This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on Nov 30 – Dec 6, 2015.

REGULATIONS should not be seen as a hurdle to the growth and progress of financial technology (fintech) services as they are meant to protect the interests of stakeholders and instil confidence in the nascent industry. 

Deloitte Touche Tohmatsu Ltd’s global leader for financial services Chris Harvey says that while a regulatory framework can be a burden, laying the foundation from the get-go ensures that the services offered adhere to market principles. 

“You basically design [the framework] from the start. I think one of the interesting things that is going on in other parts of the world is that regulators are working with fintech firms to make sure they are compliant when they launch in a market,” he adds.

Harvey was speaking on the sidelines of the Global Banking Conference 2015 organised by the Asian Institute of Chartered Bankers. He is the author of Deloitte’s recent report, titled “Staying ahead of the pack: How financial services firms are planning to win”, in which he talks about the measures being taken by financial services firms to transform their business in response to the disruption caused by these fintech firms.

The global financial services community has been through turbulent times in the aftermath of the 2008 global financial crisis, which saw regulators around the world imposing tighter capital requirements aimed at preventing another economic catastrophe. While the numerous measures have made it more difficult for financial institutions to do business, it has made room for innovative products with simpler structures in the marketplace, which was previously mired in complex offerings. 

Regulations such as the implementation of the Basel III capital adequacy requirements have seen banks tighten lending. As a result, the fintech sector is booming as it engages in deals ranging from online investing portals to mobile payment systems, and transforms financing operations and processes to make them more lithe, efficient and transparent.

Seeing immense potential in the burgeoning sector and aiming to lessen the country’s reliance on commodity export earnings, Malaysia is the first country in Asean to legislate the fintech industry. The Securities Commission Malaysia came up with a regulatory framework for equity crowdfunding in February, and is in the midst of formulating regulations to govern peer-to-peer lending platforms and automated investing, to name but a few.

While local regulators are keen to promote innovation in generating a vibrant and sustainable economy, they insist that parameters are necessary from the outset to instil credibility and trust. Stakeholders, however, have conflicting emotions about the move as they feel it could hamper innovation in the sector. 

Harvey asserts that a comprehensive regulatory framework is essential to protect the interests of investors.  Citing countries with a thriving fintech sector such as China, Harvey says regulators have actively engaged industry players to make certain that what comes out is right for the customer and marketplace. “Chinese regulators have been very forward thinking and have worked with a number of the fintech firms to launch new products and even new banks,” he adds. 

“Most of the regulations are actually pretty simple — not in terms of execution, but in terms of what [the framework] sets out to do. And it sets out to do the right thing, which is to protect consumers and the financial system. I don’t see it as necessarily inhibiting innovation. If it does, it is probably not the sort of innovation we want.”

Banking industry plays catch up

Fintech firms in developed economies such as the US and the UK are flourishing as the sector has gained recognition as the future of financial services. According to a banking industry white paper by MarketResearch.com and Banking Reports, global investments in fintech are expected to reach US$19.7 billion (RM84 billion) this year, almost double the US$10 billion last year.

The white paper — “Five banking innovations from five continents” — says 60% of all fintech investments originated outside the financial establishment while another 20% of investments went from banks to fintech companies. This is expected to rise to 40% by 2020.

The annual global investment in fintech firms is expected to reach US$46 billion by 2020. In 2014, the investments were led by the US (63%), followed by Europe (18%) and Asia (12%). 

Harvey notes that fintech firms, or disruptors as they have menacingly come to be known, are here to stay. And he is averse to blaming innovative products as the root cause of the 2008 global financial crisis. 

“I think if you look at the real seeds of the financial crisis, it was due to one of the more simple products that we have out there — mortgages,” he says. 

“It was actually created by the sale of subprime mortgages to individuals who really shouldn’t have got them. And then the way those packages of debt were treated, the way they were derivatised and sold on the markets. The reality was that the crisis was not created by derivatives, but derivatives enabled it.”

The great advantage of fintech firms is that they are free from the burden of legacy, complex systems and processes that other financial service providers are saddled with, says Harvey. “In many cases, they are unregulated so they don’t have to comply with all the regulations, like the banks. What they are doing is attacking specific parts of the value chain. 

“What they are not doing is taking on the full end-to-end — they don’t have balance sheets, they don’t have big technology stacks to look after. It is a lot easier for them, so they are seen as a big threat. You can see the deposit base of most banks being attacked by some of these new lending and deposit mechanisms that are coming in.” 

In September, Deloitte published its “Staying ahead of the pack” report on a global survey that showed financial services firms are transforming their business operations in response to these rapidly mushrooming disruptive entrants, not just by revamping their customer-focused technology but by digitising their backend processes. The survey had polled 200 executives from banking, securities, insurance and investment management firms around the world, and found that these firms were discreetly transforming their businesses in anticipation of the disruption in the industry. 

While avant-garde customer-focused technologies continue to be the priority, many of the financial services firms surveyed said they were overhauling their internal operations by their digitising processes.

Nearly two-thirds of respondents said they anticipated new industry entrants and were pursuing innovation to keep up with the potential disruptors.

“You can see the payment value chain already being disrupted by e-wallet services such as Apply Pay, PayPal and Ali Pay,” says Harvey. “The advice I normally give my bank clients is that they should be looking at where the most customer friction is — in other words, where it is really difficult to do business, and where that meets at the point of the greatest profit. These are the points that disruption is securing, which is why they occurred in payments, which is why they are occurring in lending and other parts of the banking value chain.”

Harvey says financial services firms are responding by innovating themselves and working with innovative organisations to essentially transform their infrastructure and provide similar products to those offered by fintech players. “The Lending Club [in the US], for example, is a major peer-to-peer lending organisation. In fact, the back end of all that are the banks.

“[Financial services firms] are also acquiring. They are going out there and being very selective and targeted. They are acquiring the fintech capability and bringing it in-house and using it to transform their services.”

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