Chapter#04

### Detailed Main Points

1. **Fintech Success Despite Challenges**:

- **User Acquisition and Valuations**: Fintech companies have managed to acquire millions
of users and achieve billion-dollar valuations, even though they face significant challenges in
scaling their operations.
- **Contrast with Incumbents**: Despite the hurdles, fintechs have outpaced traditional
financial institutions in leading technological innovation.

2. **High IT Spending by Banks**:

- **Investment Growth**: In 2018, IT spending by banks in North America grew by 4.9% to
US$104 billion, while global spending increased by 4.2% to US$261 billion.
- **Comparison with Fintech Investment**: Bank IT spending in 2018 was almost four and a
half times greater than the total venture capital investment in fintech for that year.

3. **Misallocation of IT Budgets**:
- **Maintenance Costs**: A large portion of bank IT budgets (more than two-thirds) is spent
on maintaining aging and outdated systems.
- **Regulatory Compliance**: A significant amount of IT spending is also allocated to updating
systems to meet new regulatory and compliance requirements, rather than on innovation.

4. **Legacy Systems and Technical Debt**:

- **Historical Technology Investments**: Banks have a long history of investing in new
technologies, such as the Remington Rand UNIVAC-1 in 1954, which leads to the accumulation
of technical debt.
- **Outdated Systems**: Many large financial institutions still rely on 40- and 50-year-old
legacy systems, which are stable but highly inflexible.
- **COBOL Dependency**: A significant portion of banking systems (43%) and ATMs (95%) still
use the COBOL programming language, developed nearly 60 years ago. This reliance on
outdated technology makes updates costly and complex.
5. **Challenges of Modernization**:
- **Specialized Talent Requirements**: Updating legacy systems requires specialized and
aging programming talent familiar with COBOL and other outdated technologies.
- **Modern Alternatives**: Fintech startups use modern programming languages and cloud-
based solutions, allowing them to implement changes more quickly and at lower costs.

6. **Cultural and Organizational Barriers**:

- **Bureaucratic Culture**: The culture within incumbent financial institutions is often
bureaucratic and risk-averse, stifling innovation and the adoption of new ideas.
- **Talent Attraction and Retention**: It is challenging for these institutions to attract and
retain top technical talent, further hindering their ability to innovate.

7. **Manual Processes Persist**:

- **Customer Onboarding**: Many processes within traditional banks, such as customer
onboarding, remain largely manual. New customers are often required to visit a bank in person
to present identity documentation and signatures.
- **Technological Alternatives**: Fintechs have automated many of these processes using
modern technologies like facial recognition software, which can be significantly more accurate
and secure than manual verification.

8. **Strategies for Incumbent Institutions**:

- **Building Capabilities**: Some incumbent financial institutions are attempting to build or
replicate fintech capabilities internally.
- **Investing in Fintechs**: Many are investing in fintech startups to gain access to innovative
technologies and solutions.
- **Partnerships**: Incumbent institutions are increasingly partnering with fintech startups to
enhance their offerings and stay competitive in the rapidly evolving financial landscape.

4.2: Incumbents Building/Replicating Fintech Offerings

 1. Standalone Fintech Offerings:
o Incumbent financial institutions can use modern tools to create new, standalone
offerings that integrate with their core systems.
o Examples include robo-advisors and payment tools.
2. Successful Examples:
o Charles Schwab's Intelligent Portfolio: Launched in 2015, it grew rapidly by
leveraging Schwab's established brand and customer base.
o Vanguard Personal Advisor Services: Another successful offering with
significant growth, reaching US$112 billion in assets under management by 2018.
o Comparison with Fintechs: Traditional institutions' offerings often surpass
fintech peers like Wealthfront and Betterment in assets under management.
3. Other Incumbent Innovations:
o HSBC's PayMe: A payment tool that quickly reached one million users.
o Bank of America's Erica: A chatbot that assists customers with daily banking
activities.
o JPMorgan's COIN: A machine learning system that automates document review,
saving significant time.
4. Collaborative Efforts:
o Zelle: A peer-to-peer payment service created by over 90 US banks to compete
with Venmo.
5. New Digital Banks:
o Goldman Sachs' Marcus: A digital consumer bank offering loans and high-yield
savings accounts. Since its launch, Marcus has attracted 1.5 million customers, $3
billion in loans, and $22 billion in deposits.
6. Challenges and Requirements:
o Separate Structures: Successful fintech initiatives often require separate
reporting lines, physical office space, and a culture distinct from the parent
institution.
o Support from Senior Management: Continuous backing from top management
is crucial but not always guaranteed.
o Deutsche Bank Example: Illustrates the difficulty of sustaining fintech projects,
as seen with Deutsche Bank shelving its digital bank plans in 2018 after a change
in CEO.

4.3: Incumbents Investing in Fintechs

1. Acquisitions and Investments:

o Instead of building in-house, many financial institutions invest in or acquire
fintech startups.
o Example: Blackrock acquired FutureAdvisor in 2015 and invested in Scalable in
2017.
2. Corporate Venture Capital (CVC) Funds:
o Financial institutions like Goldman Sachs and Citi have set up CVC funds to
invest in fintech startups.
 o From 2013 to 2017, Goldman Sachs made 37 major fintech investments, focusing
on lending, while Citi made 25, focusing on databases and security.
3. European Investments:
o Banco Santander has invested in 19 fintech startups through Santander
InnoVentures.
o Insurers are also investing in insurtech firms through their venture arms.
4. Challenges of Corporate Venture Capital:
o Financial institutions are newcomers to venture capital, facing competition from
established fintech-focused VCs.
o Risk of adverse selection: financial institutions may only see startups that top VCs
have passed on.
5. Strategic Objectives:
o Unlike traditional VCs, CVCs prioritize strategic benefits such as access to
insights and potential partnerships over financial returns.
6. Startup Concerns:
o Fintech startups may fear incumbents using their investment to learn and build
competing products.
o Accepting investment from one financial institution might deter others from
partnering or investing due to competitive concerns.

4.4: Incumbents Partnering with Fintechs

1. Increasing Partnerships:
o Over 82% of incumbent financial institutions expect to increase fintech
partnerships in the next three to five years.
2. Small Business Lending:
o Partnerships help incumbents combine their scale and capital with fintechs'
streamlined processes.
o Examples: JPMorgan Chase partnered with On Deck Capital, and Santander
partnered with Kabbage.
3. Other Financial Services Partnerships:
o Munich Re partnered with insurtech startups, providing capital and expertise.
4. Cultural Differences and Innovation Labs:
o Fintechs and incumbents have different cultures and values, leading to partnership
challenges.
o Incumbents often create internal innovation labs to facilitate collaboration and test
new technologies.
5. Challenges of Innovation Labs:
o Labs may lack executive support, meaningful budgets, and authority.
o Labs sometimes serve more for PR than for actual transformation.
o High turnover in innovation teams due to frustration and lack of empowerment.
6. Internal Resistance:
o Innovation lab projects often face resistance from staff focused on immediate,
measurable economic impacts.
o Tension arises between long-term innovation goals and short-term performance
metrics.
Chapter 5: The Emergence of Techfin

1. Shift in Focus:
o Attention is shifting from fintech startups to large technology companies
(techfins) as potential disruptors in financial services.
2. Advantages of Techfins:
o Existing User Base: Large tech companies already have vast user bases (e.g.,
Google’s one billion Gmail users, Facebook’s two billion accounts).
o Frequent User Interaction: They engage with users daily through digital
channels.
o Data and Personalization: They possess years of user data to personalize
financial offerings.
o User Trust: Users are comfortable sharing sensitive data with these tech
companies.
3. Potential for Disruption:
o Users are open to financial products from tech companies they already use.
o A survey by Bain & Co found that nearly 60% of US bank customers are willing
to try financial products from tech firms.
o 73% of millennials are open to switching to techfin products.
o Over 80% of respondents in China and India are willing to purchase financial
products from large tech firms.

China as a Template for the Growth of Techfin

1. China's Leading Role

 Integration of Financial Services: In China, major technology firms, Tencent and Alibaba, have
successfully incorporated financial services into their digital platforms. This has made them
leaders in the techfin space.

2. Transformation of Payments

 Alipay and WeChat Pay:

o Alipay: Launched by Alibaba in 2004 to facilitate online payments.
o WeChat Pay: Launched by Tencent in 2011 as part of their messaging app WeChat.
 User Base:
o WeChat: Over 1 billion users globally, with 800 million using WeChat Pay.
o Alipay: Over 620 million users.
 Market Share:
o In 2016, Tencent and Alibaba controlled 90% of the $8.8 trillion mobile payments market
in China.
o This dominance in mobile payments is significantly larger compared to the West, where
mobile payment transactions are much smaller in scale.
3. Expansion Beyond Payments

 Diverse Financial Services:

o Loans, Credit Scoring, and Wealth Management: Both Alibaba and Tencent have
expanded into these areas.
 Ant Financial:
o Yu'e Bao: Alibaba's financial arm, Ant Financial, includes Alipay and runs Yu'e Bao, the
world's largest money market fund, with $266 billion in assets (as of March 2018).
 MyBank:
o Launched by Alibaba in 2015 to offer financial services to individuals and small
businesses.
o Operational Model: Online-only, processes loans in under three minutes without human
involvement.
o Growth: By leveraging Alibaba’s user base and Alipay’s data, MyBank rapidly grew,
lending $65 billion and serving over seven million small business owners by October
2017.

4. Consumer Integration

 WeChat’s Versatility:
o Multi-functional Platform: Users can perform various activities like transferring money,
paying bills, buying products, booking services, and more, all within the WeChat app.
o User Engagement:
 WeChat users spend significant time on the platform, with more than one-third
spending over four hours a day.
 This is much higher compared to other platforms like Facebook, where the
average user spends about 22 minutes a day.
 Cultural Integration:
o Digital Red Envelopes: During the 2018 Chinese New Year, 688 million WeChat users
participated in the tradition of sending or receiving digital red envelopes, highlighting
the app's cultural significance.

Summary

In China, technology giants like Tencent and Alibaba have effectively integrated financial
services into their platforms, transforming the payments landscape with Alipay and WeChat Pay.
They dominate the mobile payments market and have expanded into other financial services like
loans and wealth management. Platforms like WeChat have become essential parts of users' daily
lives, offering a wide range of services and keeping users highly engaged. This level of
integration and user engagement showcases the potential for techfin models to disrupt traditional
financial services globally.

Alibaba’s and Tencent’s Expansion Beyond Payments

1. Diversification of Financial Services:

 After establishing dominance in payment services, Alibaba and Tencent expanded their offerings
to include various financial services like loans, credit scoring, and wealth management.

2. Ant Financial's Money Market Fund:

 Ant Financial, Alibaba's financial arm, operates the world's largest money market fund called
Yu’e Bao, with assets under management surpassing those of traditional financial institutions like
JPMorgan.

3. Tencent's Wealth Management Products:

 Tencent provides extensive wealth management products through its platform, offering direct
access to products from major mutual fund managers in China.

4. Agility and Scalability:

 Leveraging their technological capabilities and vast user data, Alibaba and Tencent rapidly deploy
and scale targeted financial offerings, catering to specific market segments and facilitating future
expansion.

5. MyBank's Inclusive Solutions:

 Alibaba's MyBank, launched in 2015, focuses on providing inclusive financial solutions for
individuals and small enterprises previously underserved by traditional banks.
 MyBank's online-only model and automated loan processing enable it to extend smaller loans
quickly, leveraging Alibaba's user base and customer data.

6. Implications for Consumers:

 Chinese consumers' financial activities are deeply integrated into their digital lives, particularly
through platforms like WeChat, which offer a wide array of services beyond finance.
 WeChat's extensive services facilitate prolonged user engagement, with users spending
significant time on the platform daily.

Simplified Summary:

Alibaba and Tencent, after dominating payment services, expanded into other financial sectors
like loans and wealth management. Ant Financial operates the world's largest money market
fund, while Tencent offers various wealth management products. These companies leverage
technology to swiftly deploy tailored financial solutions, like Alibaba's MyBank, which serves
underserved individuals and small businesses. In China, digital platforms like WeChat integrate
financial activities, encouraging users to spend considerable time on these platforms daily.
Explanation of Sections 5.2.3 and 5.3:

5.2.3 Alibaba’s and Tencent’s International Expansion

 WeChat's Reach:
o WeChat has over 70 million users outside of China, with availability in 25 countries and
13 currencies, mainly focusing on ASEAN countries.
o However, the full range of services may not be accessible to users outside China.
 Alibaba's Presence:
o Alibaba and its subsidiary, Ant Financial, have a significant stake in Paytm, a major Indian
e-commerce and payment company with over 100 million users.
 Global Ambitions:
o While current efforts are concentrated in Asia, signs of expansion like Alipay terminals in
Honolulu and WeChat ads in the London Underground indicate global aspirations.

5.3 Early Techfin Developments Outside of China

 Global Interest:
o Tech giants worldwide are observing Alibaba and Tencent's strategies, aiming to replicate
their success in financial services.
 Facebook’s Approach:
o Facebook is exploring payment functionalities within its Messenger app, already
available in the US and the UK, with potential expansion to Europe and India.
 Kakao's Success:
o South Korea's leading messaging app, Kakao, launched a digital bank that attracted over
a million account openings and $1 billion in deposits within a week.
 Amazon's Involvement:
o Amazon has ventured into small business lending since 2011, extending over $3 billion in
loans to thousands of companies, leveraging its data advantage from its platform.
o It has also explored innovations in payments through services like Amazon Pay and
Amazon Go.
 Speculation on Amazon's Future:
o Rumors of Amazon acquiring banks like Capital One circulated, but direct entry into
banking is challenging due to regulatory barriers.
 Strategic Positioning:
o Instead of directly entering banking, tech giants like Amazon, Apple, Google, and
Facebook strategically choose aspects of financial products to integrate, avoiding
regulatory hurdles and building trust for potential future expansion.

Summary

 Chinese tech giants like WeChat and Alibaba are expanding internationally, focusing on Asia but
showing signs of global ambition.
 Other global tech companies are following suit, with Facebook exploring payments, Kakao's
success in South Korea, and Amazon's significant involvement in lending and payments.
 Rather than direct entry into banking, tech giants prefer strategic integration of financial
services, leveraging their existing platforms and customer trust for future opportunities.