17. April 2020
Michal Dallos (8 articles)
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Fintech Business Models + Case Study

What is a Fintech?

Fintech refers to companies that integrate technology into their financial service offerings in order to change the way how financial assets are created, managed and exchanged. The extensive utilization of technology allows fintechs to streamline their operations and manage risks in a different, very efficient way comparing to traditional financial institutions. These companies are also establishing entirely new ways of customer relation. By adopting an ‘inclusive finance’ approach, they allow a much broader customer segment to access financial products and services.

Despite the sophistication of the utilized technology, the customers do not need to be IT-experts at all. In contrary: easy to use mobile apps or web pages (= high quality user experience UX) allow clients to obtain a tailored product in just few clicks at any time from any place in the world.

Brief History: The Origin of Fintechs

It is interesting to notice that the interconnection between banks and technology had already started since the end of the 19th century. In the beginning, the technology was mainly used for transfer-related services in the form of cable telegraphs. The next milestone was the launch of calculators and ATMs in 1967, marking the starting point of the transformation from an analogue to a digital industry. Already since the mid-1990s the financial services industry has become the primary customer of IT-products and services, leading to over US$ 197 billion of IT-related spending in 2014.

The broad usage of the term fintech started after the Global Financial Crisis (GFC) in 2008 when startups entered the market and began to “attack” the establishment of financial services. This development was empowered by the following factors, a constellation that resulted in an ideal ‘fintech breeding ground’:

The Aftermath of Global Financial Crisis

Bad reputation of banks after 2008: the public perception of the responsibility of banks for the financial crisis damaged the reputation of many formally trusted institutions. Customers were more than ready to seek financial services elsewhere.

Increase of regulations on banks after 2008: the changes in banking regulations after the GFC aimed for: 1. improving the resilience of individual banks, which means reducing the risk of financial institutions’ failure; 2. improving the resilience of the financial system in total, which means reducing the systematic impact when a large institution fails, and 3. reducing the risk of bailout in a future financial crisis. All these regulatory efforts, combined with a very low global interest rate level, have led to a significant reduction of the profitability of banks – thus weakening the traditional players in the financial services market.

Broad availability of internet & smartphones

The level of internet utilization after the year 2000, followed by the popularization of smartphones a decade later, allowed companies to reach customers anytime, anywhere. This entirely new Customer Channel (CH) had been ignored by traditional institutions for a long time but was immediately embraced by fintechs (and other startups).

Shift in customer expectations

New digital business models are based on the principle: everything-immediate-everywhere. This leads to the expectation of highly personalized services via digital customer interaction. In consequence, companies utilizing digital business models are more capable in keeping a tight Customer Relationship (CR) than traditional banks. An additional motivator is the customer convenience: it is much more convenient to open a bank account on your cellphone, than going to a bank, waiting in the line and dealing with a possibly unmotivated employee handing you over a pile of documents to be filled out.  

Unregulated market for P2P lending, crowdfunding, and mobile payments

While for banks and other traditional financial institutions there has been a significant increase in regulatory requirements after 2008, the newly designed business models operate in a widely unregulated market. The reason is obvious: since many new business models utilize novel concepts like peer-to-peer or crowd-funding, the regulators have to follow the developments.

Investors’ willingness to fund fintechs

After the burst of the dot-com bubble in 2000-2002, investors became less ready to invest in tech-related companies. Particularly in Europe, the venture capital market virtually disappeared for years. This situation has improved since 2008 and investors are financing startups again – not only in the financial services sector.

Initial Business Strategy of Fintechs: Unbundling

Many traditional financial institutions have developed over time to become universal service providers. Let’s take the example of a universal bank, an institution providing commercial banking, investment banking and other financial services such as insurances. The numerous activities of a universal bank can be categorized into customer relationship business (such as saving and loan services for customers, wealth management, corporate banking, …), product innovation business (development of products saving and retirement funds, standardized loans, …) and infrastructure businesses (covering payment processing, ATMs, IT-infrastructure …).

The strategy of startups to enter the financial services market as specialist-firms is to overperform the universal service providers in individual services, hereby unbundling these services in the market. These specialists provide only a limited range of services with a much better value to the customers than the established generalists.

The following image shows an example of the situation in 2015:

Unbundling the Bank, source: CB Insight

Categories of Fintechs

The host of fintechs can be grouped into the following categories:

1. Payment
2. Insurance
3. Financial Planning & Cash Management
4. Lending
5. Trading & Investment
6. Data & Analysis
7. Security & Blockchain

Payment processing, mobile payment, reward programs, prepaid & credit cards

Examples: Alipay, PayPal, Klarna, TransferWise, Square, Circle, Flywire, Remitly, AeroPay, Doxo, DailyPay, Q2ebanking, Headnote, Plastiq’s

Underwriting, insurance brooking, claims & risk management

Examples: Oscar, Insureon, Lemonade, Knip, Bima, Slice Insurance, Trōv, Neos, Acko General Insurance, ZhongAn

Personal finances, retirement planning, enterprise cash management, tax & budgeting

Examples: Strands, Slice Technologies, Mint

Corporate & personal loan, mortgages, P2P lending, crowdfunding

Examples: Avant Credit, SoFi, Asset Avenue, LendingClub, Funding Circle, DianRong, Kabbage, Creditshelf, Symbiont, LendingHome

Investment management, roboadvisory, trading pricing + algorithms + IT, trading platforms, brokerage & clearing

Examples: Succession Advisory Platform, Wealthfront, Motif, Nutmeg, Betterment, Cadre, Ellevest

Big Data provision + analysis, data visualization, predictive analytics, data providers

Example: Credit Benchmark, Solivis, Metromile, Digital Reasoning, Kreditech

Digital identity, authentication, smart contracts, fraud management, cybersecurity, payment + settlement via blockchain, digital currency

Examples Security: Verimi, Veracode, TeleSign
Example Blockchain: Coinbase, Quantempla, Ripple Labs, Shapeshift, Symbiont, Xapo, Bitfury Group

Case Study Creditshelf and Iwoca: German lending sector fintechs

Creditshelf, founded in 2014, is a pioneer of digital SME financing in Germany. This multi-sided platform arranges loans for SMEs in a segment from 100.000 to 5 million euros, with a duration up to 60 months and no physical collateral security required. This segment is typically not served by traditional banks, while Credishelf makes these loans investable for institutional and professional investors. The proprietary algorithm enables an efficient risk analysis, allowing a digital-only loan assessment based on uploaded documents. The processing period is only 48 hours, comparing to several weeks in traditional banks. July 2018 Creditself raised a total of 16,5 million euros when it went public.

Source: Own research of Business Modell Company

The loan segment below 100.000 euros in Germany is served by a different fintech market player, the UK based iwoca, founded in 2011. Since 2015, it provides in the German market loans in the range from 1.000 to 100.000 euros, based on various AI modules that analyze numerous online platforms as well as bank account data of the borrower. The processing and the payment of the loan is typically below 48 hours.

Fintech Sector toward the End of 2019: Maturing and Re-Bundling

As the fintech sector evolves, we can observe trends of its maturing.

Increase in late stage funding

In 2019 there was a shift from early stage seed and Series A funding towards Series B+ funding. This is a clear sign of maturing. In Series A (2020 in US: average funding is ~$14 million with average ~$20 million pre-money valuation), investors allow startups to finish their product development and to execute their go-to-market strategy; for a company to qualify for Series B funding (with triple size in funding), it needs to demonstrate a strong achievement in terms of market footprint.

Business Model: Rebundling of Services

When a sector matures, the next logical step is the rebundling of services. This trend can lead to two directions: either traditional banks incorporate fintech services or the fintech startups group their services.

Examples of banks acquiring startups are numerous: ING Diba incorporating Scalable Capital in its offering and acquires the lending platform Lendico, Hauck & Aufhäuser acquiring Easyfolio and develops Zeedin, Depobank taking over Prestacap… The list goes on and on.

The same applies for the bunding of services: ‘neo-banks,’ namely bank fintechs like Fidor, Penta, and N26, are integrating into their offering billing, accounting, and more services previously provided by other fintechs.

However, the most impressive example of the fintech sector maturing is the rise of new giants such as Ant Financial Services (part of Alibaba). In mid-2019 Ant Financial was the most valuable unicorn in the world. With $150 billion of valuation it was more valuable than Goldman Sachs ($79.46 billion) and Morgan Stanley ($79.05 billion) combined.

Case Study: Ant Financial Services

Ant Financial Services 蚂蚁金服 has its origin in the payment system Alipay, founded in 2004 as a payment department of Taobao to meet the challenge posed by eBay’s acquisition of China’s Eachnet.com. Alipay was designed to enable transactions between customers and merchants – in a society where these two parties lacked mutual trust in each other. The solution is as following. After the customer placed an order, Alipay escrows the purchase price, which will be transferred to the merchant only until the customer has received the product. The key value proposition is not the execution of the financial transaction, but setting up a trustworthy relationship between sellers and buyers in a society with very limited credit cards usage. Alipay has solved the key problem that once challenged the Chinese internet marketplace: distrust.

In 2008 Alipay entered the mobile payment business. In 2011 it introduced the QR code payment method, which allows offline stores equipped with an individual QR code to process a mobile payment by letting customers scan the code with their cellphones. This convenient and cost-effective application, with only 0,6% of processing fee and no POS equipment purchase required, has led to a surge in the number of users. In today’s China, the QR code payment is the most popular payment method, where even the smallest market purchases are made cashless. With 870 million customers in March 2018, Alipay processes ca. 50% of the online transactions in China and has approximately 6x as many registered accounts as PayPal and 4x as Amazon.

Source: Own research of Business Modell Company

In October 2014 Alipay was rebranded as Ant Financial Services, leaving Alipay to be the mobile wallet and payment service. Ant Financials Services started to expand with numerous additional financial services:

Yu’e Bao
Ant Insurance & Ant Fortune
Zhima Credit
Hua Bei
MY Bank
Jie Bei
Zhao Cai Bao
Xiang Hu Bao

Yu’e Bao 余额宝 (means ‘Leftover Treasure’ in Mandarin), launched in 2013, is a personal investment management platform. Users can collect their unused, hence “leftover” balance deposited in their Alibaba e-commerce accounts to invest in short-term fixed-income instruments. The Yu’e Bao investment account is linked to other Alibaba accounts, allowing a back-and-forth transfer on demand. The acceptance of this service is extensive: in 2018 around 50 million users entrusted Yu’e Bao with about 250 billion yuan. Reasons for its striking success are: 1. extremely low participation threshold of only 1 yuan; 2. minimization of transaction costs comparing to other established players like banks, and 3. higher returns than commercial banks.

Ant Insurance 蚂蚁保险 and Ant Fortune 蚂蚁财富, both launched in 2015, are platforms allowing insurances and financial institutions to engage customers directly and efficiently, selling, respectively, insurance and wealth management products and services. AI is employed in operational optimizations, marketing and risk management processes.

Zhima Credit 芝麻信贷 (or Sesame Credit), launched in 2015, is a private credit scoring and loyalty program of Alipay, providing a score system for individual users, collecting both online and offline information. High credit score allows for example an easier access to loans from Ant Financial and results in a more trustworthy profile on e-commerce sites within the Alibaba Group. Even baihe.com, a Chinese dating portal, uses Zhima Credit data as a part of its desirability rating system.

Hua Bei 花呗 (Ant Credit Pay, meaning ‘let’s spend’ in Mandarin), launched in 2015, is a virtual credit card, allowing ‘buy first pay later’ ranging from 500 to 50.000 yuan. There are two forms of repayment: 1. buy this month, pay next month with up to 41 days interest-free period, and 2. Ant Installment with payback periods of 3,6,9 or 12 months. On the due day, Hua Bei automatically deducts the balance from Alipay, Yu’eBao accounts or a debit card. In case of insufficient funds, a daily interest of 0.05% is charged.

MYBank 网商银行 (Ant Micro Loan) was introduced in 2016. This service provides micro-credits to small businesses in China, in particular to three categories of borrowers: 1. people in rural areas; 2. internet startups, and 3. Taobao/T-Mall sellers. The loan volume is limited to 5 million yuan. MyBank operates entirely virtually, with an extremely streamlined big data operations approach. Within minutes of submitting the application form, the loan is approved and the money is wired to the borrower.

Jie Bei 借呗 (Ant Cash Now, meaning ‘let’s borow’ in Mandarin), launched in 2015, is a consumer loan service allowing Ant users with high Sesame Credit scores (above 600) to obtain a credit line ranging from 1.000 to 50.000 yuan, with a duration of up to 12 months.

Zhao Cai Bao 招财宝 (Ant P2P lending platform, meaning ‘wealth-generating treasure’ in Mandarin), launched in 2014, allows small businesses and individuals to directly obtain a loan from investors, provided that a financial institution has guaranteed the loan and would repay in case of a default. The loan has an average size of 70.000 yuan, duration 3-12 months with an annual interest rate of 3-5% and is divided among up to 200 investors.

Xiang Hu Bao 相互宝 (meaning ‘mutual protection’ in Mandarin), launched in October 2018, is a health insurance with an entirely new business model. Traditional insurances build an investment fund, based on monthly insurance premium payments in order to provide future protection. Xiang Hu Bao follows the strategy of a mutual aid network against 100 types of critical illnesses, including thyroid cancer, breast cancer, lung cancer, critical brain injury and acute myocardial infarction. After a member becomes sick, s/he is entitled to a cash payout. After initial approval of a case, the expenses are borne by the entire Xiang Hu Bao collective. Micro-payments members are thus linked to individual cases. Ant Financial claims 8% management fee on all expanses paid out, while ceiling the first-year payment to 188 yuan. Acceptance criteria for the participation in Xiang Hu Bao is a Sesame Credit over 650, no pre-existing conditions, no record of continuous medication over a prior 30-day period and age below 50. The identity is tracked by blockchain technology. Participants in their 40s can claim up to 100.000 yuan, and younger members up to 300.000 yuan. By the end of 2019, Xiang Hu Bao has attracted more than 100 million participants.

Future Trends in the Fintech Sector: Outlook 2020+

As already stated, the fintech sector is currently entering a maturing phase. This trend will strengthen as expected. In addition, following key trends are likely to be observed in the next future:

Increasing of fintech’s customer base

More and more customers are likely to use fintech services and products. This is mainly due to two factors: 1. Customers increasingly accept the services offered by fintechs, the performance of which is ever enhancing. 2. Fintechs continue to strengthen the ‘inclusive finance’ approach, addressing hereby additional customers segments.

According to the World Bank, there are still 1.7 billion “unbanked” adults in the word, who have no account at a financial institution or through a mobile finance provider. Approaching this customer segment, hence ‘serving the unserved’ located mainly in developing countries and emerging economies, will be one of the future key trends to observe.

Consolidation of the fintech sector

The appearance of new fintech giants is the natural consequence of the fintech sector maturing. ‘Digital-only bank’ will become increasing common. ‘Universal fintechs’ are likely to become the digital counterpart of the traditional ‘universal banks’, providing the customers with all financial related services as well as related scorings from a single source only.

Big Data & Fintech

Analysis of structured and unstructured information will continue to help fintechs to outsmart the traditional financial institutions not only in terms of customer segmentation, but also in fraud detection and risk management. Utilization of the Big Data approach will also strengthen the ‘inclusive finance’ approach of fintechs, as already demonstrated by Ant Financial Services.  

Further advances in technology

Advances in AI / deep learning, blockchain and quantum computing will provide in the foreseeable future a solid technological basis for new business models. These new approaches will lead to new services, such as: smart financing models, decentralized finance, enhanced cryptography – to name a few.

Advances in technology will remain the key for the advancement of fintechs, after all, fintech stands for ‘financial technology’.

Fintechs and the Corona Crisis

In April 2020, when this article is being written, the end of the corona crisis is not yet foreseeable. We all do not know what the “new normal” is going to look like. However it’s likely to differ from the past 10 years of economic growth.

From fintech’s perspective, on the bright side: in the current crisis, all business models relying on direct human contact are suffering. As fintechs utilize computer, mobile and internet technologies in order to reduce physical personal interaction, they are likely finding themselves amoung the winners in 2020. This is in particular true for larger, well established fintech companies on the market.

On the dark side: as observed in many previous crises, investors are among the first to stop their activities and to reduce they willingness to invest. This will hit the early stage fintechs particularly hard, whose business models are not yet proven. Many startups, hence many fintechs, may not make it through the crisis.