Digital disruptors: offering threats and challenges

By Malanee Hutton

Digital disruptors are rapidly changing numerous sectors the world over. And South Africa is no exception. Even though local industries are being challenged at a slower pace, our research has shown that in recent years there have been ground-breaking innovations. That is noteworthy, given the subdued macroeconomic environment.

As a bank that prides itself on being at the forefront of innovation, RMB was keen on understanding the pace and nature of change being wrought by digital disruptors and after engaging with more than 100 players, we were pleasantly surprised. Savvy consumers are now more adept at using new technologies and with that shift has come a greater demand for efficient yet affordable products and services.

New capabilities such as Blockchain technology, data analytics, machine learning and Artificial Intelligence (AI) are now shaping financial services, the insurance industry and related legal fields.

It’s a shift in paradigm we’re embracing to ensure that RMB places itself in a position to leverage these new developments to better serve our clients.

In brief:

  • Blockchain technology has the potential to dramatically change financial services and legal transactions by cutting out the “middlemen” and the red tape, thus saving costs in a manner that had not been envisaged before.
  • A growing number of companies are using data analytics for a range of functions, including selecting stock options.
  • AI and machine learning are being deployed in a range of fields, including what’s now defined as RegTech or regulatory technology. Instances where RegTech is already being used include the implementation of Know Your Customer rules, saving much time and money; and in getting consumers to comply with the Financial Intelligence Centre Act.
  • Insurtech is a broad term referring to innovations that are disrupting current insurance industry models. Existing models make use of broad actuarial tables to assign policy seekers to a risk category. That ultimately results in a certain number of customers paying more than they should, because only basic data is used to make the determination. But with the greater use of data collected from technologies such as GPS and activity trackers, risk profiling can be more nuanced. Last year one of the new players in South African insurtech became the first insurance start-up to be accepted into Google’s Launchpad accelerator. It uses an app to tailor quotes for new customers. Photos of items that are to be covered are identified by an AI system and quotes for premiums are sent back to customers for acceptance. The new player is underwritten and reinsured by established companies.

But it is perhaps to be expected that the largest numbers of start-ups are in FinTech businesses, a hybrid of financial services and technology and they are rapidly entrenching themselves in numerous aspects of our lives. Through simpler and cheaper services, they are driving financial inclusion at a pace never seen before.

In South Africa, the most disruption has been in retail banking, but investment banking and capital markets are also vulnerable to threats from the newcomers. And the relative sophistication of the local financial services industry does not make it immune to the threats posed by FinTech start-ups.

However, if the innovations possessed by these startups are seen as opportunities, then the sector will be better positioned to identify areas for collaboration with the new players. In recognition of the pace change in the financial services sector and the risks and opportunities posed by FinTech, the South African Reserve Bank last year released its Project Khokha report.

Project Khokha was a simulated use of distributed ledger technology or Blockchain technology in the South African banking system to test the resilience of the system. A FinTech Unit that was established in 2017 is examining the new technology’s strategic and regulatory implications for the country.

RMB’s own study has yielded some fascinating insights. At the heart of the FinTech ecosystem are the startups run by entrepreneurs who are out to disrupt traditional financial services. We found that most entrepreneurs are mostly tackling retail payments and remittances.

Through innovation they are addressing the need for greater financial inclusion of people in rural and underserved areas; providing basic banking to the previously unbanked consumer; and making payments and money transfers simpler with lower fees. By providing simpler, faster and digitised options in retail banking, they are tackling a real burden for consumers.

The entrepreneurs behind the FinTechs themselves offer interesting case studies. Many had built their products or services with a team of two-to-five individuals. In most cases, the startups were bootstrapped (they attempt to build the company without any official funding cycles, preferring to pull themselves up by their bootstraps). However, the more mature businesses were looking for a strategic partner, a bank or large corporation in order to scale up their operations.

For instance, through the use of an app-based service, foreigners living in South Africa are able to send money abroad. Set up in response to the high cost of international money transfers to and within Africa, the service now operates in 10 countries. Retail cash points are used to send money to mobile wallets and it has around 1 000 agents in local communities marketing the product.

There are already collaborations between FinTechs and banks on open banking platforms where banks contribute their expertise in security, authentication and compliance and the FinTechs develop customer-focused solutions. This kind of tie-up ensures that customers enjoy a personalised banking experience under the protection of the banking industry while banks gain access to new revenue streams.

One of the more celebrated players in this turf was acquired by Visa in 2011 for $110m and is one of the largest providers of mobile financial services in the world, operating in more than 34 countries across Africa, Asia and the Middle East. Offering mobile financial services to unbanked and under-banked mobile subscribers, including person-to-person payments, bill payments, wireless airtime top-up, and ticketing, it illustrates the strides made in the sector.

Incumbent financial services players are realising the need to augment their services with those developed by FinTechs while maintaining existing customers and expanding into new markets. But they are grappling with the new relationships in an environment that is still fluid.

There are five ways in which links between established players and new FinTechs are being built. They include capital investment by the banks in FinTechs; the use of the FinTech’s products by banks; through mergers and acquisitions; specific programmes tailored for collaboration; and joint ventures.

Funding by FinTechs is harnessed from multiple sources, mainly venture capital investment, angel investors, private equity investment and from large corporates and institutions.  The SA SME Fund is a venture capital fund established by the CEO Initiative to support small and medium enterprises. It has R1.240 billion in investable capital.

Angel investors are generally high-net-worth individuals who invest their personal funds in startups in exchange for equity. According to the Southern Africa Venture Capital and Private Equity Association, in the period 2014 to 2016 angel investors were involved in 112 deals worth R122 million, indicating the rapid pace at which such investment has grown.

As opposed to the seeding and development capital provided by venture capital firms, private equity firms focus more on offering growth capital to businesses. Their concentration has tended to be on established, mature businesses and when it comes to FinTechs, they most likely identify businesses with a functional product or service and an established client base.

Our research has found that there is no “middle of the road” FinTech start-up. They are either in the mature stage of their businesses where they are in a position to spin off other businesses or new product lines or they plateaued in the early stage and the product was not adopted by the market.

In our observation, a strategic partnership offers the best model for success. It allows the start-up to flourish via some sort of capital injection, whether cash, mentorship or other resources. It also allows the incumbent the chance to gain a foothold in a new market or to further entrench themselves in a current market without having to build the capability internally. However, this engagement model is under-utilised and usually comes about through an existing relationship between the two.

Significantly, we have realised that the “pay-it-forward” model of Silicon Valley (where the start-up founders reinvest in the start-up community, having gone through a lucrative exit with their own businesses) is yet to be seen in South Africa. This indicates that the FinTech start-up community in South Africa is still relatively young, and entrepreneurs are focused on their own growth before investing in the growth of others.

Even though South Africa leads in innovation on the continent, according to the GSM Association, there are 135 mobile money services active in Africa. With the proliferation of smartphones and improved internet connectivity, digital platforms are rapidly become the norm for a range of services. The potential for local FinTech players to expand into the largely untapped markets across the continent is therefore immense.

South Africa, like the rest of world is at an inflection point as far as financial services innovation is concerned. To borrow from the quote made famous by Warren Buffett: “Only when the tide goes out do you discover who’s been swimming naked”.

Not harnessing the new energy created by digital disruptors in the sector will expose us to the risk of being swept up by a big, unexpected wave, or having a million little ones erode our current business models.

Access RMBs exclusive guide to, and analysis of, the South African FinTech landscape, including this year’s most influential and disruptive financial services companies. It’s everything you need to know. Clear. Concise. Expert.

Hutton is Head of Digital Capabilities at Rand Merchant Bank.

This article was published in partnership with RMB.

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