Faculty & Research
Faculty & Research
Is Fintech Poised to Replace Brick-and-mortar Finance?
By Oliver Rui
Recently, the People’s Bank of China (PBoC) released the Fintech Development Plan 2019-2021, including guidelines, basic principles, development targets, key tasks and supportive measures for fintech development in the next three years. The plan has attracted a lot of industry attention. But, what is the purpose for introducing this plan? What impact will it have on the fintech industry? And, what does the future hold for fintech?
From 1 to 100: Fintech in China
If the development of fintech in Silicon Valley can be summarised as going “from 0 to 1”, in China, it was “from 1 to 100”. In 2017, Goldman Sachs released a report on fintech, which included a set of data on the status of China’s fintech industry. For example, from 2010 to the end of 2017, the size of third-party payment transactions increased by more than 97 times, ballooning from 1.1 trillion RMB to 107.3 trillion RMB. During that period, approximately 16% of those transactions were consumer-related and 56% were from transfers between individuals. In addition, between 2012 to the end of 2017, total online loan assets grew 100-fold, from 28 billion RMB to 2.8 trillion RMB.
By 2017, China had far outstripped the US in terms of its investment in fintech, with funding of $7.7 billion (USD), compared to with $6.2 billion (USD) in the US. By 2018, four of the world’s top ten fintech companies were Chinese – Ant Financial, JD Finance, Du Xiaoman Financial and Lufax – all of which had become household names in China.
In addition, according to EY’s Global Fintech Adoption Index 2019, China’s fintech adoption rate is the highest in the world at 87% – compared with only 46% in the US.
A four-point guideline supporting the development of fintech in China
In the past few years, the fintech sector has experienced enormous growth in China. At the same time, however, due to a lack of regulation and delayed policy intervention, confusion has emerged, for example, in the area of unchecked growth of P2P lending. The recent introduction of the Fintech Development Plan 2019-2021 is evidence of the PBoC’s increasing interest in and recognition of the fintech sector. Moreover, the four-point guideline contained in the plan may help see the prospects of fintech in China.
First, fintech must serve the true purpose of finance, and innovations must be introduced for the sole purpose of helping finance better serve the real economy. The goal of fintech is not to disrupt traditional brick and mortar finance, but to empower it through the use of technological solutions, to promote supply-side reform and to reduce financing costs for the public.
Second, the fintech sector must grow in a safe and manageable manner. The PBoC will not allow disorderly, chaotic or rampant development to happen and will take measures to rein in confusion in the fintech industry.
Third, fintech must be developed in a way that is helpful for promoting inclusive finance to the benefit of people’s livelihood.
And, fourth, openness and mutual benefits must be embraced to create a healthy climate for the whole financial sector.
The plan also outlines key missions in six areas – specifically, strengthening the strategic deployment of fintech, promoting the rational application of fintech, energising quality and efficiency increases in financial services, building financial risk prevention capacity, bolstering fintech regulation and strengthening foundational supports for fintech. The gradual implementation of these measures is expected to usher in an era of more secure, orderly and healthy development for the fintech sector.
At present, indirect financing plays a dominant role in the private sector. Small and micro businesses also have especially limited access to cheap, easy capital. Developing fintech can help improve the quality and efficiency of financial services – thus benefiting more SMEs and households with reduced costs – and at the same time can inspire new business models and products. Therefore, the introduction of the plan is a significant step forward for the financial industry.
The future: Will fintechs replace traditional financial institutions?
Previously, some industry insiders worried that fintechs would replace traditional financial institutions. This fear was heightened further after the introduction of the PBoC’s plan. But, will fintechs really replace traditional financial institutions in the future?
To answer this question, we first need to understand what finance is. The purpose of finance is to realise the optimal distribution of capital across time and space amid uncertainties and to serve the real economy and maximise social utility.
The biggest barrier to this end is adverse selection through a lack of symmetric information and the existence of ethical hazards. The impact of adverse selection is enshrined in Gresham’s law, “bad money drives out good”. The core capability of finance is to identify and price risks. All technologies are designed to help better understand customers’ willingness and ability to pay, and to price them accurately, allowing for optimal allocation of limited resources to entrepreneurs who can best create value for society. Along this line of thought, today’s fintech is just a variation on traditional finance and doesn’t alter its nature.
Banks or traditional financial institutions have a natural advantage in terms of capital costs, while internet businesses or high-tech companies are competitive in operating costs. It was believed that the cost of customer acquisition online was very low, but in fact, acquiring customers online is frequently more expensive than offline.
Fintechs are intrinsically innovative and attuned to the workings of the internet, have regulatory arbitrage to leverage and enjoy first-mover advantages. Their ability to provide standardised financial products and use low-cost long tail marketing gives them an edge. On the other hand, traditional financial institutions boast a natural monopoly in brick-and-mortar finance, unrivalled financial expertise and capital strength, and strong customer bases. Therefore, their strengths lie in the creation and sale of personalised financial products to a wide-ranging customer base. Indeed, both have unique advantages and their relationship is one of complementarity instead of life-or-death rivalry.
Oliver Rui is the Parkland Chair in Finance and a Professor of Finance and Accounting at CEIBS. For more on his research and teaching interests, please visit his CEIBS faculty profile here.