IT training data science banking and fintech khotailieu

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Cornelia Lévy-Bencheton

Fitting It All Together

Data Science, Banking, and Fintech

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LSI

Data Science, Banking, and Fintech

by Cornelia Lévy-Bencheton

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Table of Contents

Data Science, Banking, and Fintech: Fitting It All Together 1

Yesterday’s Bank: A Rigid Culture, Strapped for Funds 2

Lending and Payments: The Behemoths 3

Value Delayed, Not Denied: Money Management 9

Going Bankless 14

Rebuilding Core 16

Tech Is Coming for Banking 17

iii

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Data Science, Banking, and Fintech: Fitting It All Together

Long considered an impenetrable fortress dominated by a few known names, the banking and financial services industry iscurrently riding a giant wave of entrepreneurial disruption, disinter‐mediation, and digital innovation Everywhere, things are in flux.New, venture-backed arrivals are challenging the old powerhouses.Banks and financial services companies are caught between increas‐ingly strict and costly regulations, and the need to compete throughcontinuous innovation

well-How does an entire industry remain relevant, authoritative, andtrustworthy while struggling to surmount inflexible legacy systems,outdated business models, and a tired culture? Is there a way forbanks and other traditional financial services companies to stay onbudget while managing the competitive threat of agile newcomersand startups that do business at lower costs and with better mar‐gins? The threat is real Can established institutions evolve in time

to avoid being replaced? What other strategies can protect theirextensive infrastructures and win the battle for the customer’s mind,heart, and wallet?

Financial technology, or fintech, is on fire with innovation and

investment The movement is reshaping entrepreneurial businessesand shaking the financial industry, reimagining the methods andtools consumers use to manage, save, and spend money Agile fin‐tech companies and their technology-intensive offerings do not shyaway from big data, analytics, cloud computing, and machine learn‐ing, and they insist on a data-driven culture

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Consider a recent Forbes article by Chance Barnett, which quantifiesfintech startup investments at $12 billion in 2014, quadrupling the

$3 billion level achieved a year earlier Adding to the wonderment,crowdfunding is likely to surpass venture capital in 2016 as a pri‐mary funding source And people are joining the conversation Bar‐nett writes, “According to iQ Media, the number of mentions for

‘fintech’ on social media grew four times between 2013 and 2014,and will probably double again in 2015.” All of this activity under‐scores how technology is rattling the financial status quo and chang‐ing the very nature of money

In this report, we examine the disruptive megatrends taking hold atevery level of the financial ecosystem by covering:

• An overview of the current banking industry

• Key participants and primary targets for fintech disruption,including lending, payments, money transfer, wealth manage‐ment, trading, blockchain, and cryptocurrencies

• Adaptive strategies of traditional financial organizations

Yesterday’s Bank: A Rigid Culture, Strapped for Funds

Established banking institutions are strapped The financial melt‐down in 2008 questioned their operations, eroded trust, and invitedpunitive regulation designed to command, control, and correct theinfractions of the past Regulatory requirements have drained budg‐ets, time, and attention, locking the major firms into constant com‐pliance reporting To the chagrin of some, these same regulationshave also opened the door for new market entrants, technologies,platforms, and modalities—all of which are transforming the indus‐try

For traditional banking institutions, focus and energy for innova‐tion are simply not there, nor are the necessary IT budgets Gart‐ner’s Q3 2015 forecast for worldwide IT spending growth (includingall devices, data center systems, enterprise software, IT and Telecomservices) hints at the challenge banks face: global IT spending is nowdown to -4.9%, even further from the -1.3% originally forecast, evi‐dence of the spending and investment restraint we see across thefinancial landscape

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With IT budgets limited, it is hard to imagine banking firms easilyreinventing themselves Yet some are doing just that Efficientspending is a top strategic priority for banking institutions Manybanks are moving away from a heavy concentration on compliancespending to instead focus on digital transformation, innovation, orcollaboration with fintech firms There is a huge amount of activity

on all fronts To begin, let’s review the competitive landscape ofprominent fintech startups

Lending and Payments: The Behemoths

To say there is no innovation in the banking world would be a grossmisrepresentation But most of the innovation is taking placearound the periphery of the financial mainland, not so much in corebanking Our first observation is clusters of venture-backed invest‐ing in transactional fintech Credit, with its inclusive functions oflending and payments, is the mainstay pillar of the banking worldand has been since the earliest times Consumers will always needcredit and will always need to make payments The sheer impor‐tance of credit and the huge volume of lending and payments trans‐actions worldwide make it a primary target for opportunisticentrepreneurs Even capturing a small slice of that huge revenue pie

is alluring because it promises a profitable business

NextGen Lending

A unique array of disruptors is jockeying for position, leapfroggingover debit and credit card processes, accelerating transactions withtap-and-go technology, reducing the need for (if not altogethereliminating) cash, and reinventing financial services While shaking

up the tired banking space with fresh competition, some newentrants are even providing a special way to impact the space forsocial good, educating consumers and welcoming brand new seg‐ments They are indeed taking a bite out of legacy banking’s marketshare and profits Some notable examples are listed here:

Lending Club and Prosper

Leading the way are companies like Lending Club and Prosper,both San Francisco–based peer-to-peer (P2P) lending compa‐nies billed as “marketplaces.” As financial intermediaries ratherthan bankers, they have created a Match.com–like model forlending, matching best of fit savers scenarios with correspond‐

Lending and Payments: The Behemoths | 3

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ingly appropriate investors Individual consumers and smallbusinesses alike can lower the cost of their credit and enjoy abetter experience with less wait time compared to traditionalbank lending Investors (or savers, as they are now called) bene‐fit from an advantageous risk-adjusted return.

What is truly original about these new firms is their sophistica‐ted data mining and analytics techniques To gather informationabout a given applicant, they sample from a wide pool of infor‐mation sources, including social media profiles, employmenthistory, GPA scores, and modeled future earnings potential.Rather than rely solely on financial or credit history, these lend‐ers focus on applicants’ current finances and future potential toscore their likelihood of being good borrowers This big-data-meets-lending method reduces risk and optimizes best availablerates for individuals or small businesses interested in loan con‐solidation, borrowing, or investment opportunities

Funding Circle

This UK “marketplace” for loans follows the same operationaland business model as Uber and Airbnb, where firms do notcarry inventory or merchandise but rather connect thousands ofpeople using nothing more than their own platforms and net‐works Similarly, Funding Circle operates in a P2P modewithout balance sheet inventory and without taking on risk Itsvalue is in connecting participants (investors who want to lendmoney) with businesses that need capital Not bound by reserverequirements, Funding Circle has loaned more than $1.2 billion

in the past five years to thousands of businesses in the UK andthe US Per Liat Clark in Wired Magazine, the main benefitcomes down to reserve requirements If a bank wants to lend

$100 billion a year, it would need $10 billion in capital BecauseFunding Circle does not need this capital up front, it “createsincredible amounts of efficiency,” says Funding Circlecofounder Samir Desai

Kreditech

Kreditech is a German company, not yet operating in the US,that has come up with an original way of scoring individualcreditworthiness They offer loans to individuals based on ananalysis of their online data, scored algorithmically Like Lend‐ing Club and Prosper, they do not rely solely on traditionalcredit rating information Kreditech focuses on lending money

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to consumers who are without a credit score and who conse‐quently don’t qualify for credit under traditional reportingmechanisms.

Kabbage

An online financing and data company, Kabbage has simplifiedthe manual bank loan application process, offering onlinefinancing to small businesses and consumers remarkablyquickly Using online social data and other tools for its under‐writing decisions, Kabbage has helped thousands of customerswho might otherwise face hurdles when financing through tra‐ditional Originally launched in the UK, Kabbage’s analyticsinclude sources such as business checking accounts, UPS ship‐ping data, and consumer details from large ecommerce sitessuch as Amazon, eBay, and Etsy

Additional entrants trooping in to take advantage of credit lendingopportunities are such nimble marketers as OnDeck, ZestFinance,

Fundbox, Planwise, Currency Cloud, Affirm, and Banking Up

Payments—Safety First

Because payments touch virtually every sector of the economy, it iscritical to provide security A big hit with consumers is the fraud-fighting Europay, MasterCard, and Visa (EMV) chip that is becom‐ing ubiquitous as it finds its way into the US credit card industry.Ron Mazursky, Director of Strategic Initiatives at Jack Henry &Associates and an expert in payment systems and banking, recog‐nizes the chip as “the next generation against counterfeit fraud incredit and debit cards at point of sale.” The chip has been incrediblysuccessful in Europe, with 90% of credit card terminals being EMV-enabled A squareup.com article reported the UK has seen a 70%decline in counterfeit transactions since adopting EMV, or chip,cards Canada reports that losses from counterfeit, lost, and stolencards dropped from 245 million Canadian dollars in 2008 to 111million in 2013 Meanwhile, credit card fraud is trending up in the

US, where fraudsters have congregated because they can’t hack thechip cards used abroad We can expect to see some needed improve‐ments in this area The US lost over $5.3 billion to credit card fraud

in 2013, up 14.5% since 2012

The EMV’s claim to security fame relies on a tech feature—it houses

a microprocessor chip that protects the card’s owner by blocking the

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capture of the account number at the point of sale and using a surro‐gate The EMV protocol is fast becoming a global standard provid‐ing greater protection against the use of stolen account numbers.Another development in the battle against fraud is biometrics,sophisticated tools to authenticate true cardholders Per Mazursky,

“The main biometric tools being developed and tested are finger‐print scanning, voice ID, photo ID and retina scanning, and we areseeing these applications grow due to improvements in technologyand the proliferation of smartphones.” The new iPhone 6, for exam‐ple, comes equipped with fingerprint ID technology Mazurskycontinues, “A number of large banks have already implemented bio‐metrics to identify bank customers, including USAA, BBVA, andothers.”

At the 2015 Money2020 show in Las Vegas, biometrics was a hottopic This market is forecast to be worth over $117 billion by 2020,according to research firm Acuity Market Intelligence Vendorsvying for a share of that revenue and looking to attract would-bebuyers were in Las Vegas to showcase their offerings to over 10,000attendees

Cash Avoidance

As a fundamental financial activity, global payment transactionsconstitute an enormous, growing, and profitable area of banking.The average consumer’s banking relationship is dominated by mak‐ing payments Consumers often interact with their banks severaltimes a day on payment-related matters, such as paying bills, buyingfinancial products, or checking on a payment status The frequency

of these interactions make payments an excellent platform for selling other financial services—it is not surprising that the pay‐ments sector is under disruptive assault, and that so many fintechupstarts are diving into the payments feeding frenzy According to aMcKinsey Global Payments Report (see Figure 1), global paymentsgrew 9% in 2014 and are expected to grow 6% per year for the nextfive years, compared to the 4% growth experienced in the precedingfew years

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Figure 1 Past and predicted global payments revenue growth (image courtesy of McKinsey Global Payments Map, used with permission)

Online payments

While the systemically important financial institutions (SIFIs) wereriveted by the financial calamities of 2008 and the enduring regula‐tory aftermath, startups and new market entrants from Silicon Val‐ley crept onto the financial scene PayPal may have started theonline payments revolution in the late ’90s, but its many followerstoday are looking to shake things up in a big way

Most notably, there is Square and Stripe These companies haveextended technology to physical payments and other value-addedservices for merchants and consumers, and thus have establishedroots in a market that banks used to dominate They have raised thebar, changing customer expectations about banks, probably forever.Founded in 2009, Square offers diverse aggregator and mobile pay‐ment services Its Square Register allows individuals to handily entercard details or swipe their card through the Reader, a small plasticdevice that plugs into the audio jack of a supported smartphone ortablet, to read the magnetic strip The platform, whose name implies

“square up” as in settling transactions or “fair and square,” is alsonotable as its cofounder, Jack Dorsey, is cofounder and CEO ofanother Silicon Valley heavyweight—Twitter Fast, easy to use, and

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