#20 Future of Finance

How major trends in tech could affect financial services particularly in Africa

Hi all - This is the 20th edition of Frontier Fintech. A big thanks to my regular readers and subscribers. To those who are yet to subscribe, hit the subscribe button below and share with your colleagues and friends. 🚀

This stack (internet, cloud, mobile) has enabled us to do old school financial services in a digital way. While the first generation of fintech companies created billions of dollars of value, because of new enablers like Plaid, Cross River Bank, Finix and Wisetack, we’re now moving past that phase to one where fintech moves from being a business model unto itself, to being the fourth layer in the stack or the “fourth platform,” wherein financial functions like payments, lending and insurance join connectivity, intelligence and ubiquity as layers of the stack upon which new companies can be built.

John Street Capital

This week I attempt to imagine where financial services will be in 10 years time, particularly from an African perspective. The continual impact of technology on finance continues to grow rapidly and this growth is expected to accelerate. Often when predicting the future in an internet driven world, we tend to be conservative largely because our world has grown on a linear scale for long periods of time.

My interest in this topic stems from the fact that like all things, narratives are critical for understanding the world and thus making decisions for the future. Fintech as the intersection of finance and technology also has pervasive narratives that if you’re not careful can drive entrepreneurs and investors to make the wrong decisions. What I mean by this is that for instance, globally the narrative around tech has revolved around some ideas such as;

1. Creating beautiful and seamless user experiences;

2. Enabling embedded finance and open banking;

3. Decentralised finance and crypto;

Upon further reflection, particularly since I started this newsletter, the obvious realisation is that Africa and a lot of the developing world needs a different conversation around Fintech. Do African clients need seamless user experiences or suitable financial products that allow them to grow their income? What’s the role of open banking in a mobile money world or worse, a world in which less than 50% of adults have bank accounts? Are we ready for De-Fi whose main innovation is a more robust and transparent accounting system? Or are we better off creating value with the resources we have and growing intra-African trade?

With this in mind, I take a look at some of the mega trends that will impact industry and finance and then analyse how Africans can ride on these trends to solve core problems such as lack of access to credit, financial exclusion, economic opportunity and economic growth.

Mega Trends that will Impact Finance and Banking Significantly

5G and IoT

5G is critical technology and a foundational element of industry 4.0. 5G is expected to usher in a new paradigm of integration between humans, things and cyber systems. To understand 5G it’s important to understand some core elements. 

1. 4G utilises mid-radio frequencies whereas 2G and 3G use low radio frequencies. High radio frequencies are used largely in satellite communication as well as car sensors. 5G enables all three frequencies to be utilised at once thus having the benefits of higher capacity as well as scenario specific utilisation. For instance, a smart watch may need low level frequencies due to battery usage whereas an automated robot will require the low latency available with high radio frequencies;

2. 5G has 100x the capacity of 4G increasing download speeds to 10,000 Mbps from 100Mbps. What’s important to note about the increased capacity is the fact that it will enable a 100x increase in data uploads. Currently, mobile networks are used more for downloads than uploads;

3. 5G has significant processing power thus making it function more than just a network, but as a distributed data centre. This enables computing power to shift from the cloud to the “edge”. Anticipated innovations like AR glasses then become economical because 5G will handle the heavy computing work thus obviating the need for significant battery usage. The same will apply amongst a multitude of devices

4. 5G enables network slicing meaning that specific services can get their own slice of the network. For instance, ambulances can get a specific slice that corresponds to their precise needs in terms of latency, speed and reliability. A different slice can be availed for streaming movies and another one for smart factories.

The natural outcome of 5G will be the maturing of IoT as an element of modern societal design that encompasses lifestyle, finance and production. Things in this case can refer to normal devices such as fridges, cars, factory machines as well as sensors and trucks. The result will be smarter cities and companies driven by increased data and information. 

Source: Thales

AI and Machine Learning

Plenty of ink has been spilled discussing the impact of Artificial Intelligence and Machine Learning on banking and finance. AI and ML will definitely improve elements such as personalisation, credit decisioning as well as operations. From the front end to the bank-end of banking and finance. Nonetheless, finance practitioners also need to be cognisant of the impact AI and ML will have on other industries which are ultimately bank customers. 

Driving the growth in AI and ML are factors such as 5G and the subsequent growth in data volumes as well as increases in the core technologies that enable AI and ML at scale. 

Source: Softbank

The slides above from the FY2020 Softbank investor presentation show that Graphics Processing Unit capabilities, Autonomous Vehicle Processors and the training time for large data sets (defined in this case as a 1 trillion parameter model) are all improving at non-linear speeds. The result is that AI and ML will impact every imaginable industry. Farmers will be able to better predict crop yields using computer imaging techniques. These same techniques will enable retailers to better manage their inventory levels. Logistics systems will be able to better predict routes and schedules whilst factories will significantly improve their efficiency and operating models.

Incumbents in non-bank industries will be significantly disrupted. AI and ML as a service will overtime be perfected enabling small companies to benefit from enterprise grade AI. 

The above is an interesting video on how AI is impacting farming.

Big Data

Data should be seen as the fourth factor of production, the 4 in industry 4.0. Data coupled with smartphones, AI and its subsequent impact on personalisation will have the following consequences;

1. Lower search and verification of products. Consumers now have much more information and don’t have to rely on heuristics such as “brand name” to make purchasing decisions. This is leading to the rise of less popular products brand growing and personalisation at the consumption level. Companies such as Atoms and Warby Parker have benefited greatly from this trend;

2. Data reduces irrational decision making as it shifts decisions away from human agents with bounded rationality to machines that theoretically can make the most optimum decisions. Of course, the domain of such decisions will initially be in areas such as resource allocation, logistics, inventory and route to market. Over time, this will impact basic organisation design from an organogram perspective where managers who are expected to have “experience” that drives good decision making will be replaced by data driven algorithms;

3. Data is non-exclusive and that’s what makes it such a powerful factor of production. Naval Ravikant refers to permissioned and permissionless factors of production. The consumption and production of data is fundamentally non-exclusive thus significantly altering some industries. A prime example is my newsletter which is permissionless. I just wake up, write and have access to a limitless number of people;

Must read thread

Naval @naval

How to Get Rich (without getting lucky):

4. 5G and IoT will lead to diverse data sources. Smart cities will lead to subjective personal data such as behaviour and routines. Smart devices will also create diverse data sources on elements such as driving behaviour, temperature, consumption patterns and health and wellness.

Big data will thus have a significant impact on industry and society as it enables a paradigm shift in the mode of production and consumption. Again, the question for the financial industry becomes one of organisational design and function to maximise the opportunities presented by big data. 

The Shift to MSME’s

5G, IoT, AI as a service and big data will converge to radically alter the competitive landscape of most industries. One theme that is likely to emerge will be the growth of Micro and Small and Medium Enterprises (MSME’s). Big data and AI for instance work together to significantly reduce search and verification costs for customers. This in turn enables customers to purchase products that are less known often from smaller companies. These companies ride on the AI capabilities of platform providers such as Amazon and Facebook to find their customers through specific targeting. What this does is to turn the competitive advantage of big brands upside down. 

Companies such as Unilever, Kraft Foods and ABInbev have grown on the back of industry 3.0 dynamics that emphasised economies of scale, efficiency across a non-changing industry and brand recognition. The latter is particularly important as in the absence of efficient search, heuristics such as brand recognition drove purchase decisions. Industry 4.0 threatens to undermine the “moats” that these big brands have built over the years. 

Consumer facing industries could in the future consist of large platforms such as Shopify, Amazon, Whatsapp and Facebook with a multitude of MSME’s selling and producing through these platforms. Gymshark is a perfect example of a company that has bypassed traditional distribution and used platforms such as Shopify and social media for product development and marketing.

In Africa and much of the developing world, what’s important to note is that with young populations and increasing literacy, it can easily be argued that over 60% of the MSME’s that will exist in 2030 are yet to be formed. This is a pure guess on my part, but the point is that if the median age is 16/17 then it’s likely that by 2030 most of these young people will be micro-entrepreneurs or work for micro-enterprises. A Rwandese coffee brand will be able to sell directly to Europe with value addition accruing to Africa.

The argument can be made that in most of the developing world, MSME’s form the bulk of businesses. Nonetheless, the key point is that MSME’s will be more efficient and more profitable with increased demand for differentiated financial services.

Some Predictions;

Traditional Banking will be Disrupted

“How did you go bankrupt?” Bill asked.

“Two ways,” Mike said. “Gradually, then suddenly.”

Ernst Hemingway  - The Sun Also Rises

Just like how industries such as Retail have been completely disrupted by Amazon and Shopify, it is feasible that banks that don’t adjust to industry 4.0 will also be disrupted in the same way. The disruption will happen gradually then suddenly. The way I perceive this is that other industries will change and the way those industries change will have an impact on the provision of financial services. For instance, smart retail that is built on AI and ML, producing large data that powers functions such as inventory management and restocking will need data driven working capital that is scenario specific. A tech driven bank can integrate with the ERP of the said retailer and define business rules that power payments to suppliers. The covenants of the credit facility will be monitored in real time thus reducing moral hazard.

In Africa, Twiga foods for instance will be able to power retailer finance through its platform. This will then integrate backwards to Twiga in the form of data and payment flows. A bank that can understand these payment and data flows can then offer more specific and suitable lending and payment products.

Banks that build the capabilities to offer financial services to such companies are likely to benefit from “winner take all” economics and the ones that don’t adjust will find their market disappearing all at once. Gradually then suddenly. The big threat is not so much internal to banks but external i.e. how other industries evolve.

Bank of Things

5G and IoT will create smart things. Huawei have released a “Bank of Things White Paper” that’s definitely worth a read. The idea is that “intelligent things” will emerge that are capable of sensing, information interaction, information processing, storage and ownership (identity). These will power economic things that can access bank accounts. 

An example given by Huawei is an autonomous car that can have a bank account. Basic transactions such as refuelling, paying for parking and paying for service can be performed by the car. Another example is a smart truck that can pay for road tolls, customs duties and insurance autonomously. The idea is that banks will have to develop the capabilities to bank things. These capabilities will ride on a complete restructuring of both IT architecture and organisational design.

Embedded Finance;

A natural off-shoot of these big themes is embedded finance where financial services are scenario specific and presented precisely where they are needed. The natural outcome of embedded finance will be the homogenisation of banks thus significantly reducing margins and profitability. Ant Financial have already proved this with their digital lending and the Yu’e bao money market product. 

This same homogenisation will occur in insurance. Banks will be reduced to infrastructure providers behind a customer facing application that belongs to another entity. Shopify offers a banking as a service product powered by Goldman Sachs and Stripe. 

Increased Credit at a lower cost

On the same note as above, assuming that customers interact with financial services through a third party interface, then big data, IoT and AI will enable an explosion in credit growth. The thinking here is that existing credit particularly in developing markets is constrained by information asymmetry i.e. banks don’t have accurate data about their customers. In developed markets, credit data is static and backwards looking leading to biases such as less access to credit for minorities. 

The explosion in data from a variety of sources will lead to stronger credit profiles. Platforms will be able to aggregate transactional data and behavioural data that is real time. Existing credit suffers from subjective data which is subject to forgery and transactional data that is backward looking. 

The orchestration of this data in my view is best done by a non-bank. Mobile money providers in Africa can for instance develop data capabilities that enable them to combine their rich transactional data with behavioural and subject data from other data sources. These could include government data and IoT data. This data can then be presented to financial service providers in a logical way enabling them to bid for loans. This will drive lower cost of credit and improved credit performance.

Data solves for adverse selection and moral hazard. If you couple this with a third party platform, then you solve for cost through competition. Ant Financial really structured their credit product based on “first principles”. WeBank has solved for adverse selection and moral hazard.

Some Closing Thoughts;

1. Financial intermediation particularly maturity transformation is based on principle that banks are well placed to solve for adverse selection through information asymmetry. However if data and platforms solve for this, do we need banks or do we just need sources of capital for lending?

2. Governments will play a critical role in the future. Taking a subset of the issues discussed above such as identity. It’s clear to see that a lot of work needs to be done to develop identity systems for the 21st century. Existing upgrades to ID systems in Africa are based on transferring static ID data based on the individual onto a digital domain. This is just the tip of the iceberg. ID data needs to include the identification of “things” and the mapping of these things onto natural persons. Additionally, ID systems should include permission management like the one we use for Google. People will need to manage their devices, manage which apps access their data and how their data is shared. Estonia is quite advanced in this regards;

3. I admire the Chinese government's principles based approach to technology. The Chinese government seems to have a comprehensive view of how technology will impact production and society. The vision 2025 strategy is quite comprehensive and shows the appreciation that the government has of technologies such as 5G. The long-term impact is that China could set standards for 5G, IoT identification, smart contracts and other critical technologies and thus dominate the 21st century. In my view, some of the energy we see around Bitcoin is driven largely by the desire to have governance protocols that are suited for the 21st century. I don’t think that Crypto is the solution to all our problems. Rather we need to design a government that is suited for the 21st century. This article by Tony Blair perfectly captures this moment. 

4. I worry that Africa will be left behind or at least will have dark zones where some countries such as Kenya, Ghana and South Africa embrace technology whilst other countries are left completely behind. My view is that the cat is out of the bag as regards technology and we can’t put the genie back in the bottle. Governments either have to adapt and create 21st century infrastructure or fall deeper into irrelevance. Francophone Africa is worrying in this regard;

5. Existing financial services providers particularly mobile money providers need to solve for other elements of finance and commerce rather than the existing focus on transaction enablement. Enabling capabilities like company registration, accounting, tax management and payments whilst integrating to big data is the next logical step. I think MoMo is best placed for the MSME explosion that will occur in Africa.

6. Writing this newsletter has shown me that successful tech companies and entrepreneurs take their arguments to their natural conclusion. What this means is that if you believe that AI and big data are expected to grow non-linearly, then design your organisation based on the natural end-state of these trends. Never in modern economic history has first principles thinking been so critical. Ultimately discussions about core banking platforms seem superfluous given that it’s just one of the many elements that needs to be considered and maybe even the least consequential.

As always thanks for reading and drop the comments below and let’s drive this conversation.

If you want a more detailed conversation on the above, kindly get in touch on samora.kariuki@gmail.com;