Why Darwin would have predicted   fintech

Darwin Quote2

A lot of air time is currently being given to the concept of marketplace banking and fintech ecosystems.  Lightweight, agile and highly networked players considered to be part of this new ecosystem are already making inroads into traditional finance.

By cutting out the banking ‘middle men’, these new specialists are delivering better service and experiences to consumers and businesses alike.  In the future, rather than a one to many relationship, ecosystem banking will deliver many to many.  Consumer choice will reign king and profits will be shared amongst many players.

Some key themes within this new fintech ecosystem include:

  • Peer to peer lending platforms, enabling lenders to get closer to borrowers, generating superior returns to bank deposits for investors
  • Non traditional credit scorers, able to make more nuanced judgements about credit seekers via social scoring and positive credit reporting.  In return they will gain access to new revenue streams from previously unbanked sections of the market
  • Mobile payment apps and digital currencies, allowing businesses to reduce per transaction costs and get to know their customers personally, removing payment frictions and generating repeat business

The rise of the fintech ecosystem seems to be a smoke signal that an ice age is descending on the banking era as we know it. To add to this bellwether, plenty of data tells us customer regard for banks has been cooling for some time.  When similar climate shifts occur in nature, power shifts soon follow.  So the once dominant-predator banks may find themselves being outsmarted by smaller and much more nimble financial flora and fauna in the not too distant future.

Paradoxically, a clear advantage in the race for the hearts and minds of banking customers may be to not sit at the top of the food chain.  In fact being small enough to readily adapt, pivot and adjust quickly to changing customer moods may be critical to fintech players in the new digital economy.

But size aside, does a new ecosystem really protect us from old risks?  Does a many to many ecosystem potentially give rise to risks we’re not even aware of as yet?  To attempt to answer these questions, we must first understand how other ecosystems flourish and survive in equally dynamic environments.

Nature’s Ecosystems

Ecosystems in the natural world are defined as the complex network of interactions between living organisms (animals, plants, humans) and non-living elements (air, water, soil).  The ability of an ecosystem to rebound after a disturbance is somewhat correlated to its degree of biodiversity, or variability in its ecosystem members.  Ecosystems that are highly dependent on a small number of species for food sources (or germination, in the case of plants), will often collapse when threatened by one or two species extinctions or large natural events.

Understanding fintech in relation to nature’s ecosystems is not as left of field as you may imagine.  Post 2008 many researchers have been drawn to a new field of study known as ‘financial ecology’.  They seek to understand what parallels can be drawn from how nature’s ecosystems buffer themselves against environmental threats.  Applying these learnings to the financial sector could possibly help regulators better manage systemic risk.

Systemic risk amongst banks represents the potential for a domino effect to take place; the chain reaction of bank failures that occurs when one bank collapses.  Due to banks’ high degree of interconnectedness, they all rely on each other for something.  And even when banks diversify, they tend to diversify in the same way, reducing the overall effect of diversification as a risk management strategy.

Given the events of 2008 and the following global recession, it would seem that banks today are not terribly efficient ecosystems by nature’s standards.  And as the relentless pace of globalisation continues, the effects of future financial system collapses will be felt far more widely and deeply than ever before.

So what is to be done?  Well, some researchers believe the key to building resilient fintech ecosystems will be in understanding why some natural ecosystems fail.  Two distinct network theories have emerged that could hold important insights into the future architecture of the fintech marketplace.

Nested Networks

According to an article by researcher Andrew Snyder-Beattie of the University of Oxford, “In a nested network, a specialist with few connections will be connected to a generalist that has many connections, including all the ones the specialist has.”  He argues that this protects both the specialist and generalist, as the generalist’s survival is almost guaranteed by the multitude of its specialist connections.  Survival of the generalist in turn protects the specialist.  Of course wide spread failure of multiple specialists could put generalists at risk.  But with specialists not tending to be directly connected, this risk is low.

This concept translates well to one model of a future fintech ecosystem, whereby a core banking platform (the generalist) is connected to a multitude of customer facing service providers, like lending platforms and roboadvisors (the specialists).  A recent post by Philippe Gelis, titled ‘Why Fintech Banks Will Rule The World’ gives an excellent overview on this.

Modular Networks

Snyder-Beattie goes on to explain a modular network as, “one that provides some degree of isolation between distinct groups.”  Simon Levin, a researcher at Princeton University argues that this is akin to managing outbreaks of disease epidemics amongst societies.  The ability to quickly quarantine sections of an ecosystem when under threat is incredibly important in preventing contagion spreading and widespread collapse.

The concept of modularity is highly relevant to banking and fintech.  It is more and more evident that increased interconnectedness between the legacy financial pillars of our economy heightens the impacts of the domino effect, rather than diminishes them.  In the new fintech ecosystem, it is important we pay attention to how we can build in these ‘firebreaks’ and modularity; preventative measures that allow us to back-burn when the fintech ecosystem gets ‘too hot’.

So all in all, Darwinian ‘survival of the fittest’ forces look to be at play more and more in the financial services sector.  In what could be seen as the ultimate irony for the industry, the often quoted desire of senior bankers to ‘let the market decide’ (especially when arguing against increased regulation that would make them more stable), could be the global banking behemoths’ very downfall.  It’s a case of being careful what you wish for.  For when it comes to banking verses fintech, free market driven evolution seems to be kicking in as we speak.

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