By Prakash Pattni, Managing Director for Financial Services Digital Transformation for IBM

Are we living through the golden age of fintech? In certain parts of the world, the data certainly suggests so as the industry evolves to keep up with demand and all eyes are closely watching the fintech space. The UK registered a record year in annual fintech investment in 2021, exceeding $11.6bn – a 217% increase from 2020 – according to Innovate Finance, the UK’s fintech industry body. That represents 45% of all fintech investment in Europe.

The fintech boom is being driven by a mix of factors, from consumer demand for personalised digital interactions in all areas of their life, to exponential growth of technologies like cloud, Artificial Intelligence (AI) and blockchain. These technologies are enabling new players to enter the financial services market with disruptive business models to meet the expectations of customers who are more digitally native than ever. 

Large technology companies are now developing banking-as-a-service models to provide retail banking services, while the buy-now-pay-later trend has driven growth in embedded finance models. In this bold new world of fintech, businesses like Klarna and neo-bank Revolut have achieved higher valuations than some established British high street banks. 

But the established banks have taken notice and see the opportunities a flourishing fintech sector can offer. More than 40% of UK financial services professionals told an IBM-Censuswide survey that their institution plans to modernise in the next five years by evolving to a platform business model using application programme interfaces (APIs) – which support the rapid innovation and rollout of various digital services, from mortgages to payments. 

Part of the beauty of this platform model is that it allows banks to consume ready-to-go innovation from fintechs more seamlessly. In many cases, this is still far more cost-effective and efficient for banks than developing the same offerings in-house. Given the pressure banks face to find new revenue streams and keep up with customer demands, they are now looking to partner with fintechs as a top priority. 

Challenges

Yet, a golden age isn’t quite the same thing as a fairytale. Despite the enormous sums of investment, fintechs – and the financial institutions they need to transact with – have key challenges to overcome to unleash their full potential. 

Perhaps the biggest source of friction holding back fintechs and banks from working together faster are the strict regulatory compliance requirements fintechs have to meet before banks can onboard them. It is essential that fintechs don’t introduce systemic risk into the financial system – otherwise their growth and risk to the financial system will be unacceptable. Onboarding can be an intensive process, often taking as long as  18 months or more. This is too long for many start-ups to wait – they must be able to begin working with banks quickly in order to achieve revenue targets. It’s also a frustration for banks, which need to be able to seize market opportunities quickly before competitors get there first. 

Security is also a top concern for banks and regulators, particularly when it comes to the use of technology and it’s vital that fintechs align seamlessly with the industry’s stringent security standards.

At the same time, fintechs need to align with the technological reality of the financial institutions they aim to do business with. With regulators insisting banks take measures to mitigate vendor concentration risk, financial services businesses need to operate in a hybrid multicloud environment, which allows them to use different cloud providers across their on-premises and public cloud platforms. IBM’s research in the UK found that 87% of financial services firms have already migrated to a hybrid multi-cloud model or planned to do so. 

Collaboration is key

For most fintechs, navigating these challenges alone simply isn’t feasible. Fintechs must team up with a partner that can help them meet the security and compliance requirements of financial institutions and then deliver the services those institutions need, wherever they need it. 

Many financial businesses are recognising that cloud platforms designed for the industry can help with this challenge, by providing automated compliance controls and enterprise grade security technology, out-of-the-box. Nearly 90% of UK finance professionals have already adopted or plan to adopt some kind of industry-specific cloud, according to IBM’s research. 

An industry cloud platform also forms the foundation of an ecosystem that connects financial institutions with fintechs and other technology providers, in a secure, compliant environment. This means transactions between all the players in the ecosystem can happen faster and ultimately helps to de-risk the digital supply chain. When a bank and its suppliers are all using the same secure platform, it eliminates complexity and fragmentation in the supply chain – the primary source of IT vulnerabilities that cyber criminals easily exploit. 

Unlocking the next phase of fintech growth

The fintech sector has undoubtedly enjoyed rapid global expansion. But financial regulators are catching up with the new business models and technologies that have risen to prominence – from cloud and AI to digital assets – and the needs of financial institutions are evolving accordingly.  Unlocking the fintech sector’s next phase of growth will require collaboration with partners that can combine deep financial services expertise with technological solutions that remove obstacles to new business opportunities with financial institutions. When that happens, the opportunities for the entire financial services ecosystem – and society at large – really will be golden.