accessible to various charitable causes.
5. Regulatory Technology: The concept of a “bank in a box” suggests banks can purchase technology solutions, including regulatory components, off-the-shelf, facilitating effective capability sharing.
6. Big Data: The implications of big data on competition merit a dedicated discussion. In financial services, big data is impacting marketing, pricing, credit risk assessment, and insurance underwriting, often by accessing information from social media or vehicle monitoring systems.

In summary, innovation within Fintech is thriving, and our role is pivotal in fostering it. We are witnessing disruptive elements, but for now, they are motivating traditional financial services to adapt, rather than presenting an existential threat. While competition in financial services may resemble the Uber model, we have not yet witnessed a “music streaming-style” upheaval.

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