Topic Fintechs Wiebke Danker, BaFin
FinTechs: Young IT companies on the financial market
An internal BaFin project group started work on the topic of FinTechs at the end of November, focusing on the new business models of young financial services providers. Drawing on expertise from the areas of banking, insurance and securities supervision, the objective of the project group is to observe the latest developments in the FinTech market, and to review whether the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) needs to adjust its processes in view of new developments in the area of digitalisation.
The FinTech phenomenon is gathering considerable momentum both nationally and internationally. Some cities are now even attempting to make a mark for themselves as FinTech centres, including e.g. London and Hong Kong. In Germany, FinTech start-ups have so far been primarily concentrated in Berlin and Frankfurt am Main.
FinTechs in Germany
It is difficult to put an exact figure on the number of FinTechs operating in Germany, partly as a result of the dynamic nature of the market. As digital technologies develop, increasing numbers of undertakings are being founded whose business models can be considered FinTech models. Some of these undertakings have, however, already discontinued their operations.
Statistics currently indicate that there are around 250 FinTech undertakings in Germany. These cover a very wide range of different business models. Many of these undertakings offer services that are similar to those provided by banks, such as loan brokerage and automated financial advice. Others supplement these traditional services with additional services, particularly in the area of payment transactions and finance management. This article provides a rough overview of the different business ideas in the world of FinTechs today.
Payment transactions and giro business
Technological trends in payment transactions also started gathering pace in Germany at the beginning of the 21st century with the introduction of the first internet payment methods. Young FinTechs are not the only companies to gain a foothold here, as some of the larger undertakings have now also uncovered this market for themselves.
Startups are also developing additional innovative and technology-based payment options, thereby positioning themselves directly between the customer and the bank. The use of smartphones is becoming increasingly important with the new payment methods, e.g. with functions such as the “digital wallet”. As such, wireless payments can now be made directly at the counter via a smartphone using NFC (Near Field Communication) data transmission standards. Special credit cards also now have this functionality. A QR code can also be read in via a smartphone and a payment made using the associated app.
There are more and more functions in the giro business area that are complementing traditional online banking. For instance, it is possible to photograph invoices using a smartphone and read them directly into a digital transfer form or to have a financial overview across multiple banks available permanently via a smartphone.
The idea of crowdfunding draws directly on traditional banking business. It involves raising capital from multiple backers (the crowd) in order to finance a project. This often takes place via web-based platforms. Both the backers as well as the borrowers can be private individuals or companies.
The four crowdfunding models most frequently used in practice include first of all donation-based crowdfunding, where the backer does not receive anything in return other than a feeling of satisfaction. In the second model – rewards-based crowdfunding – there is a prospect of a compensation that is symbolic in nature, e.g. inclusion of the backer’s name in the closing credits of a film financed using crowdfunding. The third business model of loan-based crowdfunding is characterised by repayment of the amount, whether with or without interest. With the fourth business model for crowd investing, the backer’s aim is to receive a financial return. The backer can either have a share in the future profits, receive company equity or debt instruments.
Automated financial advice
Automated financial advice is another business model used by FinTechs. The customer uses a program that provides support in financial investment decisions, i.e. without a human investment adviser. Platforms are often used for this whereby the potential investor enters personal data that is significant for the purposes of the investment decision. Among other things, this also includes their risk appetite along with the investment amount. Algorithms subsequently calculate the investment options that are then put forward to the customer as proposals. The platforms frequently draw on exchange-traded funds, since the costs associated with these funds are the lowest and the easiest for customers to understand.
One further option for automated financial advice consists of linking a securities portfolio with the portfolio of a successful trader. The trader’s trading decisions are then also automatically implemented for the customer.
The platforms are generally customer-friendly. They are usually easy to use and are characterised by a favourable and transparent cost structure. The customer must review his or her decision with the same level of care, however, as they would with traditional investment advice. Whether the automated financial advice involves individual investment advice within the meaning of the German Banking Act (Kreditwesengesetz – KWG) and the Securities Trading Act (Wertpapierhandelsgesetz – WpHG), to which special obligations apply, depends on the drafting of the relevant offer.
Startups in the insurance industry frequently take the form of internet comparison platforms or internet insurance intermediaries. They mediate specific insurance services, for example for technical equipment. Coverage can also be provided for special events, such as a stadium visit or an excursion made by a day nursery.
One particular development in the insurance industry that is becoming increasingly important is the collection and assessment of large quantities of data, which is also known as “big data”. This has become a well-known phenomenon in motor vehicle insurance in the form of telematics policies. Among other things, these assess driver behaviour, which can have an impact on the relevant insurance premium. The media have also reported increasing cases of health data being collected via mobile phone or special wristbands.
The innovative business models implemented by FinTechs also include the use of virtual currencies. The most well-known virtual currency at the moment is Bitcoin. Other examples of virtual currencies include Litecoin and Ripple.
The virtual currencies have been accompanied by two developments in the area of electronic financial services. On the one hand, there is the idea of creating a cryptographic, i.e. encrypted, substitute currency for limited amounts of money which exists in addition to legal tender. This can be produced via a mathematical procedure by anyone who owns a PC with the required computing capacity. On the other hand, block chain technology has already attracted much public attention thanks to Bitcoins. Block chain technology is the technological basis for Bitcoins and is used to manage all Bitcoin transactions in a decentralised network. No intermediary is required here, such as the central banks in the central bank system, since the block chain logs the transactions and therefore no information asymmetries arise. This is why it is conceivable for this technology to be used by financial services providers for other business processes beyond exchanging Bitcoins. Some of the larger banks are already reviewing this option.
Significance for BaFin
BaFin now needs to ask itself how it intends to handle the innovative FinTech market. BaFin President Felix Hufeld highlighted this fact in an interview in the December edition of the BaFinJournal. He also commented on the subject in his speech at BaFin’s New Year press reception. The challenge with this is not to stifle innovation through excessively strict regulation on the one hand, while at the same time preventing these innovations from voiding the supervisory principles on the other, since FinTechs do not operate in a vacuum. Their business models also need to be in line with the regulatory requirements and consumer protection. If we see that a FinTech is operating in an area subject to mandatory authorisation, then it must comply with the same supervisory regulations as the established institutions. This clear rule creates trust, both for the consumer as well as with the other market players.
However, whether or not certain FinTechs require authorisation from BaFin for their activities or whether they are subject to trade supervision is not always clear at first glance. Business models that appear to be similar can actually differ from each other when examined more closely and this has a direct impact on the duties that the undertakings need to comply with. At the same time, issues may arise regarding collective consumer protection, and BaFin follows up on these as part of its new mandate based on section 4 (1a) of the Act Establishing the Federal Financial Supervisory Authority (Finanzdienstleistungsaufsichtsgesetz – FinDAG).
The digitalisation promoted by the FinTechs also has a significant impact on the established financial services providers that are subject to supervision by BaFin. Many banks, insurers and investment firms are already actively addressing this issue. They are entering into cooperation agreements with FinTechs, taking inspiration from their models and developing their own ideas. This may have a direct impact on the channels of distribution, communication channels and internal processes at the established financial services providers, and BaFin must play an active role in it.
As such, there are some complex issues that emerge for BaFin from these developments. Among other things, the project group is already looking at the issue of how to familiarise the young undertakings with the extensive topic of supervision. BaFin’s focus here is on providing reliable and timely supervision that is to be adapted to the current state digitalisation. The goal is also to meet the needs of FinTechs while applying the required level of supervisory thoroughness. BaFin is already holding discussions with the relevant undertakings with the aim of implementing these measures.