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The banking sector is about to undergo a revolution — one far removed from the Hayne royal commission.

While customers may be revolted by the parade of scandals, the real revolution will come from elsewhere.

When complete, the royal commission will put forth a range of recommendations for the banks. Digital disruption, a far greater threat, will have no road map, and come at any time without notice. How the banks respond will be critical. Fintech is to the finance sector what iTunes was to the music industry, or Google to the classified advertising business.

Fintech is the application of technology to financial services or used to help companies manage the financial aspects of their business, including software and applications, processes and business models. While the application of technology is not new, what is undergoing rapid change is the shifting focus from back-end processes to consumer-facing technology.

The Future Examined lunch hosted by The Australian and Deakin University last Wednesday demonstrated how vast the change could be for a sector where the big four account for 80 per cent of the country’s home loans and a third of the market capitalisation of the S&P/ASX 200. Certainly, Australian banks have been good at investing in technology to improve customer experience, grow revenue and lower costs, particularly compared to global peers.

But as Jason Yetton, CEO of peer-to-peer lender SocietyOne made clear, it is unlikely that the four big banks will come up with disruptive technological ideas themselves. This is because it is unlikely they will devote the people and resources given the complexity and regulation they face.

While banks are trapped by the opposing forces of quarterly returns and government oversight, nimble start-ups like SocietyOne are chipping away at high-margin pillars of banking like personal loans, the credit card business is seeing market share disappear, and small businesses are crying out for lending models that don’t require them to put the family home on the line. Technology players, with their lower costs, see opportunity aplenty.

Recognising they have no choice but to protect their positions, banks are spending a lot of money in the fintech space. One question is whether to grow their own solutions or buy in technology from a third party.

Simon Cant, co-founder of venture capitalist Reinventure, says it will probably be done by third party players working across multiple banks.

Hence their investments are not necessarily customer-facing. For example, investment in online services such as OpenAgent, which helps people find and compare real estate agents, makes sense to a bank that has mortgage origination as a stock in trade.

This is a common play with revenue coming from advertising and referrals. I know several people working on ideas in this space but they face an uphill battle unless backed by significant resources and are able to protect their intellectual property.

Whether banks or private plays capitalise most from fintech in the long run may come down to trust.

While banks are already highly regulated, in the digital space technology has raced ahead of regulation. For example I released a report last year, Estate Planning in Australia, which highlighted that guardians and executors in general have no ability to access the digital accounts and assets of those who die or become disabled. This is causing problems and we are only now discussing legislation.

The issue in fintech is that new players can gain market share before regulators have a chance to react, giving them speed to market and time to build up presence. Management of financial data by fintechs operating outside the umbrella of regulation is a concern, just as much as the threat of automation leading to even more contractions in banking employment.

The number of start-ups in the fintech space has grown rapidly. As Yetton noted, “less than five years ago there were less than 100 fintechs in Australia now it’s closer to 600 with the majority in payments and lending and an increasing number in blockchain”.

If we want to have competitive businesses in a global financial world we will need to scale up in number and financial backing. Six hundred players backed by some $750 million seems a lot, but over time this will consolidate as we saw with the early dotcoms.

At the moment, the big banks could buy out or outspend any fintech start-up. But what happens when they are competing with Amazon, Apple or Alibaba? For a fintech start-up, getting access to capital is the first step to recruiting customers. For international ­giants, that are either sitting on piles of cash, or have AAA-rated credit, money is no obstacle.

Picking long-term winners by investors and banks is critical for the future of finance in Australia and it does not come without foresight, luck and courage.

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Written by Dr Adam Steen, Professor of Practice of the Faculty of Business and Law.

Originally published on The Australian.

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