October 24, 2018

Financial Services Disruption Is The Future

The Wall Street Journal has published an excellent piece on Ant Financial, a major disruptor in China's financial services markets. Titled 'Jack Ma's Giant Financial Startup is Shaking the Chinese Banking System' it reviews both the successes to date and upcoming challenges as it navigates the changing regulatory landscape.

Its role in China's banking system is remarkable. As the article notes:

It handled more payments last year than Mastercard , controls the world’s largest money-market fund and has made loans to tens of millions of people. Its online payments platform completed more than $8 trillion of transactions last year—the equivalent of more than twice Germany’s gross domestic product.

Ant Financial Services Group, founded by Chinese billionaire Jack Ma, has become the world’s biggest financial-technology firm, driving innovations that let people use their phones for buying insurance as easily as groceries, enabling millions to go weeks at a time without using physical cash.

Their growth has attracted complaints from competitors and restrictions from regulators including stopping use of Ant's credit scoring system and limiting Ant's high yield asset mix. Bank-style capital requirements may be next.

The vice governor of China’s central bank, without specifying a company, recently warned that some influential payment institutions shouldn’t think of themselves as “too big to be regulated.”

Ant executives reject the notion their company is acting like a bank without oversight. They say they are simply bringing financial services to people the banks have ignored.

Whether regulators are protecting incumbents or protecting the safety and soundness of the financial system is likely in the eye of the beholder. Other fintech companies backed by JD.com and Baidu have pledged to offer less direct banking services and work as platforms for traditional banks.

Ant's size is breathtaking. It has more than twice as many users as PayPal. Payment transaction volume is almost 70% greater than Mastercard's. It seems that Ant has won consumers and businesses with its convenience, ease of use, and low costs. But the regulatory changes will alter its business model. It wants to be known as a 'technology provider or “lifestyle platform,” with future profits coming mainly from fees from institutions using its technology.' Having established itself as a standalone entity in 2010 Ant has leveraged its technology and data to make it easy for customers to boost returns on savings. They leveraged their data to create a credit scoring system. But as with other innovations regulators stepped in to hold them back. After initially encouraging private firms to develop credit scoring systems in 2017 they ruled that the systems 'were “far below qualification.” ' This year they licensed a state-owned company to nationalize credit scoring.

“If the banks do not change, we will change the banks,” Mr. Ma pledged at an entrepreneurship conference that year. An Alibaba unit later began making loans to some small businesses.

Disruption is here to stay. Incumbents can disrupt themselves by:

  1. Identifying segments underserved by existing FIs. One example would be customers served by check cashing and payday loan locations. Don't accept current cost structures that might make serving these segments unprofitable. Rethink policies and processes to eliminate costly steps to focus on delivering what these segments need.
  2. Eliminating pain points that make doing business difficult to impossible or just plain frustrating. Think of how Rocket Mortgage has shaken up the mortgage market by streamlining many steps in the process to offer pre-approval in days instead of weeks or months. They're not the cheapest but they have stripped other 'costs' from the application process while adding certainty.

The alternative is to rely on regulators to stifle competition. The costs that regulators impose are akin to tariffs. They will restrict competition while increasing costs. This advantages current players while raising costs for customers.

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