Fintech in the Arab World:
A Healthy Competitor but not yet a Game Changer
1. Fintech – A Global Overview
a. Definition and Drivers
Financial technology, commonly referred to as FinTech is defined by the Financial Stability Board (FSB) as “technologically enabled innovation in financial services that could result in new business models, applications, processes or products with an associated material effect on financial markets and institutions and the provision of financial services”. In other words, financial technology encompasses tech-enabled products and services that improve traditional financial services, and tend to be faster, cheaper, more convenient and more accessible as they employ technology to support financial transactions among businesses and consumers. According to the FSB, the demand side driver of financial innovation is shifting consumer preferences in other words higher customer expectations for convenience, speed, cost, and user-friendliness. Supply side drivers include technological advances as well as changes in regulatory and supervisory requirements.
b. The Size of Global Investments in Fintech
According to The Pulse of Fintech – a quarterly report on global fintech trends produced by KPMG, global fintech funding declined to $24.7 billion in 2016 ($13.6 billion of which came from Venture Capital investments) compared to a record-setting $46.7 billion in 2015. As at November 2016, cumulative investments exceeded $100 billion in more than 8,800 fintech companies, and according to the annual PwC FinTech Report, global cumulative investment is expected to surpass $150 billion by the end of 2017. In the second quarter of 2017, the fintech market made a strong rebound with total investment more than doubling on a quarter-to-quarter basis to more than $8.4 billion across 293 deals. Large increases in private equity funding and M&A funding propelled the increase, while venture capital investment remained relatively steady.
c. Fintech Key Sectors
According to the Basel Committee on Banking Supervision, fintech is associated with 3 main sectors directly related to core banking services: credit, deposit, and capital-raising, payments, clearing and settlement, as well as investment management (See Figure 1).
Source: Basel Committee on Banking Supervision, 2017.
The first wave fintech sectors are lending, capital raising, and payment solutions. Lately, “three trends indicate the rise of a more developed second wave sector which requires the acceptance of first wave technology by customers and regulators, one that brings financial technology to international money transfers, digital wealth management, and insurance,” (Wamda and Payfort, 2017). Another new technology in the fintech industry is blockchain, a digital, decentralized, public ledger in which transactions made in cryptocurrencies such as Bitcoin are recorded chronologically. However, according to the managing director of the IMF Christine Lagarde, virtual currencies such as Bitcoin pose little or no challenge to the existing order of fiat currencies and central banks, as they allow for peer-to-peer transactions without central clearing houses i.e. without central banks hence they are too volatile, risky, and opaque for regulators.
Fintech products and services are often developed by startups which are nascent companies that promise to considerably improve the way individuals and companies bank by collaborating or competing with established traditional financial service providers such as banks (Wamda and Payfort, 2017). According to PwC, the observed global trend is toward innovative models of collaboration between fintech and banks rather than competition as the majority of fintech companies seek to partner with banks
d. Fintech Opportunities and Threats
Several opportunities as well as risks emanate from Fintech and affect consumers, banks, regulators, and economies.
Risks stemming from financial innovation on consumers include cyber risks, data privacy, data security, and discontinuity of banking services. On the other hand, benefits include greater financial inclusion, better, faster and more tailored banking services, as well as lower transaction costs (Basel Committee on Banking Supervision, 2017). According to Mark Carney, Governor of the Bank of England, “consumers will get more choice, better-targeted services and keener pricing. And most fundamentally, financial services will be more inclusive; with people better connected, more informed and increasingly empowered”.
Concerning the impact of fintech on banks, threats on the banking system according to the Basel Committee on Banking Supervision include strategic and profitability risks, increased interconnectedness between financial parties, high operational risk (systemic and idiosyncratic), third party risk, compliance risk, money laundering and terrorism financing risks, as well as liquidity risk and volatility of bank funding sources. Moreover, “4 out of 10 banking customers expressed decreased dependence on their bank as the primary financial service provider, according to a global survey. Collectively, fintech startups are thus about to unbundle the traditional bank,” (Wamda and Payfort, 2017). On the positive side, opportunities include improved and more productive banking processes, positive impact on financial stability due to increased competition, innovative data use for risk management and marketing purposes, as well as RegTech (BCBS, 2017).
This brings us to the benefit of fintech to regulators. Regulatory technology, also known as RegTech, is a subclass of FinTech which uses new technologies, particularly information technology, to solve regulatory and compliance requirements more effectively and efficiently. Hence, RegTech has enormous potential to better detect misconduct through cloud computing and greater access to data and information, enable better compliance solutions, increase efficiency and profitability, and reduce barriers to entry. This is particularly promising in a sector with rapidly growing compliance costs due to daunting regulations such as Know-Your-Customer (KYC) and AML/CFT regulations.
In economic terms, a 2016 report by McKinsey Global Institute predicts that widespread adoption and use of digital finance could increase the GDP of all emerging economies by 6%, or a total of $3.7 trillion, by 2025. This additional GDP could create up to 95 million new jobs across all economic sectors.
2. Prospects of Fintech in the Arab World
The 2017 “State of Fintech Report” prepared by Wamda (a platform fostering entrepreneurship in the MENA region) and Payfort (a Middle East-focused payment service provider) sheds light on the current state of this nascent yet thriving industry in the Arab region.
According to the report, the “sharp rise of FinTech across the Arab world likely stems from 4 unique factors that make the MENA region perfect for innovative new approaches to finance”:
- Currently, 86% of adults in the region still do not have bank accounts, relying almost exclusively on cash for their purchases. Companies that overcome this hurdle will have a large potential clientele to sustain their growth and promote financial inclusion.
- SME lending in the MENA region is half of the global average, leaving plenty of room for innovative new companies to provide financing.
- Ecommerce is growing quickly in the region and is set to quadruple over the next five years.
- Finally, 1 in 2 banking customers have said that they are interested in experimenting with new digital services.
The key findings of this report are summarized below:
In the Arab world, the number of startups that operate in the financial services industry increased from 46 in 2013 to 105 by the end of 2015, and is expected to reach 250 by 2020.
Fintech startups span 12 countries, distributed between GCC countries (43%), the Levant (29%) and North Africa (29%). 75% of startups are based in 4 major hubs – the UAE (home to over a third of the region’s fintech companies), followed by Egypt, Jordan, and Lebanon.
MENA-based fintech startups employ over 1,600 people in MENA.
Fintech start-ups in the MENA region raised a total of $100 million over the past decade, and are expected to attract $50 million in investments in 2017, suggesting that the MENA region is about to transition from a frontier to an emerging market in fintech.
Between 2010 and 2013, at least $16 million was invested in fintech; between 2014 and 2016, the amount increased to $36 million. The sources of funding are international venture funds, accelerators and – most recently – banks that started participating in the investments.
The compound average growth rate (CAGR) of fintech startups increased from 26% over the period 2006-2010 to 40% over the period 2011-2015. Actually, half of all MENA-based fintech startups were founded after 2012.
Payments are the most popular fintech sector in the region, accounting for half of all MENA-based fintech startups. Payments and lending startups together represent 84% of all MENA fintech startups.
To date, over 20 fintech startups from the US, Europe, Australia and elsewhere entered the Arab world, which raises the level of competition.
The main obstacles facing fintech startups in Arab countries are visibility, customer education (lack of awareness of fintech startups, and a partial lack of understanding services), and trust (banks may lack innovation, but startups lack trust due to security concerns and fear of scammers).
The core challenges reported by Arab fintech entrepreneurs are policies and regulations, human capital (hiring and retaining talent), raising investments and partnerships, and customer acquisition (markets and demand).
Regarding the impact of fintech on Arab banks, according to Standard and Poor’s, the biggest impact of fintech innovations will be felt by banks’ retail business lines, such as money transfer and foreign-currency exchange. This applies to the Arab region since services such as money transfers have proven to be a lucrative business for GCC banks due to the region’s large expatriate population that regularly sends funds back to their home countries. Lending and personal or institutional finance services are two other activities threatened by fintech. Hence, to realize the full potential of financial technology, Arab banks and fintech startups need to partner up and share their experience and expertise. “Fintech startups can help banks improve their consumer experience, reduce operating costs, and discover new opportunities for growth. As for banks, they can benefit startups with their brand credibility and consumers’ trust, expertise in financial risk and regulatory demands in addition to providing them with an audience for their apps,” (Bizri, 2017).
Basel Committee on Banking Supervision BCBS (2017). Consultative Document – Sound Practices: Implications of Fintech Developments for Banks and Bank Supervisors. Bank for International Settlements. August, 2017.
Bizri, L. (2017). The Role of Banks in Fintech. Arabnet April 10, 2017.
Carney, M. (2017). Speech: The Promise of FinTech – Something New Under the Sun? Deutsche Bundesbank G20 conference on “Digitising finance, financial inclusion and financial literacy”, Wiesbaden 25 January 2017.
Financial Stability Board FSB (2017). Financial Stability Implications from FinTech –Supervisory and Regulatory Issues that Merit Authorities’ Attention. June, 2017.
KPMG (2017). Pulse of Fintech – Q2 2017. Global Analysis of Investment in Fintech.
McKinsey Global Institute (2016). Digital Finance for All: Powering Inclusive Growth in Emerging Economies. September, 2016.
PwC (2017). Global Fintech Report. Redrawing the lines: FinTech’s growing influence on Financial Services. March, 2017.
Standard and Poor’s (2016). S& P Global Market Intelligence – An introduction to fintech: Key sectors and trends. October, 2016.
Wamda and Payfort (2017). The 2017 State of Fintech Report.Ô
Union of Arab Banks