Here’s Why We Need Fintech Disruption Now More Than Ever

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Thanks to the wonders of digital innovation, a television today costs about a tenth of what it did in the 1980s. Two-thirds of Americans now carry smartphones that compute faster than the average desktop in the 1990s, for a fraction of the cost.

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Yet there’s one field that has proven stubbornly resistant to the kind of disruption that eases prices and boosts efficiency: finance.

That notion might elicit howls from asset managers, who have watched fees steadily erode over the last decade. But the data bear it out. Despite decades of advances in communications technology, data analysis - and pharmacological stimulants - bankers aren’t any cheaper than they were a hundred years ago.

Thus the need for fintech disruption, more now than ever.

That’s the conclusion of New York University professor of finance Thomas Philippon, who compiled U.S. financial data dating back to 1880 in order to determine how prices have (or haven’t) changed. As it turns out, Americans have paid a premium of about 2 cents on every dollar intermediated through the banking system for most of the last century.

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In an updated version of the study, Philippon finds prices have relaxed since the financial crisis, but not a ton.

“Finance has benefited more than other industries from improvements in information technologies,” Philippon writes. “But, unlike in retail trade for instance, these improvements have not been passed on as lower costs to the end users of financial services.”

Even adjusting to account for the increased quality of financial services – more low-income households and high-risk firms can access credit these days – finance is about as expensive as it was in the 1970s. So either financial innovations have failed, or someone's getting fleeced.

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The underlying reasons might inspire debate. Philippon pins the blame largely on market concentration: a few lumbering giants keep new, potentially cheaper entrants at bay, allowing incumbents to keep prices higher than they ought to be.

“If one steps back, it is difficult not to see finance as an industry with excessive rents and poor overall efficiency,” Philippon writes, making the financial sector sound like North Brooklyn.

Solving that problem is even knottier. The regulatory environment exists largely to provide a top-down check on needless complexity and runaway leverage in those massive, systemically important banks. It’s less attuned to bottom-up innovation.

“If the goal of financial regulation is to foster stability and access to services,” Philippon writes, “then regulators should consider policies that promote low-leverage technologies and the entry of new firms.”

If only it were so simple.

Fintech is definitely having a moment, but probably not the kind Philippon wants. Some of the sector’s brightest stars have looked awfully dim in 2016, rehearsing the same kinds of pre-financial-crisis failings that created such an appetite for disruption in the first place.

Lending Club, the leading peer-to-peer loan company, had to dump CEO Renaud Laplanche in May after it was found that the company had sold $22 million in bonds on faulty premises. Moreover, Laplanche had failed to disclose his financial ties with a firm Lending Club was thinking of investing in. The entire peer-to-peer sector sank on the news.

Then there’s bitcoin, the most rabidly hyped of fintech saviors. Last week the cryptocurrency suffered what was, according to one count, its 37th attack, and the second-largest in its history. Hackers compromised the digital wallets at Bitfinex, a leading storage center and bitcoin trading hub, making off with $65 million in digital lucre.

And bitcoin’s more cerebral little brother Ethereum had its own brush with doom in June, when resourceful hackers exploited a glitch in the code to pilfer $60 million of the currency from a digital investment trust that had been advertised as “a new breed of human organization never before attempted.”

The future of money is looking a bit like its ancient past.

Maybe it’s unfair to expect fintech mount a meaningful challenge to the likes of JPMorgan and Nasdaq in just a few years. The aspect of the financial world that makes it so apt for disruption – its top-heavy concentration – is also what makes it so hard to disrupt.

Neither should the engineering challenge be minimized. The technology of finance is probably second only to agriculture (and maybe one "other" profession) in how long humans have spent honing it. Financial startups inevitably bump into realities that explain why banking is so cumbersome to begin with. They tend to to end up focusing on pesky chores like verifying customers’ identities, or trying to establish systems that are actually indeed secure.

The FT’s Izabella Kaminska has helpfully boiled the fintech startup lifecycle to eight phases. Phase 1: “Fintech startup creates a tool using engineering logic borrowed from information technology methodologies, tries to go it alone.” Phase 2: “Fintech startup realises client acquisition is really hard and costly. Oh, and the tool either doesn’t scale or there’s some other unintended consequence related to risk or liquidity.”

Eventually the company takes on the very qualities it arose to circumvent and sells itself to a bank. Phase 8: “Fintech is absorbed into the bureaucracy of banking. Innovation stalls.”

Philippon nods to this reality. “In theory, the blockchain technology could improve the efficiency of the market, but if there is no entry, this could simply increase the rents of incumbents.”

Absorption into the old guard of banking might be bummer for upstart techies, but there is some consolation – specifically, the monetary kind. Excepting a couple go-go pre-crisis years, the wages of financial professionals are higher than they’ve ever been relative to everyone else.

That’s not a bad club to join.

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