Because of my involvement with banks and bank stocks, I hear a lot about financial technology -- aka fintech -- these days. There is a new article or report every day that seems to espouse the wonders of financial technology and the extraordinary profits to be made investing in these exciting new companies. I get at least two emails a day suggesting fintech stocks that I must buy right now before they change the world of banking forever. With both BankDirector and Benzinga currently touting their annual fintech awards programs, the pace has picked up in the last few weeks.
I have said in the past that I don't think this whole fintech thing is going to work the way everyone thinks it will. Most of us are pretty comfortable with banks and the fact that they are regulated, and there is insurance to make sure we cannot lose our money. Banking is not going to go away, and most of the slick new fintech providers are never going to submit to Federal Deposit Insurance Corp. (FDIC) regulation if they can avoid it. I suspect most of them could not comply and remain profitable.
With all the hoopla surrounding financial technology, I thought I would share my insights and thoughts about the wonderful world of fintech. I spend a lot of time talking to bankers and other bank investors, and I think I have a pretty good handle on how all this plays out.
My first observation is that all these online lenders that pass themselves off as financial technology companies are merely non-bank lenders. It is true that many of them have developed some very efficient and fast underwriting algorithms. That doesn't make them a technology company. They are lenders who do not have a deposit base, and at the first signs of liquidity problems in the broader economy they will see loan losses just like any other non-bank lender will experience. There will be widespread consolidation in this space, including many in these high-tech forms of lending being acquired by banks that want to improve their lending processes.
I see a similar picture in the payments space. I don't use any of the new mobile payment applications, but my kids do. The ability to pay with your phone is a must for many of the millennial generation and that isn't going to go away. However, as banks develop their own payment devices and options, consumers will prefer to have their funds in a FDIC-insured account rather than an uninsured payments account. As cyberattacks become more frequent, there also will be a greater reluctance to have bank accounts linked to outside providers. Most payment firms would be best advised to begin looking for a bank that is willing to buy them and fold the company into their current banking operations.
Robo-advising has become a hot topic and is often seen as the fintech wave of the investing future. I love the idea of robo-advising as most investors are not very good at making money in the markets. I am pretty sure that if I stole some of Wesley Gray's ideas on pairing value and momentum and added an asset allocation model similar to the one Mebane Faber uses I could put together a very efficient robot money manager.
The problem with the idea of automated money management is not that it won't work. It probably will. The problem comes from the fact that it is people making the decision to put money into the program and take money out of it. They will react in a very familiar fashion by adding money when the markets are exciting and taking money out when markets are scary. Human emotions and psychology will keep robot investing from becoming the success it could be.
The real money in fintech will come from regulatory technology -- regtech -- and cyber security. I expect IBM's (IBM) recent purchase of The Promontory Financial Group so it can pair compliance and banking expertise with its artificial intelligence program Watson will be a huge success. Programs that reduce the cost and time required to keep up with ever-changing state and federal requirements will be very profitable.
There is no question that banking is moving to the online world. The pace of this will continue to accelerate in the future, and that creates a tremendous opportunity for cybersecurity companies. Companies such as Unisys (UIS) and Vasco Data Security (VDSI) should see strong growth from their cyber security products.
The idea of fintech is exciting, and there will be some opportunities for investors. However, much of what is touted as the next big thing is merely going to be a new technology that is acquired by either an existing technology company or one of the banks themselves.