Top 10 Reasons why Silicon Valley cannot disrupt Wall Street (yet)

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Fintech Golden Quadrant

Top 10 Reasons why Silicon Valley cannot disrupt Wall Street (yet)

This is the 2016 update on our independent critical examination of the running meme of “fintech disruption” in the financial services space.

The “Top Ten list of why Silicon Valley cannot Disrupt Wall Street (yet)” was published first here in October 2014

Motivation

The possibility, heck inevitability, of “Silicon Valley” (Henceforth abbreviated SV, representing new technology entrants) aiming to “disrupt” Wall Street (Abbreviated WS, representing incumbents) is one of the fascinating memes of our times. Yet while the potential of technology to reshape financial services is not really in question, the manner and timing are entirely different stories. At Open Risk we decided to play devil’s advocate and create a Top 10 of why it won’t happen! So here it goes, our top 10 reasons why Silicon Valley cannot disrupt Wall Street (yet).

As time passes on we will be validating the points against the realizations, with the first installment being this (Jan 2016) update.

The Top Ten List

  • Reason No 10: Lack of track record

  • The current bloom of internet and mobile based business models is the main success story of SV. But this is primarily a consumer / mass market phenomenon. The corporate story around digital transformation (and the role of SV in this process) is still quite a bit less profound. In finance, large fraction of conventional commercial and “high” finance is linked to corporate / sovereign clients where the relationships are completely different and low-tech to boot: Think of Powerpoints, Phones (for talking, not for browsing) and Looong Meetings. Excel is brought in when one needs to impress the natives. This is 99% voodoo, 1% science. SV has no track record in this low tech space. Hence the near term question is restricted to the possibility of SV using technology to disrupt consumer finance as opposed to all finance.

  • 2018 Update: As approach potentially a turn in the credit cycle, the lack of significant scale will mean that the lack of track record will be hanging as a shadow also in the future

    2016 Update: The consumer focus remains true. There are fintech entrants active in small business lending but this is not yet a disruptive practice (existing banks follow the same segmentation). In fact as time goes on it seems that it is the payments space that is the most active domain…

  • Reason No 9: Protectionism

  • In our increasingly multi-polar world, there will be little appetite from power centers worldwide to pay rents to US based tech companies for all the financial activity in their domains. So we are further restricting the discussion to regions where the SV influence / leverage is unquestionable. We assume that the US is one such region, and we restrict the scope to US consumer finance.

  • 2018 Update: Spectacular confirmation as the pre-existing world order is slowly being dismantled

    2016 Update: Remains as true as ever. There are already indications of divergent official sector attitudes across jurisdictions (with some being more permissive or “light touch” than others). This lack of uniform standards will further prevent any concept of “cross-border” fintech for the near future

  • Reason No 8: A nagging little timing problem

  • Under-regulated US consumer finance going haywire was the cause of the worst recent financial crisis in the US, which then metastasized worldwide. The idea you can spawn a shadow-banking based US consumer finance sector in the aftermath of this massive disaster shows the mojo of the SV clan (or is it desperation in the face of diminishing realistic projects in its core areas?). In any case, the poor timing will likely bring more resistance and scrutiny than disruptive technology adoption in other areas of economic activity. While lip service to innovation will be paid, the last thing regulators need at this stage is a confidence sapping shadow banking version of the subprime crisis.

  • 2018 Update: We completely missed the US deregulation movement here

    2016 Update: Remains as true as ever. Shadow banking is one of the top concerns of regulators worldwide

  • Reason No 7: The IT backwardness of banks is selective

  • SV is the undisputed king of information technology (that is what it does!). But WS is not uniformly in the IT stone age. In the broader “banking” sector, 70’s mainframe’s serving consumer finance co-exist with co-located HFT platforms serving “high” finance. Why such under-investment in consumer finance IT? Possibly just a long “cash-cow” period and the lack of competitive pressure. But nothing prevents banks from adopting more modern IT infrastructure. Actually most needed technology is now open source and widely available! SV can successfully supply modern IT to banks but this would be more help transform the existing system rather than a shift of power.

  • 2018 Update: While every bank has spend lavishly in the past two years to polish its innovation image, its not clear how much has become part of its DNA.

    2016 Update: The accelerated experimentation of banks with blockchain technology illustrates this point. Even while the tech is still far from solving real problems, banks are more than capable to invest resources to adopt and even try to monopolize (e.g., patent any fintech ideas).

  • Reason No 6: What’s new under the sun?

  • One of the hallmarks of SV “disruption” is the deployment of so-called big data analytics. SV might have the idea that they just invented quantification? Well quantification in finance (from credit scoring to the most exotic pricing of credit structures) is not exactly new. Using previously unavailable data to “improve” credit scoring is about a day’s worth of work for a motivated quantitative analyst, even while hampered by mainframes and obsolete software.

  • 2018 Update: Remains true as ever. Yet banks are still far from benefiting from collaborative practices pioneered by big tech

    2016 Update: Remains true as ever. In fact, if anything, the trend for the tech giants is to open source their advanced big data analytics (see Google Tensorflow etc.) This means that there is no competitive advantage in risk analytics that cannot be replicated fairly easily

  • Reason No 5: What’s new under the sun that actually works?

  • Financial models are like Schroedinger’s cat: They only work when nobody looks inside the box. SV is currently under the thrall of information windfalls from private data. When you are lucky enough to have informative new data you don’t need “big data analytics”, you just eyeball them and you are good to go (remember excel?). But once permissible data boundaries are established in law, the game of behavioral changes, adverse selections and moral hazard starts. That’s when modeling becomes 50% voodoo and 50% science.

  • 2018 Update: We are all waiting for Godot. There is zero indication that it will be different this time”

    2016 Update: As they say, unless you've demonstrated ability over a full credit cycle, claims to better risk management are little more than “forward looking statements”

  • Reason No 4: Senior funding

  • There may well be trigger happy equity investors to provide risk capital for “disruptive” US consumer finance, but will there be willing senior investors to provide funding to any meaningful size and under what conditions. Senior funding represents fintech “coming of age”. But if that only happens via the well known banks, rating agencies and lawyers then fintech is clearly not disrupting the industry but being co-opted.

  • 2018 Update: Fintech has been co-opted

    2016 Update: The jury is still out on this one. There has been activity around P2P securitisation, but with the caveats of Top Reason 5, this is unlikely to be an easy channel

  • Reason No 3: Privacy Concerns

  • The premise behind much of fintech is that current widespread “redefinition” of privacy (some tech industry leaders are “intensely relaxed” about privacy – when it concerns others), can be extended without backlash in consumer financial transactions. In fact it is possible that privacy concerns around financial transactions will instead wake up dormant consumer reflexes. This can be a boomerang even for the established SV “social business” models, let alone create new opportunities

  • 2018 Update: The privacy backlash has happened

    2016 Update: The jury is still out on this one. Banks increasingly realize that their long standing privacy culture might be (next to the regulatory barrier) another defense mechanism

  • Reason No 2: Discrimination Risk

  • One of the key metrics of the quality of a credit model has the unfortunate name: “discriminatory power”. The use of newly obtained private data for credit selection will need to play well with anti-discrimination laws, where discrimination is to be understood in legal, not statistical terms.

  • 2018 Update: Financial inclusion is what everybody still talks about but few deliver

    2016 Update: Not yet on the radar screen. A recent KYC related inappropriate lending incident in the US will fuel further debate about the selection process of fintech services

  • Reason No 1: Imperial Overreach

  • SV will have to survive the inevitable indigestion from its current over-production before biting major new chunks of the economy.

  • 2018 Update: The major market correction seems to confirm this view

    2016 Update: This seems to have been confirmed soon enough, by the evident lack (as of Q4 2015) of exits and accumulation of “unicorns”