Regulation Innovation / Briefing 1:
THE FIVE TECH TRENDS
The first thing to understand about fintech is that it is far more about “tech” than “fin.” Financial people tend to underestimate the size and speed of the coming change, simply because the forces driving it are mostly developing outside their field of vision -- in the technology world, not in finance. These massive innovations are essentially traveling through the financial realm, creating and altering financial products and channels in the process. Like all technology change, moreover, these shifts are global.
Their technology roots have many implications, including that regulatory responses will be shaped heavily by regulators other than the ones overseeing banking and finance.
The second thing to understand about these trends is that each is an enormous force in itself, but still looks deceptively small because the technologies are also converging. Most innovators are already leveraging several of them (which is one reason some fintech is radically breaking old molds). As they continue to merge, they will spark explosive change.
Regulation Innovation, accordingly, starts with examining the Five Tech Trends.
Trend 1: Big Data
Big data is the proliferating information being generated by our modern digitized lives. For consumers, it includes information gleaned about our buying habits, entertainment preferences, and social media activities. It also includes geolocation data gathered by location-aware devices like our phones and cars.
Another source is information gathered by the expanding use of cameras, large and small that use facial recognition technology. These can identify who and where we are and can assess our reaction to what we’re hearing or seeing – such as whether we frown or smile as we look at merchandise in a store. Here’s more on facial recognition.
Another enormous category is the burgeoning Internet of Things, or IOT – the interconnections between all the little computers embedded in devices surrounding us. These range from smart thermostats and baby monitors to electronic keys and cameras, to electronic scales and fitness trackers. We will soon have smart refrigerators and washing machines that automatically order resupplies when, say, the milk or detergent is running low. These devices have the ability to map intricate and voluminous data about our tastes, movements, associations and lifestyles.
In addition, government is contributing to the big data revolution by digitizing records. In finance, examples are the CFPB’s databases on consumer complaints and the Home Mortgage Disclosure Act. These have been designed to use “application program interface”, or API, capability, to make it easy for third parties to acquire and work with the data. While data like HMDA information is old, it can now be combined with other proliferating and detailed big data, boosting the power of all of it. The same trend is underway at all levels of government, from accessibility of property titles to records of birth, death, marriage and divorce. The Obama Administration views federal records as a national resource that should be available for public use to the extent consistent with protecting privacy. Such steps are creating explosive growth in the amounts and types of available data.
As discussed below, big data is driving toward financial inclusion by making it possible to know more about individual consumers and thereby fine-tune risk assessment and underwriting.
Still, big data is problematic simply because it’s so big. That brings us to the second trend.
Trend 2: Artificial Intelligence
Big data differs fundamentally from the information traditionally collected by financial companies. Unlike credit scores, verified customer information, or a bank’s own information on its customers, big data sources are massive and messy. Information is often inaccurate – it’s typically collected for reasons that don’t require accuracy at the individual level. Furthermore, the information is lodged in databases that don’t easily connect.
However, we are learning to put this new data to work through artificial intelligence, or AI. The terms “machine learning,” “deep learning,” and “neural networks” all refer to the ability of computers not only to amass and process information efficiently, but actually to learn -- to think. Today’s machines solve complex problems through rapid, powerful trial and error and pattern recognition. Some have the capacity to search, quickly, all the digitized information in the world (which, as noted above, is skyrocketing in volume). Here is an excellent Wired Magazine article on how machine learning is changing our lives.
For example, we now have computers that not only can diagnose cancer by accurately reading radiology reports, but that have also noticed attributes of tissue outside the malignancies they were analyzing and pointed out important patterns that scientists had not even asked them to look for. In finance, an example is Goldman Sachs’ Kensho, which can answer thousands of complex “what if?” questions from investors and brokers, in simple text, in seconds (for instance, what would happen to homebuilding stocks if a category 5 hurricane hit the U.S. mainland?).
For a quick, fascinating look at AI, see these images of Google’s photo-search computers “dreaming.” After the engineers stopped feeding information to them, they continued to “think” about what they had “seen,” and this is what was on their minds….
The use of new data analysis in financial services raises complex public policy challenges. Again, these trends are a massive force driving toward more financial inclusion, because alternative data and analytics can assess the risk profiles of consumers who have thin or no credit files or complex credit situations. These applicants are typically rejected in today’s systems, but may in fact be creditworthy. In some ways, new technology offers a 21st century, high-tech version of the kind of traditional banking where the banker personally knows a customer well enough to make a sound loan despite problematic circumstances. That system works well on a small scale and for borrowers fortunate enough to have such a banking relationship -- which, of course, many people do not. More data and better data analysis can open up a semblance of such nuanced evaluation on a larger scale.
On the other hand, regulators of course worry about new models that have not yet been tested through an economic downturn, especially given the failure of credit risk modeling in the financial crisis. Policymakers also have concerns about fair lending issues arising from new data uses, including disparate impact risk. In addition, new collection and uses of data raise concerns about privacy and cybersecurity.
Most banks do not yet employ these techniques, partly due to the regulatory uncertainties around them. However, many fintech companies do. As new data methods become refined, they may tend to give a competitive edge to innovators using them over companies that don’t, simply by enabling more sound and profitable lending decisions. For community banks seeking to grow, alternative data could make broader markets reachable. We may also reach a point where financial companies will be penalized for not using big data analytics, if it in fact proves to be both highly inclusive and predictive. Future videos and briefings will explore all these issues at the intersection of regulation and innovation.
AI carries profound questions for the future. Many dramatic predictions about it have not yet proven out, but it seems clear that big change is coming and accelerating, and could profoundly change the human experience. One scenario is depicted in the movie Her, about a human-like, voice-only operating system -- with its startling final plot twist. This year Microsoft withdrew a new AI-based chatbot (talk robot) named Tay after one day, because she had “learned” abhorrent views through her online conversations. People also worry about (or hope for) the evolution of trans-human technology like enhanced eyesight (watch for author Brett King’s upcoming book, Augmented). The growth of AI could reach a point that Vernor Vinge in 1993 called the singularity, in which computers with superhuman intelligence could create change as significant as the rise of human life itself. Ray Kurzweil, who received the National Medal of Technology and Innovation in 1999, has written The Singularity Is Near, predicting that humans will eventually transcend the limitations imposed by our physical bodies and brains.
Here is one of my favorite Ted Talks, by Jeremy Howard, on “the wonderful and terrible implications of computers that can learn.” He shows how computers can “see” and “listen;” can learn to recognize pictures and words; can “write;” and can collaborate with humans. He gives insights into how Google search can find information for us so instantly and accurately. He also addresses the daunting implications of all this for society. It’s my top background link for this briefing.
Natural Voice Technology
I believe voice technology will close the last mile of financial access for millions of people who have difficulty using today’s standard product forms and channels. Many people don’t understand (or are frankly bored by) financial information as normally presented. Voice tools can change that.
We already have sophisticated voice technology. Products like Dragon Dictation can instantly translate voice to text and vice versa, while other tools can translate one language to another, even mimicking the voice of each speaker. If you didn’t watch the Jeremy Howard TedTalk above, watch it now. At about 4:30, he demonstrates machine learning translating his own talk into Chinese. And watch this wonderful demonstration of schoolchildren using Microsoft Translator to communicate.
Many of us already use Siri, Apple’s voice assistant on our IPhones, to dial phone calls, make restaurant reservations, report the weather, or set up reminders and shopping lists. You can ask Siri fact questions. If you ask, “who is Bill Gates?” she’ll send a Wikipedia article to your phone and ask if you want her to read it to you. You can say, “Find pictures of polar bears,” and she’ll find them.
The same is true of Microsoft’s Cortana. I was in a hotel room last fall and she suddenly activated on my laptop. I said, “Cortana, what are you doing?” She said, “I’m working out the mechanics of a virtual fist bump.”
Here’s a blog post I wrote about my wonky week of getting Cortana, Google Photo, and an Apple Watch all within a few days, and being amazed as they all began doing things for me, often at their own initiative (technology taking the initiative is another theme we’ll explore, as is fintech’s playful use of humor). It was especially impressive that they sometimes cooperated – even though they come from three different companies.
And now, we have the Echo – Alexa -- Amazon’s new voice-only personal assistant. As I write this, she is sitting on my kitchen island where she does things like reports the weather, adjusts the lights or thermostat, and reads me the news. I’m going to say, now, “Alexa, tell me a joke.”
Here’s her answer: “What did one flag say to the other? Nothing, it just waved.”
An important thing about Alexa is that it has no way to interface with us, except voice. There’s no keyboard, no screen to touch. This Wired Magazine article is thought-provoking about the importance of this. It discusses the potential for voice interface to mirror the power that Steve Jobs recognized when he first saw the graphical user interface, or GUI, and knew that touchscreens would be the future of computers. The article predicts that the voice interface will bring technology to millions of people currently at or outside the margins of access (including the twenty million people in the U.S. who cannot see).
Importantly, voice technology “unlayers” information and brings it instantly to the top. Suppose you need your bank routing number. Instead of looking it up, you can have your voice assistant simply read it to you. Alexa is new, but Capital One has already created a banking app for it.
For a mindboggling demonstration of what voice interaction can already do, watch this demonstration of Soundhound’s Hound (be sure to stay for the financial questions near the end).
The power of voice will magnify as it converges with big data, AI and, as discussed below in Trend 5, mobile. It will put a personalized, smart, interactive, helpful financial coach, equipped with a supercomputer, in all of our phones.
Trend 4: Digital Currency and Blockchain
The blockchain was created by the anonymous inventor of Bitcoin. Also called “distributed ledger technology,” or DLT, it is a record of a chain of transactions, posted on the internet in a manner that’s transparent, unbreakable, and unfakeable. Because it’s on the internet, the information moves almost instantly and at nearly no cost.
The initial driver for its creation was a desire to make Bitcoin an alternative currency. Given Bitcoin’s colorful early scandals involving drug trafficking and fraud, the mainstream financial world originally tended to dismiss it. However, the ingenious design of the distributed ledger is now inspiring a profusion of innovation aimed at using it to transform many systems and to change our lives.
Given its roots in Bitcoin, blockchain technology has focused initially on changing finance. Innovators are applying it to models that range from being a “currency” -- “digital currency” or “crypto-currency” -- to an investment, to a new or enhanced payments infrastructure. Hundreds of innovators are putting it to use in payments -- seeking to wring nearly all the expense and delay out of them and essentially do for money what the internet did for information by making it instant, free, and shareable with anyone. (We’ll discuss some of these emerging models in the next briefing, Meet the Innovators.)
In addition, central banks in the U.S. and throughout the world are exploring the possible benefits, and risks, of creating government-issued digital currency. Governments and payments clearinghouse systems are also evaluating ways to streamline and accelerate central payments systems.
Beyond finance, blockchain solutions for other use cases arise almost daily – thousands of companies are working on them. These include recording legal titles and contracts, redesigning stock markets, and organizing complex flows of operations to strip out complexity, cost and delay from activities like large bank information and processing systems.
The U.K. Office for Science has produced an especially interesting report on the potential for distributed ledgers and the regulatory opportunities and issues arising from them. It begins by saying:
The progress of mankind is marked by the rise of new technologies and the human ingenuity they unlock…(We may be) witnessing one of those potential explosions of creative potential that catalyse exceptional levels of innovation. The technology could prove to have the capacity to deliver a new kind of trust to a wide range of services. As we have seen open data revolutionise the citizen’s relationship with the state, so may the visibility in these technologies reform our financial markets, supply chains, consumer and business-to-business services, and publicly-held registers.
The same report says, “(Distributed ledger technologies) have the potential to disrupt the whole economy, and society.”
The report’s reference to trust is critical, as blockchains make it possible to engage confidently in transactions with people we don’t know, without the help of mutually trusted intermediaries and without traditional contracts. The trust is built, efficiently, into the technology itself.
The blockchain is yet another technology that drives toward financial inclusion. Digital financial access is rising worldwide, especially in the developing world where (as discussed below) cell phones will soon be ubiquitous. The low cost of executing financial transactions on the internet is likely to disrupt the remittance industry. This efficiency, combined with the fact that digital currencies are almost infinitely divisible, will also make it economically viable to process micro-payments. People will be able to send and receive a few cents, opening up enterprise in the developing world and generating whole new business models everywhere.
In addition, real-time settlement of financial transactions can remove one of the factors that drives consumers into high-priced cash and payday lending services, namely the inability, today, to know when a check or electronic payment will clear.
Here is my blog post on the consumer benefits of Bitcoin.
This area, like the others, will raise enormous regulatory challenges that we’ll explore in later briefings.
Trend 5: Online & Mobile
Financial services have been online for years – a majority of banking is now done there. What’s new, today, is the successful advent of innovative business models delivering services entirely or mostly online, capturing enormous efficiencies compared with traditional branch-based infrastructure. Many also use very sophisticated data analytics and offer a markedly superior online user experience, or UX -- typically because they’ve been designed by technology people, rather than financial people. Some of these companies hope to change finance in the same way Amazon changed bookstores and retailing.
Among the online players, there is particular interest in “marketplace” lending (formerly called peer-to-peer lending) that matches borrowers and investors online. We’ll explore more about this in the next briefing on “Meet the Innovators.”
Even more innovative than online services, though, is mobile technology – it may, in fact, be the most revolutionary of all the five trends.
Financial people tend to think of mobile as being about payments, but finance is a tiny fraction of the change underway. We are seeing a fundamental reshaping of how we live, a shift potentially on the scale of the invention of money itself, or agriculture, or electricity or the internal combustion engine.
The smart phone has become a layer, an interface, between the individual and nearly everything in the world. It mediates what comes in to us, and what goes out. It is reshaping communication, relationships, social norms, information, education, entertainment, work, commerce, shopping, buying, selling, creativity, health and fitness, time-management and nearly everything else. People use the phone for self-expression, to share music, to share humor. They use it to seek advice. They use it to compare prices. They use it to track calories and monitor exercise. There is almost no realm of human life not being altered by it – people even use it to guide prayer. When the phone is converted to a watch or other wearable, it takes on additional capabilities.
This has huge implication for finance. One is mobile payments -- a topic we’ll explore extensively in the series. Beyond that, the phone will leverage all the five technology trends to become a single, powerful financial tool. It will consolidate all our financial information in one place; use that automatically and painlessly to build budgets; organize and handle payments; use behavioral economics to nudge us toward goals and away from financially damaging temptation; enable effortless saving and reinforce it by entertaining us with amusing text messages; block out dangerous products; and become our financial coach – eventually by voice.
Again, all the new technologies are converging in the phone. Since it knows where we are, it can alert us as we walk toward Starbucks if our budget can’t afford a latte today. It can remind a hurried mom with fidgety children to hold spending at the grocery story to hold to the $75 she can afford. If we overspend, it can recalculate and help us monitor a reduced daily budget. It can find the best choice of a credit card or car loan or mortgage and explain why. It also take the initiative to help – for instance, offering to talk about a retirement plan, for someone who doesn’t know how to start or where to turn.
It will also address the widespread failure of financial literacy education. Josh Reich, founder of Simple, points that when the automobile was invented, people couldn’t drive without understanding how it worked. Then we got automatic transmissions, and now most people can operate a car with no idea of what’s under the hood. (And now we’re even going to have driverless cars). Finance will go through the same transformation. After a century of U.S. federal policy fostering “financial literacy,” only a tiny percentage of people understand finance. Today’s technology, though, can help people build healthy financial lives without sophisticated knowledge, by using tools that deliver helpful information, right when it’s needed. The phone education can be customized, and can be made interesting and even enjoyable.
Smart phones will also put financial comparison tools in everyone’s pockets. These have already emerged, but big data and AI will massively enhance them and build them conveniently into the phone, synthesizing fast-growing data on consumer reviews and complaint scores, as with Yelp, Open Table or Trip Advisor. (Amazon already lets customers rate its credit card on the product page, just like a TV or a pair of socks.)
Even more profoundly, the financial coach in the phone can eventually flat-out prevent poor decisions by screening out products with hidden adverse terms, whether the person fully understands them, or not. This mimics the medical concept of a “smart membrane,” letting in the good and blocking out the bad.
Think about it this way: the new technology means that businesses will know everything about us, and we will also know everything about them.
Most importantly, cell phones are the most democratizing force in the history of finance. They can deliver services to almost everyone, everywhere, at very low cost. In the United States, they are disproportionately highly used by lower-income and minority consumers, including for financial tasks (partly because many of these households never adopted more expensive PC-based banking.) A 2015 Federal Reserve study found:
Mobile phones are prevalent among unbanked and underbanked consumers. —The share of consumers who are unbanked is 13 percent, and the share who are underbanked is 14 percent. —Sixty-seven percent of the unbanked have access to a mobile phone, 65 percent of which are smartphones. —Ninety percent of the underbanked have access to a mobile phone, 73 percent of which are smartphones. —Forty-eight percent of underbanked consumers had used mobile banking in the 12 months prior to the survey.
People have phones. They know how to use them. They already use them for financial tasks. As more financial tools come into the phone, people’s lives will be transformed.
Outside the United States, cell phones are even more ubiquitous, because many parts of the world never had landlines and so adopted mobile earlier. More people in the world have access to cell phones than to toilets. Governments, NGO’s and businesses worldwide are rapidly building a global population that has full access to digital financial services. The relative American slowness on mobile is creating disadvantages for the U.S. in ways we will explore in the series.
One more note on demographics. Millennials are now the largest generation in the history of the world, in the U.S. and worldwide. In 2015 they surpassed the Baby Boomers, who will henceforth decline sharply as a percentage of population. Just as the boomers did when their numbers surged, the millennials are already exerting an outsized influence on the culture and the economy. Their preferences, including for mobile services and fast, easy transactions, will reshape finance.
Those are the five tech trends driving financial innovation: 1) big data, 2) artificial intelligence, 3) natural voice technology, 4) the blockchain, and 5) online and, especially, mobile. Again, each is huge, but they are also converging. (Check out my bonus video, Why Does Jo Ann Barefoot Have An Xbox (since she’s never played a videogame in her entire life? It explains that four of the five tech trends have already converged in my own living room, in my Xbox.)
Nodes of innovation in each of these trends will increasingly connect with the others. Most innovators are already leveraging several of these technologies at once, and will add more. When big data combines with machine learning, and creates services delivered through voice-based consumer help, modernized by the blockchain, and delivered through the smart phone, everything changes.
Each of these trends, and all of them in combination, will raise enormous regulatory challenges – most of which will cause permanent uncertainty about regulatory standards and expectations. We will examine these in Video 3, Meet the Regulators and discuss how to integrate them into a strategy for regulation innovation.
Suggested Action Steps:
- Have your innovation team assess your company’s use of alternative data and analytics
- Have it assess your company’s strategy for mobile services, and especially how it rates with millennial customers (hint: ask your young employees)
- Register innovation team members for a tech-focused conference like Emerge, Money 20/20, LendIt, Finnovate, or SXSW – SouthBySouthwest(I’ll be speaking at many of them)
- Subscribe to Barefoot Innovation, my free podcasts
- Watch for the next video and briefing, where we will Meet the Innovators who are leveraging all this technology to transform finance