Australia’s big banks (which are also New Zealand’s big banks) are renowned for their stellar profits, generating returns on equity above 15 per cent every year since the early 1990s.

The explosion of investment in financial technology, however, and the proliferation of fintech firms eager for a piece of the action, will see banking disrupted in the same way traditional media was kneecapped by the internet.

Fintech investment worldwide has surged from US$1.8b in 2010 to $US19b last year, with almost three quarters flowing to firms offering personal financial services. In 2015 around A$440m of that investment occurred in Australia, according to a recent analysis by Frost & Sullivan, which estimates the big Australian banks will miss out on A$13b of revenue by 2020.

The fintech forerunners in Australia have primarily sought to provide retail customers with cheaper more effective banking — better returns on loans and deposits, cheaper funds management, and better access to capital markets. Acuity spoke to the CEOs of three leading fintech firms in these areas.

Peer into the future

Peer-to-peer lending, which brings borrowers and lenders together in an online marketplace, has the potential to make substantial inroads into Australia’s A$105b consumer loan market, a market ripe for disruption, which contributes returns on equity of around 30 per cent to the major Australian banks’ bottom lines.

While official interest rates have been falling the world over, unsecured personal loans from a major bank, which include credit cards, still incur interest rates an astonishing 12-15 percentage points higher than its depositors receive (banks’ overall net interest margin is about 2.25 per cent, dragged down by the more competitive home lending).

Apart from a fat interest margin, banks’ fees on credit cards and personal loans rose more than 4 per cent to $1.9b last year.

Society One, the largest and the first peer-to-peer lender in Australia, opened its website in late 2012, attracting half a dozen competitors in its wake. Its low cost model means it can sustain a net interest margin of a little over 1 per cent — implying returns of 9.65 per cent for “depositors” and 10.9 per cent for unsecured personal loans.

“For me, it is similar to how the credit unions started in the 1950s and 1960s — building societies and merchant banks made it hard for people to get personal loans, so community members backed each other — but without the job sector or geographic bounds,” says Jason Yetton, Society One CEO and a former Westpac senior executive.

Australia’s peer-to-peer lending market is still tiny, but surging. In April, Society One’s outstanding loans surpassed A$100m, with half of that amount lent since January. Morgan Stanley reckons the Australian peer-to-peer lending market will grow to around A$21b by 2020, made up roughly equally of consumer lending and small business loans. Even those sums would only be 10 per cent of the respective markets.

Rather than offer a “rack rate” level of interest for all depositors and personal borrowers, peer-to-peer lenders use advanced algorithms to tailor the risk appetite of investors to the creditworthiness of borrowers.

“Investors create their own portfolio; they don’t have any information that would compromise the borrower’s privacy. If someone borrows A$30,000 to buy a car there might be 20 to 50 underlying lenders,” explains Yetton.

Banks are getting eaten from both sides — fintech is taking bits of the most contestable parts of the value chain, and then we’ve got regulations squeezing banks on the other side.

Asset management shake-up

The biggest financial piñata is asset management, which is especially bloated in Australia because of compulsory superannuation, which gives the financial services sector a captive and largely disengaged market.

The big four banks and AMP ultimately control around three quarters of the financial products available to retail investors. The Grattan Institute has estimated Australia’s asset management fees are three times the OECD average.

According to Chris Brycki — a former UBS banker who founded Australia’s first automated investment services, Stockspot, three years ago — around 45 per cent of the returns made by bank-controlled managed funds from 2008 to 2013 were paid out in fees.

“It shocks me how much money is still actively managed in Australia. Sure, some managers are brilliant but most retail investors don’t have access to those people, and index funds will consistently beat the typical manager,” he says.

Stockspot strips back three fat fee layers.

Firstly, the cost of financial advice, which can be around 1 per cent a year of the investment balance, becomes automated completely. By answering a series of questions online, Stockspot gauges investors’ risk tolerance and constructs and manages a portfolio of low-cost Exchange Trade Funds.

Secondly, the “platforms” that dominated the funds management industry and allow investors access to an array of different managed funds, and charge around 0.25 per cent a year in fees, have been made obsolete by cloud computing technology.

Finally, investment management, brokerage and bid-ask spreads are minimised through the use of low-cost exchange traded funds provided by big providers such as Vanguard and Blackrock.

“Add all these up and a typical person is paying 2 per cent to 3.5 per cent a year on their investment,” Brycki says.

By contrast, Stockspot will invest A$50,000 to A$250,000 for 0.066 per cent a year plus a A$77 a year admin fee — a fact that should ultimately wreak havoc on the fund management industry.

“Finance is meant to lubricate the real economy, not the other way around,” Brycki says.

While Stockpot won’t reveal the level of assets under advice, it claims many thousands of clients.

“The average age is 36, mainly professionals who don’t want to be ripped off; actually 10 per cent of our clients are in finance themselves — which doesn’t surprise me,” he adds.

Shares economy

Investment banks won’t be immune from the fintech onslaught, either. OnMarket Bookbuilds has developed technology to open up initial public offerings to retail investors, and at the same time ensure the issuer gets a price per share that reflects the actual demand.

Around six million Australians hold shares directly, but they typically read about IPOs after they have happened. While Australia has seen around 1,000 IPOs over the past decade, only Telstra and Medibank had widespread public participation.

“Our laws fully provide for retail investors; the very reason a prospectus goes out is so the public is fully informed,” says Ben Bucknell, OnMarket Bookbuilds managing director, pointing out only 14 per cent of large IPOs in 2014 had any retail involvement in Australia.

Indeed, the Australian stock exchange is proposing to make retail involvement even more difficult by reducing the minimum number of shareholders for newly-listed companies from 400 to 100.

“Everyone should be treated fairly in the share market; Hong Kong and Singapore have minimum retail involvement mandates of 25 per cent and 40 per cent, respectively,” Bucknell notes.

The top five, Goldman Sachs, UBS, Macquarie, Morgan Stanley and Citi, advise on more than 60 per cent of new IPOs in Australia and typically charge fees of around 3 per cent of the value of shares sold to 6 per cent for smaller offerings. OnMarket Bookbuilds, which has patented its share register book building technology in 20 countries, charges a small fraction of this. In a typical year of A$30b of new shares, placement and rights issuance, that adds up to hundreds of millions of dollars.

The bigger problem in this industry is not so much the fees, but rather that the investment banks that oversee IPOs tend to offer the shares to their most profitable clients. The UK’s Financial Conduct Authority, which compelled investment banks to provide it with five years of internal data, showed this convincingly in a recent analysis of the UK market.

“There’s no shortage of companies looking for equity capital, yes there is around about A$500b in self-managed super and around A$180b of that is held in cash,” Bucknell says.

Consumers are notoriously slow to change financial institutions for a better deal. Poor financial literacy is largely to blame. But the savings these and other fintech firms offer are so large that it is difficult to see how they and their competitors will not cause swathes of traditional banking to shrink significantly. As Microsoft founder Bill Gates has said, people tend to overestimate change in the short term, but underestimate it in longer term.

p2p pioneer

New Zealand’s banks might be owned by Australia’s big four, but financial technology there is developing independently, reflecting the country’s unique comparative advantages — farming and political neutrality.

“There’s quite a lot going on here, on a number of different levels,” says Adrienne Duarte CA, chief financial officer at the Bank of New Zealand.

Harmoney — New Zealand’s biggest peer-to-peer lender — has already written NZ$250m of personal loans, around twice as much as Australia’s biggest P2P lender, Society One. Duarte, an Australian who spent years working in senior roles for National Australia Bank, says New Zealanders tends to be quicker adopters of fintech than Australians.

“New technologies get rolled out even more quickly in New Zealand within companies,” she says.

Duarte points to unique fintech firms Wynyard and Figured. Wynyard is a provider of sophisticated software to track financial and cybercrime, and money laundering. Listed on the New Zealand stock exchange in 2013, the group now boasts over 250 employees and has already partnered with major crime agencies in Europe and the United States.

“New Zealand has an advantage in this area because it tends to be politically less threatening,” says Duarte.

The Bank of New Zealand has taken a 17 per cent stake in Figured, which offers financial software to help farmers manage their cash flows and liaise with bankers and consultants more easily.

“Keeping fintech in house doesn’t allow it the freedom to develop the way it needs to,” she says.

While Duarte is a little less bullish than some about P2P lending — “it sounds like a great idea until there’s a credit downturn” — the threat posed by the loss of customer information, she says, is the greatest challenge for traditional banks.

“As rich payment and credit information flows to other providers, the quality of decisions banks can make declines and the cost of making those decisions increases; there’s a risk of becoming a dumb balance sheet,” she says.

“Banks are getting eaten from both sides — fintech is taking bits of the most contestable parts of the value chain, and then we’ve got regulations squeezing banks on the other side.”

See a profile interview with Duarte in the March 2016 issue of Acuity.

New bankers

Some fintech companies like to play down their direct competition with established banking. Not so Josh Stollman, chief executive of Tyro, which provides EFTPOS and banking services to small to medium-sized businesses.

“Australia is the ‘bank bastion’: A$40b of bank profits a year is huge and a significant tax on each Australian consumer and business,” he says.

Tyro has set up and subsidised a fintech hub in Sydney to encourage other firms to take on the big banks.

Founded by three Australian engineers in 2003, Tyro now has over 15,000 clients, 250 employees, and facilitates transactions of A$8b a year — quadruple the level of four years ago. Last year it became the first technology firm to obtain a banking licence, thanks to regulatory changes aimed at making banking more competitive.

“We’re a software house; technology is our DNA. We have developed our core banking platform entirely in house,” he says.

“We’ve just launched a deposit account and we’re about to launch a first cash flow-based lending product with frictionless, instantaneous access to debt when businesses need it,” he adds, citing evidence of A$60b of unmet demand for such loans in Australia.

Tyro’s integrated cloud-based platform means it can offer banking services, which are integrated with Xero cloud accounting, at much lower cost and with greater security than established banks. Its business accounts automatically receive an increasing interest rate depending on how long businesses keep their money on deposit, removing all the frictions of term deposit management.

Tyro’s rapid growth should continue. Australian banks’ fee income from businesses rose 3.9 per cent in 2015 to A$8.2b, with more than three quarters of the increase stemming from small businesses. Moreover, merchant service fees, which banks charge businesses for acquiring their card transactions, rose 9.2 per cent over the year and made up more than a quarter of the total.

“You would think with such significant growth of transactions and volume that competition and economies of scale would deliver businesses savings, even from their legacy systems — but no,” says Stollman.

Stollman applauds the local regulators’ decision to relax banking and payments rules to allow it to compete with the major banks, but he says Australia won’t flourish as a fintech hub until banks are compelled to meet “open data” principles.

“Europe and the UK are far ahead of Australia in this regard. If banks are able to charge excessively for this information, new business models won’t be viable,” he says.

This article was first published in the August 2016 issue of Acuity magazine.