Transformation of conventional Banking. Opportunities and risks of Fintech companies in Asset Management

Table of Contents

Figures

List of Tables

List of Abbreviations

1 Introduction
1.1 Relevance of the topic
1.2 Research question
1.3 Structure and approach

2 Changes on the market
2.1 Overview
2.2 Digitalization
2.3 Changes in customer behavior
2.4 Internet
2.5 Mobile

3 Banking
3.1 Banking in Germany
3.2 Retail Banking in Germany
3.3 New trends of Retail Banking

4 Asset Management
4.1 Type of Investors
4.2 Service Type
4.3 Place of Service and Investment Objective
4.4 Market Participants
4.5 Processes
4.6 Intermediaries

5 Fintech
5.1 Definition
5.1.1 Impact of Fintech
5.1.2 Impact of Robo Advisors
5.2 Asset Management
5.2.1 Personal Financial Management
5.2.2 Robo Advisory
5.3 German market in comparison
5.4 Regulations for Robo advisors
5.5 Legal classification of Robo Advisory models in Germany
5.6 Analysis of the Business Model
5.6.1 Business Model Canvas
5.6.2 Key Partners
5.6.3 Key Activities
5.6.4 Key Resources
5.6.5 Value Proposition
5.6.6 Customer Relationships
5.6.7 Channels
5.6.8 Revenue Streams and Cost Structure
5.6.9 Customer segments

6 Investigation
6.1 Introduction
6.2 Aim of research
6.3 Structure
6.4 Results
6.4.1 Characteristics of the companies
6.4.2 Answers
6.4.3 Analysis

7 Conclusion
7.1 Development
7.2 Digitalization
7.3 Partnerships
7.4 Security concerns
7.5 Modification of the industry
7.6 Summary

8 Appendix

Reference list

List of Figures

Figure 2.1: Development of mobile subscriptions

Figure 3.1: Elements of German banking system

Figure 3.2: Market shares of bank groups

Figure 4.1: Criteria of distinction

Figure 4.2: Elements of Asset Management

Figure 5.1: Threats related to the rise of Fintech

Figure 5.2: Key characteristics of Business Model Canvas analysis of Robo Advisory

List of Tables

Table 5.1: Activities of Robo Advisors across the advisory process

Table 5.2: Legal classification of Robo Advisory

Table 6.1: Investigation results

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1 Introduction

1.1 Relevance of the topic

During the 21st century the way business is done has changed dramatically. The internet and the trend of digitalization have caused modification in all areas of life. The music and movie industries with the emergence of Spotify and Netflix have now new leaders while those two companies provide only online services. Not only the new technologies, but also changing customer behavior are responsible for the mentioned transformation.

Consequently, financial services have changed according to customers' demands. Not merely the established players, as for example big banks had to apply new strategies but also new companies found the opportunity to provide those services that big banks couldn’t or just were too slow for. Those new players or fintech (financial technology) companies provide financial services using modern and innovative technologies. Customers seeking new innovative functions are using fintechs mainly for Financial Planning, Asset Management and Payment purposes. Online and mobile products that are provided by those new market participants that have an innovative character are considered the future of financial industry. Due to the increasing number of customers seeking those services, big banks decided to focus now on the development of retail banking, since ignoring those new trends can lead to a threat.

“Banking is necessary, banks are not” is a famous quote by Kovacevich that describes the new progression in the world of financial services. In order to find out whether this is applicable to the field of retail banking, the focus of this work will be on the subsegment of asset management that was facilitated by the algorithm-based approach. Artificial intelligence and machine learning-based applications explore and open new possibilities in asset management, realizing new ways of financial services. The sub-segment robo advisory is assigned to portfolio management systems that are algorithm-based. This revolutionary technology provides investment recommendations and makes investment decisions with a high degree of automation.

1.2 Research question

Digitalization represents the transformation of data and information from the analog to digital environment. This process is considered as one of the biggest trends of the last years that will have an even bigger influence on the society in the future. Developments like Industry 4.0 are responsible for the changes of big enterprises, while expansions of robo advisory in wealth management target the private sector. Consequently, on the one hand new strategies and processes need to be implemented by the companies, while customers observe new chances and risks that have an impact on their every-day life. Since digitalization is a trend that has an influence on the society, it is a topic that needs to be investigated in all possible directions, including the consequences for the banking industry.

Big banks, as for example Deutsche Bank and Commerzbank in Germany, are considered as the most powerful providers for asset management services. However, this condition is now shifting due to the new emerging fintechs that want to compete with those big market players. Furthermore, customers have changed their preferences and search for innovative ways to invest money and make provisions. On the other hand, even if currently the annual growth of managed assets of robo advisors continues to skyrocket, the usage of the stock market for wealth management purposes is still not popular in Germany (Statista, 2017a). Statistics show that in year 2016 only 6.7 percent of German households' financial assets have been invested in shares, while 36.4 percent was invested in save and time deposits (Statista, 2018a). There are a lot of reasons for customers' avoidance of this way of asset management, whereas knowledge deficits in this field might be one of them. The new technologies like robo advisory that will be discussed in this work aim to enable unassisted asset management without any direct intermediaries, such as consultants. With the help of automated financial advisory based on mathematical algorithms, companies aim to provide optimized portfolio management. Consequently, robo advisory implies cost reductions for the customers and increases the whole market of asset management by providing high transparency standards.

To find out to what extent the field of asset management will undergo a shift through the trend of new technologies, this work will mainly investigate, if fintechs and especially robo advisors will be able to compete with the established market actors like banks or investment management corporations. The main question is, which method of asset management will enjoy the bigger success in the future or consequently will be pushed out of the market.

For this purpose, the services provided by fintech companies will be presented and analyzed. Therefore, the following questions are relevant:

1. What are the new technologies and what is their value for customers?
2. What could be new and future regulations for robo advisory companies?
3. Are the new technologies stable and reliable?

The question leads to another discussion concerning the business models of two methods of asset management that are topic in this work. On the one hand, the conventional asset management with the typical consultant as intermediary, and on the other hand completely automated robo advisory. Further considerations regarding the future of both ways of asset management will be discussed in this work.

Since the topic is quite extensive, clear boarders will be set. The most numbers, statistics as well as analyses provided in this work, focus on the German market. Furthermore, the investigation about the new technologies will mainly focus on the field of robo advisory as the most important component of asset management.

1.3 Structure and approach

This work contains 7 chapters, starting with the motivation and research question. Secondly, the general situation on the market will be described, including the changes of customer behavior. This serves the purpose to give an understanding about the current market conditions. Thirdly, the banking sector will be described, considering definitions and regulations. In this work the focus will be on the German market, therefore, consumer behavior and details about the German retail banking industry are relevant. Subsequently, chapter 4 deals with asset management and the new trends in the industry. Chapter 5 describes the development of the fintech industry. Definitions and regulations of the fintech companies are part of this chapter. In chapter 6 the scientific investigation will be conducted and presented. The results will show how stable the new technologies are, in order to give an outlook for the future in the next chapter. Prospects for the future of retail banking and especially asset management will be mentioned in chapter 7. General current trends and forecasts are also part of this chapter.

Since only limited literature is available about the fintech industry and especially robo advisory, the investigation part includes a qualitative approach with interviews that have been conducted with qualified specialists that work or research in the robo advisory industry. The question of whether and how the robo advisors will survive the next financial crisis, is topic of the interviews. There has been no financial crisis that might have caused unforeseen problems for the systems, ever since the creation of robo advisory. Thus, it is unknown how those technologies will react to chaotic market situations. The idea was to ask companies to what extent they are prepared for a financial crisis. The findings of this investigation will deal with the possible future outline of those fintechs providing algorithm-based asset management. The question about the security framework has been answered with a view to examining the future development of the robo advisory industry.

2 Changes on the market

2.1 Overview

A survey has found out that 34 to 84 percent of Germans feel that digital technologies make their life easier (Statista, 2017b). Such a clear agreement shows that digitalization is one of the biggest trends in 2018 and has an impact on all industries. People are confronted with this topic every day, not only in their free time but also at work, when the appointment at doctor's office can be booked online and all the invoices are available on a server. Also, customers want more transparency and to be able to have a peek behind the scenes. In other words, people want to receive the maximum of information when thinking about buying a product or using a service. The process of digitalization is a big help to make investigation and compare services before making decisions. Since the recent trends have led to big changes of customer behavior those trends will be described in this chapter.

2.2 Digitalization

“The use of all technological possibilities for a new customer experience, extended business models and a leap in efficiency in the handling” is a quote that gives an appropriate description about the current transformation (Pratz/Eistert, 2014: 22). The transformation of information in a digital storage defines the process of digitalization. The impact of digitalization exists not only in the B2B but also B2C segment.

Technological possibilities include all information and communication tools that can be used by the customer anywhere and anytime. Even if in the beginning the influence was mainly on the corporate world, now also the private sector is going through a shift. This shows the following survey: In Germany 76 percent of people have agreed that digitalization facilitated the access to knowledge and education (Statista, 2018b).

Digitalization also enables a better connectivity between the clients and the suppliers. New communication channels are accessible for the customers and are a big value for the companies. Moreover, in the field of education and politics the people have now more power and can participate to a certain extent in important decisions (Graf/Stern, 2018).

One of the major aspects of digitalization is the fact that there is now enough place for new actors. In the movie sector the shift is noticeable very well. The established structures, technologies, actors and relationships have been completely reorganized. The trend goes away from physical DVD towards digital access. The transformation of a sector is dependent on the innovations that are released and the way those can be used.

2.3 Changes in customer behavior

The changes in the society and the industries through the mentioned trends has led to a shift in the way of thinking of customers. A survey has shown that there is a tendency among customers to use every single tool to receive enough information about a product or a service (Statista, 2018a). One can conclude that people want to receive the required information in order to have a clear understanding about the products they will buy. Customers also expect a high customer support or service that is helpful in the case of problems and questions (Statista, 2017c). In Germany 56.5 percent have stated that in the banking and insurance industry it is of relevance that the companies are modern and innovative (Statista, 2013). In other words, the relationship between customer and supplier has evolved that far that people not only want a high-quality product with the best price, but also additional services.

2.4 Internet

The highest number of internet users in 2018 was measured in Asia with 2 billion. Furthermore, 4.2 billion users have been measured worldwide, a number that has increased by 1 billion since 2017. In Germany in 2016, 88 percent of the population was measured to use the internet and in 2017 already 91 percent. These figures show that the number of users worldwide and in Germany is rising constantly. The German language is considered the second most used language in the internet, following English (Statista, 2018b).

2.5 Mobile

The high increase of internet users is connected to the high developed industry of mobile devices that enable the people to have access to the internet anytime and anywhere. The number of mobile users including smartphones that are able to use the mobile internet worldwide in 2018 is about 2.6 billion and is expected to rise about 1.2 billion until 2021 (Statista, 2018c). In Germany the number of smartphone users has reached the 57 million mark and represents about 68 percent of the whole population (Statista, 2018d). Worldwide it is expected that 1.5 billion smartphones will be sold, a number that is compared to 2012 more than double (Statista, 2018e). In Germany about 22.7 million smartphones have found a new owner in 2018, a stable number since 2012, when the number of sold smartphone has reached the 20 million mark. The number of tablet users will be about 1.28 billion worldwide until 2021 (Statista, 2017d). According to Ericsson, an international communication provider, in 2023 the number of worldwide mobile subscriptions will be about 8.9 billion. The number of smartphone subscriptions will increase from 4.3 billion in 2017 to 7.2 billion in 2023 (Ericsson Mobility Report, 2018: 3).

Figure 2.1: Development of mobile subscriptions

Abbildung in dieser Leseprobe nicht enthalten

Source: Own diagram based on Ericsson, Ericsson Mobility Report June 2018, 2018: 1.

The newest 5G technology will be most successful in North America. In 2023, according to the Mobility Report, 48 percent of the subscriptions are expected to be for 5G. However, there are still regions in the world where not even UMTS or LTE has been introduced, such as Middle East and Africa. There is a fundamental change that will take place until 2022, since most mobile phone customers have so far used GSM/EDGE networks, but by 2020, 80 percent of all contracts will be based on the UMTS and LTE standards (Ericsson Mobility Report, 2018: 9). These numbers show that in a few years the whole world will be even more connected than now. It is remarkable that North America will have the super-fast 5G very soon while others will still have areas without any internet connection.

Those gadgets are already mainstream in all developed countries and for all age groups. A survey has shown that in Germany more than the half of the nation, younger than 39 years, could not imagine a life without a smartphone (Statista, 2010). Whereas people use the mobile internet for: 1. Media 2. Communication 3. Others, including surf, shop and play (ADR/ZDF, 2018: 1). One can say that people are dependent on the usage of smartphones on the daily business. “Understanding the relationship between customer satisfaction, experience and network performance is the key to designing networks to drive loyalty” (Ericsson Mobility Report, 2018: 20) means that the providers need to deliver high quality connection, and this is one of the goals for the future. The possibility of being online anytime and everywhere and connected to the rest of the world, enjoying all the advantages of digitalization, is getting more important for the people.

A survey by Salesforce.com has conducted research about the behavior of people in the internet. The Mobile Behavior Report claims that on average people spend 3.3h a day on their smartphones (Salesforce, Mobile Behavior Report 2014: 6f.). While watching TV, at least once per day, 65 percent of tablet owners use their gadgets. Among all respondents, 68 percent have claimed that it is important that companies they interact with are considered as technology leaders. In other words, people know and understand that the connectivity between the customer and the supplier is of big importance and want the enterprises to be present on the web. This survey does not represent the German population, however shows the trend of the population worldwide. The people want to be online and use their smartphones and have the infrastructure for those purpose.

Communication providers will have to develop a bigger network to satisfy the customers. People want an easy access to the internet and be able to conduct day-to-day operations efficiently. Some are dependent on the service to work, since writing emails and uploading videos or other activities that need an internet connection is part of many people's work. Those trends described can be transferred to the banking industry, as people experiencing high quality services in the retail industry will expect the same service from their banks. Financial services providers need to establish a standard that can compete with other industries in order to keep their customers.

3 Banking

3.1 Banking in Germany

The Banking system in Germany consists of 2 parts of credit institutions. The Commercial Banking System that focuses on making profits and the European System of the Central Banks which includes the Deutsche Bundesbank (Central Bank of the Federal Republic of Germany) and its central administrations. They pursue policy and economic goals through stabilization of prices and loan supplies. One differentiates between Universal and Specialized Banks. In Germany Universal Banks conduct and offer all banking businesses, while Specialized Banks only offer individual banking services. In addition to the Deutsche Bundesbank that is a single supervisory mechanism, the European Banking Authority and the Federal Financial Supervisory Authority (BaFin) serve as institutional supervisory authorities. The universal banks can be divided into 3 levels: private credit institutions, public-law and cooperative banks.

Figure 3.1: Elements of German banking system

Abbildung in dieser Leseprobe nicht enthalten

Source: Own diagram based on Hellenkamp, 2015: 15.

Credit Institutions as for example Deutsche Bank AG, Commerzbank AG or HypoVereinsbank AG provide almost all banking services for all customer groups (private, corporate and institutions). They especially focus on the securities business, investment banking and the classic lending business, always targeting on profit maximization.

The Public - Law Institutions include the Sparkasse sector that acts as a financial network. Those are subject to the regional principle and are active in the territory of the municipal guarantor. Essential tasks of the Sparkasse sector are the promotion of austerity, wealth creation and a safe investment environment of the population.

Cooperative Banks pursue the goal of the economic promotion of its members. The institutes of the cooperative sector act as part of a financial network. Those are for example Deutsche Zentral-Genossenschaftsbank AG and Westdeutsche Genossenschafts-Zentralbank AG. They have a nonprofit focus and their clients are involved in the Bank's success as well as in decision making (Hellenkamp, 2015: 25f).

Figure 3.2: Market shares of bank groups

Abbildung in dieser Leseprobe nicht enthalten

Source: Own diagram based on Statista, 2018f.

This statistic shows the market shares of the banking groups in Germany according to their business volume in 2017. At the end of 2017, the total business volume of the banking market in Germany amounted to around 7 trillion euros. The cooperative sector's market share was about 12.6 percent. The market share of the German Landesbanken was around 11.6 percent.

3.2 Retail Banking in Germany

Retail Banking covers the sale of standardized financial products and services for the non-wealthy individuals who have little or no need for advisory. One can say, it is about services as processing of payments, account management and credit cards, consultancy, investments in financial products, lending and insurances. Those services serve the purpose of covering the financial basic needs of the customers (Eilenberger, 1997:189).

However, in the last years the number of bank branches has decreased from 40,276 in 2010 to 31,949 in 2017, due to the loss of relevance of the bank branches in connection with the high costs and other reasons that will be discussed in the following (Statista, 2018g).

3.3 New trends of Retail Banking

The trend of online banking is the result of new technologies that enable the customers to manage all their transactions online from their computer or smartphone. Statista.com, an online statistics platform, has published the number of users of online banking in Germany, whereas 45 percent of the whole population have been using the service in 2017 and 50 percent in 2018. In other European countries like Estonia the number of online users has exceeded 80 percent of the whole population (Statista, 2018h). In addition, the simplified ability to offer financial products and services over the Internet is leading to the rapid growth of online banks, financial brokers or insurance providers. Especially the classic and simple services such as account management, payment transactions and bank transfers are now usually used online. In addition to the better conditions for account management, many customers value the convenience, simplicity and availability of online services. In addition, the online market is characterized by high transparency and comparability (Messerschmidt et al., 2010: 78). The shift from the analog to the digital banking shows the impact in the banking industry and the worldwide change of customer needs.

Another trend represents the Non and Near Banks that provide financial services and act as substitutional competitors of banks due to the range of banking products they offer. Those competitors can be hardware manufacturers, internet companies or communication providers. Companies like Apple and Samsung focus on the production of mobile gadgets and have the direct connection to the customers. One can observe that internet companies like Facebook, Google and Amazon are powerful actors on the market, since the core of their businesses is to collect data of their customers. This enables them to evaluate and categorize the data and predict customer behavior. If those companies start using the collected information to provide financial services, the retail banking can change dramatically and new leaders might arise (Keese, 2018).

4 Asset Management

In the following the most important elements of asset management will be described. Asset management deals with the process of planning, realization and control of clients' assets by companies providing financial services that are usually investment banks. Those companies offer the whole range of financial products. The account that is used for those processes is held by a financial institution (Jacob, 2012:13f.). In this work classical investment business in retail banking refers to financial services in the form of investment advisory and financial portfolio management provided by credit institutions within the meaning of § 1 (1a) sentence 2 no. 1a and § 1 (1a) sentence 2 no. 3 of KWG (German Banking Act).

Figure 4.1: Criteria of distinction

Abbildung in dieser Leseprobe nicht enthalten

Source: Own Diagram based on Jacob, Differenzierungskriterien, 2012: 14.

4.1 Type of Investors

One can distinguish between private and institutional investors, whereas private investors can be divided in retail customers and more wealthy customers.

4.2 Service Type

In relation to the participation of the investor, advisory about a capital investment is considered an investment advisory that always includes technical processing and is regulated in §1 (1a) sentence 2 no. 1a of KWG. During investment advisory assets will be evaluated considering the individual situation of the client. The client discusses his current financial situation and investment objectives and receives recommendations including financial instruments tailored to the customer needs. An important feature of the investment advisory is the remaining decision-making power on the client's site. On the other hand, financial portfolio management within the meaning of §1 (1a) sentence 2 no. 3 represents the financial portfolio management when the customer provides only investment guidelines while the asset manager makes individual investment decisions (Kneer/Kurz, 2016: 4f.).

4.3 Place of Service and Investment Objective

Other components of the asset management are the place of the service & the objective of the investment, whereas the service providers can be differentiated with respect to their legal seat. Providers can also be differentiated according to their objective or asset management segments. Some of them are specialized in fields like assurance or real estate (Jacob, 2012: 15).

Figure 4.2: Elements of Asset Management

Abbildung in dieser Leseprobe nicht enthalten

Source: Own Diagram based on Jacob, Elemente im Asset Management, 2012: 16.

Among most important instruments of asset management are securities and bonds. Those elements contain their own characteristics considering duration, profit sharing or security. Shares represent the right to membership of a stock corporation or a comparable foreign company. The companies issue shares and generate equity, while shareholders buy shares and then receive dividends. On the other hand, bonds have a nominal value that serves as the basis of assessment for the interest rate and represent the repayment amount that the investor has borrowed to the company. Also, other possibilities exist to invest money as for example real estate or art.

4.4 Market Participants

Market participants can be private persons or companies that buy and sell financial instruments and buy or sell them on the stock market. However, when thinking abstractly economy, social culture, politics and law, technology and nature can be considered as market participants. Investors can participate not only as buyers but also as sellers, whereas those can invest their assets in a direct way or through an intermediary, such as fund.

4.5 Processes

The most important process is to analyze the real value of the instruments. This process is always subject-related due to the price on the market that occurs through trade of all market participants. The investor needs to consider risk and liquidity and after proper analysis, make his decision about the instrument (Jacob, 2012: 15f.).

Since the conservative investment products in the current low interest rate environment tend not to even outweigh the annual inflation rate, clients search for better ways to invest and manage their asset. The financial general education of the German population, however, has considerable deficits, especially in the field of investment (Plickert, 2016). In contrast to other products or services, the results can be monitored and measured. A survey shows that banks are the preferred partner to acquire investment products for more than half of retail investors (Statista, 2011). The German population seems to have a traditional attitude towards financial topics and does not trust other methods of asset management.

4.6 Intermediaries

Those participants that are between the investors and the contracting parties that he or she is investing in are called intermediaries. Those provide several different services, firstly supporting the process of conclusion of contracts, secondly helping with the transformation. Transformation takes place if the batch size of the investment needs to be adjusted. Thus, financial providers, mostly banks, get small amounts of money and refinance them by lending bigger amounts (Jacob, 2012: 86)

5 Fintech

5.1 Definition

Before describing in detail to what extent the fintech companies have changed the retail banking, it is relevant to provide definitions and give an overview about their scope of activities. The BaFin (Federal Financial Supervisory Authority) characterizes fintechs as "young companies that offer specialized and particularly customer-friendly financial services with the help of technology-based systems" (BaFin, 2016a: 63). Fintech is a short form for the collective term financial technology and consists of the two words: financial services and technology. One can say, fintech describes companies and innovative business models which are mainly internet-based, digitalized technologies or products and offer services in the financial sector. However, in the most cases, they do not develop new products but adapt the existing ones to the needs of customers, following customer orientation at the same time focusing on market gaps (Nicoletti, 2017: 3).

5.1.1 Impact of Fintech

PricewaterhouseCoopers has conducted a survey about fintechs that are reshaping the banking industry. This survey has shown to what extent the industry is expected to change through the formation of new market participants. In total, 76 percent of the banking respondents claim to fear that some part of their business is at risk owing to fintech companies.

Loss of market share is considered the biggest worry of the banks. Through the better conditions and more retailed services, the fintech companies are expected to take over market shares in the banking industry, put pressure on margins, provide better information security and increase customer churn. The fintechs are observed in the banking industry as the biggest threat for the next years that will take over a part of the market share. Almost the same amount thinks that the margins might change through the provided services by the fintechs. On the other hand, all sectors together expect the fintechs to put pressure on the margins, as the most likely scenario. In summary, the new firms on the market represent a change for all finance related industries with the possible outcome of pushing out the present ones. Fintechs provide the services that the customers demand with the help of new innovative technologies. Therefore, those market participants that didn’t change their product portfolio according to the needs of the customers are expected to go through negative changes. The Global Fintech Report 2017 by PWC shows that the number of people worried about their part of the business has increased from 76 to 88 percent, an indicator for the expansion and impact of new services in the banking industry (PricewaterhouseCoopers, 2017: 5f.).

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