When I first entered finance over 20 years ago, financial innovation could effectively be summed up as the clever manipulation of “law” over assets. Different types of bonds were being developed — for example, high yield bonds. Rights to future assets were emerging everywhere, including hedges (derivatives). Instruments were structured to avoid tax costs, bonds were only funded by asset pools including asset-backed debt, CDOs, and credit risk was spread via credit default swaps .
At the time, financial innovation was a matter of “financial engineering” or “structured finance”.
This was the heart of the financial revolution of the 1980s, 1990s and early 2000s. Some of them are continuing: the recent emergence, for example, of contingent capital bonds (which convert into shares when a given bank reaches certain levels of distress), or some of the more creative forms of middle market debt financing in the non-custodial shadow lending/specialized financial space.
Yet the above type of innovation is now small fry compared to something else that has emerged as a huge financial juggernaut: financial technology innovation. Of course, the old form of innovation has always had its limits. They were basically “epicycles upon epicycles” of some of the oldest financial instruments in the world, namely debt and equity. But the fintech revolution, and the extent to which it has reached today, is now of enormous magnitude.
Technology may have periodically brought diseconomies to our banking system (whether through internet misinformation, or the abuse of high-speed trading, or the endless replication of sometimes unoriginal and unnecessary social media start-ups) . However, that aside, the former Federal Reserve Chairman Paul Volcker’s famous statement that “the only useful thing banks have created in the last 20 years is the ATM” was probably correct.
The application of technology to finance is now so ubiquitous, with so many possibilities, that nothing less than a new revolution in financial innovation is underway thanks to fintech. Many of these actions (if listed) are worth watching and investigating. It takes so many forms:
- Online Lenders – OnDeck, Funding Circle, Upstart, Kabbage, Lending Club, Better Finance
- Payment systems – WorldPay, Square, PayPal, FUNDtech, Vantiv
- Trading systems – Tradeweb, markit, E-Trade, Ice, fxcm
- Financial Research – Stocktagon, Bloomberg, SNL, Seeking Alpha
- Personal finance – Credit Karma, smartasset, OnTrees, mint
- Retail investment – pattern, FutureAdvisor, StockR
- Insurance – Ebix. guide wire
- Back-off systems – fiserv, Sage, FIS, Paychex
- Consumer credit – Cardlike, Simple
- Equity Funding – angel.me, CicleUp, TAIL
- Real Estate/Mortgages – Moving, Ellie Mae
- Institutional finance – Addepar, Quovo, StockTwits, estimation
- Mobile banking – iDa Mobile, Apply Pay
To some extent, this financial revolution was a natural product of the broader technological revolution. But it has also accelerated since the credit crisis. It was catalyzed in this way because the custodians were simply so constrained after the credit crunch that they weren’t responding to requests for credit/funding from the United States. has increased considerably since the crisis to fill this void. But this phenomenon has collided with the technological revolution, which means that many of these new specialist finance companies are not just old-fashioned lenders.
To be sure, some specialty finance companies are conventional, providing for example traditional leases on a given asset, but the dynamic innovation in specialty finance has come from those players who have themselves become fintech companies. They have integrated fintech integrally into their business – in their sales methods (selling products online), in their underwriting systems (using AI algorithms to analyze cohorts of borrowers), using fintech to accelerate back office and transaction processing. Thus, the harsh regulation of custodians by Dodd Frank himself contributed to this fintech escape.
That said, the big banks are now rapidly catching up, incorporating these new financial innovations into their old legacy systems, buying up the (once-startup) innovators, and slowly learning to innovate themselves (maybe?). It is critical that banks do this and over time we are likely to see more of this innovation from the banks themselves.
These changes also have socio-economic consequences. The idea of the “rich” 1% of the financial revolution itself becomes obsolete. Indeed, just as technology has eliminated many jobs in industry, it is now eliminating many jobs that were once the lucrative jobs of the financial sector of the 1990s (equity brokerage or commodity trading). Increasingly, spot stock trading, commodity trading, futures trading can be done and managed electronically. The margins of these companies have thinned and these trading functions simply no longer need the volume of people they used to.
However, that leaves perhaps 0.1% – that is, the very few who have unique technologies, intellectual property or patents that make a difference. This small group is still able to realize incomes and capital gains that are considerably out of proportion to the rest of the population. And this is not a socialist observation; rather, it is the very nature of advanced technological capitalism.
Of course, the counter-argument to the above is that the technological revolution itself has created many new jobs. Everyone who has to maintain systems in banks (about 10% of all staff in big banks are now computer technicians), everyone who has to write programming code, etc. Yet concern is also growing that even this work can largely be done by AI machines sooner or later (if it hasn’t already). For example, the coding itself may already be written only by other computer systems, etc.
Keynes spoke of the nirvana where all our work would be done by intelligent machines, and the central problem of the economy (finite resources) would be solved – all men could live at leisure. He was onto something, but it clearly doesn’t reflect what he was planning. Nor do I believe that old-fashioned socialism or tax-heavy redistribution of wealth is the answer (ideas that were themselves largely the product of the industrial, not technological, revolution ). Large-scale redistribution always tends to undermine growth and innovation.
Maybe at some point (and maybe it’s already happening) all of the proprietary rights to the technology, or the intellectual property, as it matures, needs to be released in some sort of ” blogosphere” where it becomes a common good, like the air — free for everyone. It’s hard to know how this could work, and it smacks of utopianism.
Yet it is clear that the fintech revolution has changed the face of banking innovation, the technology revolution is changing the face of our economies, and we need to find new forms of political economy that make this new world work for at least minus the vast majority. Population.
Jérémy Josse is the author of Derivatives of dinosaurs and other trades, an alternative approach to financial philosophy and theory (published by Wiley & Co). He spent over 20 years in the financial services industry with various leading companies including: KPMG, Schroders, Citigroup and Rothschild. Josse is also a visiting scholar in finance at the Sy Syms business school in New York.
Josse has no position in the stocks mentioned in this article.