Perhaps it is the stoic nature of the financial services industry that enabled it to resist disruption for so long, but there can be no doubt that technology has now burrowed into the heartland of the banking sector, leading to a wave of innovation in traditional markets like foreign exchange, stocks and shares, borrowing and saving.
Markets, such as betting, music and aviation, were disrupted by Betfair, Napster and budget airlines well over a decade ago, but financial services' own disruption has been fairly recent. This is surprising, when you consider that services like PayPal have been in existence for as long as Amazon and eBay, without sparking widespread disruption.
You may recognise the names of many of these new young players, but it's unlikely you will have seen them on the high street, as this revolution is taking place almost exclusively online, enabled by the low barriers to entry that modern technology affords.
Who is leading the revolution?
Young, social and not always from a financial services background, these 'disrupters' have lived through a lifetime where access to technology (and creating it) is second nature, and where consumers have choices, are transient and looking for value. By applying this ethos to their own products and services, they are winning new customers from a range of demographic groups.
The way companies like Transferwise, which is disrupting the foreign exchange transfer service, and Nutmeg, which offers low-cost investment portfolio management, are able to pass this value to their customers is by saving a fortune on technology. Unlike their larger competitors, they have been able to start from scratch in the age of cloud, big data and mobile, thereby avoiding expensive overheads like legacy IT systems, branch networks and people. They also have talent and an entrepreneurial spirit that appeals to people who are tired of the same old services.
A perfect storm?
Disruption would not be truly possible without the right environment. The recession, coupled with disillusionment towards traditional finance providers, has coincided with a surge in internet adoption and trust in online providers. According to the latest Ofcom Adults' Media Use and Attitudes Report 2014, over 83% of adults now go online, nearly all 16-35 year olds are online (98%) and use in the over 65s has increased by almost 10% over the last two years, with 42% now online. Additionally, six in 10 adults now own a smartphone and 55% send and receive emails using their devices.
The largest growth demographic is the over 65s, with 20% now owning a smartphone, and 17% owning a tablet – a figure which has trebled in just a year.
One third of all mobile users claim to buy things via their phone or use their phone to check their bank balance.
All of which points towards emerging financial service providers accessing an audience that is no longer constrained by the traditional barriers of entry and trust, which would have prevented disruption on this scale several years ago.
Sustainable disruption?
The darling of the alternative finance revolution in the UK is undoubtedly peer-to-peer lending. True disruption ensued when a new market was created by Zopa in the UK. It recognised the opportunity to undercut loan and savings providers in the consumer market, by acting as a low margin middleman from a purely online platform and taking a small fee for the service.
Since Zopa, the business loan market has been further disrupted by the likes of Funding Circle and rebuildingsociety, invoice discounter Market Invoice, and supply chain financier Crossflow Payments. All of these platforms operate a high volume, low margin service, which creates value for businesses and the individuals and institutions lending money through them. Assuming they can retain the trust of their users and avoid scandal, there is no limit on how much these businesses can grow.
What has been significant is the political backing that 'alternative finance' has received. By allowing innovation and not legislating against it, the government has permitted disruption. This comes back to the 'perfect storm', where politicians have been put under pressure to increase funding to SMEs and have been given the license to back disrupters. This might not have happened in a boom cycle.
Competition breeds sustainability in markets. Businesses and consumers now have an ever-increasing pool of resources to tap, and crucially, these funds are not all reliant on the capital markets, meaning that if alternative finance continues to grow, we should have a more sustainable system, which is less sensitive to market movements.
The low margin aspect means that providers should be able to flex with any interest rate rise and still offer value for all parties. As a result, a future recession shouldn't mean a complete withdrawal of business loan products because there are many more providers operating now that would thrive in that environment. Alternative providers have evolved from the last resort, to the first option for many SMEs in just a few years.
What's next?
To date, pensions and insurance are two markets that haven't seen disruption on the same scale as personal and business loans.
Pensions in particular might need political assistance to make self-invested personal pensions (SIPPs) more accessible to people, but the high administration charges, which are causing many people to lose value, are exactly the sort of motivating factor that disrupters favour. If people were able to invest their pension themselves in a wider range of investments and pay minimal fees, you could certainly have an appealing product. Looking at the rest of the financial services market, you can clearly see the hallmarks of evolution. Existing providers are bending to trends as we all become more social, faster and less loyal. They're also looking to collaborate with disrupters to boost relations with their own customers.
But where customer inertia and superior technology might have protected financial services from significant disruption in the past, this is no longer the case. Technology is cheaper and easier to access than ever before, and people have acquired a taste for new online-only services.
Beyond any doubt, the disruption of financial services is only just beginning.
Nick Moules is marketing and communications manager for rebuildingsociety
The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organisation or its member firms.
