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Just a few years ago, many expected that small but flexible and rapidly developing fintech startups would, if not replace classic banking, then certainly force traditional players to make room. But for now, the "guys in jeans" and "gentlemen in suits" are at the forefront of the revolution in finance.

43% of residents of large Russian cities have used at least two fintech services in the past six months, according to a study of the penetration of financial technology services, which is conducted annually by EY , for 2017 (for more details on the methodology, see the inset). In Moscow and St. Petersburg, this figure is even higher - 46%, and over the year it has grown by 11 percentage points. Only 12% of residents of Russian cities with a population of over one million have never used fintech services.

Russian megacities are ahead in terms of fintech services penetration not only of the US (33%, which is also the median value for 20 markets included in the study) and Singapore (23%), but also of the world's largest financial center, the UK (42%). Russia is second only to China (69%) and India (52%).

But who provides these services and does this mean that it’s time for traditional banks to step aside?

Should I worry more?

Fintech companies have forced consumers to rethink their expectations of financial services providers, setting a new, higher bar. They have succeeded in setting the tone – they now determine the direction, shape and speed of innovation in almost every segment of financial services, according to the World Economic Forum’s 2017 study “Beyond Fintech: A Pragmatic Assessment of the Disruptive Potential in Financial Services.”

In 2017, EY included 17 services in five categories in its research: online money transfers and payments, financial planning, savings and investments, cash loans, and insurance. It does not matter which organization provided the service to the person.
The global study was conducted in 2017 across 20 countries, with consumers surveyed representing a representative sample of the online active population in each country.

They changed the way financial services are structured, delivered, and consumed, but failed to become dominant players or significantly impact the competitive landscape, the study found. They overestimated customers’ willingness to abandon traditional financial services providers. Many fintechs had ambitions to overtake traditional financial services players, but instead turned to partnerships after struggling to overcome economies of scale and achieve customer adoption.

For the study, which was conducted jointly with Deloitte, the heads of several dozen major banks, payment systems, consulting companies and other market participants were surveyed.

Global findings are also confirmed by EY data on the behavior of Russian consumers. “Traditional banks have great prospects and can remain relatively calm in the near future – even fintech users do not lose contact with them,” EY points out. 64% of respondents have used their bank’s support line in the last six months, 98% have visited the bank, and 75% access their bank’s online resources at least once a week. Fintech users are much more loyal to their main bank, where they receive advice on issues related to personal finance, EY summarizes.

Google instead of fintech

The main competition for traditional financial institutions in the coming years will be IT giants like Facebook , Google and Amazon due to their leadership in key financial market technologies – cloud computing, artificial intelligence and big data analytics, the authors of the Davos Forum study indicate.

Financiers understand that the main trend now is to provide services at the right time and in the best way for the client. The advantage is with those who control a significant part of the daily interaction of clients with each other and with service providers - they can convert their control into income, and it does not matter through advertising or financial transactions. "The development of technology forms new customer expectations, and this creates the preconditions for the emergence of fundamentally new ways of providing and consuming financial services," says Alexey Chubar, Head of Digital Transformation at VTB . "Today, it has become commonplace to be able to pay by phone or watch, perhaps tomorrow biometrics will be enough, while the client's convenience will always be in a reasonable balance with ensuring the security of transactions." It is important, according to him, that the modern everyday experience of clients increases their demands for the quality of banking services: they are not ready to wait, put up with poor service and overpay.

Bankers are transforming their businesses to stay in the game. Thus, many Russian banks over the past three years have implemented big data analysis and predictive analytics, artificial intelligence and machine learning technologies, biometric authentication, cloud technologies, and are testing and piloting projects related to distributed registries.

Unite to compete

The technological revolution in the financial industry has led to the consolidation of competitors. In order to develop and implement new technological solutions, first the world's largest banks, and then Russian players, began to unite into consortiums.

"I think the threats that banks will lose to fintech are not confirmed. Banks today, on the contrary, have themselves become drivers of digital methods of work and the digital economy"
President – Chairman of the Management Board of VTB Andrey Kostin
Interview with Russia 24 TV channel, February 2018

The first such association was the R3 CEVLLC consortium, which initially included nine of the world's largest financial organizations: Barclays, BBVA, Common Wealth Bank of Australia, Credit Suisse, Goldman Sachs, JPMorgan & Co., Royal Bank of Scotland, State Street Corporation and UBS. Here, solutions based on distributed ledger technology (blockchain) are developed and tested. Currently, R3 includes several dozen participants, and the Russian bank VTB does not rule out joining (although it is not yet conducting direct negotiations). At the same time, the IT giant IBM created the Hyperledger project, which united more than a hundred technology and financial companies (including Cisco, Fujitsu, Hitachi, Intel, JPMorgan, SWIFT, Wells) - also to search for solutions based on blockchain.

In Russia in 2016, under the auspices of the Central Bank, the Fintech Association was created, the founders of which were the leaders of the Russian market - VTB, Sberbank , Alfa-Bank, Gazprombank , Otkritie Bank, Qiwi Bank and NSPK.

The Fintech Association develops and implements new technological solutions for the Russian financial market. Its main areas of activity are identification, authentication and digital identity management; development of the retail payment space; implementation of open APIs (application programming interfaces to provide service providers with access to the financial infrastructure) and distributed ledger technology.

What has already been done in these four areas in Russia?

* Biometrics of the future

From July 1, 2018, a unified biometric system will be launched in Russia, which will allow banks to identify clients remotely, without visiting their offices. The largest market players have been preparing for this for several years. Thus, VTB was one of the first on the market to start testing a two-factor biometric model for recognizing clients in an updated mobile application. “The VTB system compares a large number of voice parameters (timbre, pronunciation speed and other features), establishes the similarity of the reference photo and the user, and also determines whether the person trying to pass authentication is real, based on facial expressions,” says Chubar.

Preparations for the launch of a unified biometric identification system are being carried out in two directions: the capture of biometric templates in offices and the use of already captured templates for accepting a client for service in a remote channel, as well as the refinement of systems for launch, says Deputy Chairman of the Board of Sovcombank Alexey Panferov. "We are currently testing various biometric verification scenarios," adds Deputy Chairman of the Board of Home Credit Bank Sergey Shcherbakov.

* Fast payments

The second know-how is a fast payment system, to which all Russian banks are planned to be connected next year. This platform will make instant transfers between its participants possible without intermediaries – traditional payment systems. Payments can be made through online services and mobile applications integrated with this platform and the Central Bank payment system. Testing of the system will begin in the near future (p2p transfers will be available first, and later – transfers between individuals and legal entities).

It is in this segment that the technological boom will be most noticeable, EY experts are sure. According to their forecasts, the penetration rate of new technologies in this sector in the world will be 87.8%, and in Russia – all 96.3%. This thesis was supported by the Russian regulator in its document “Main directions of development of financial technologies for the period 2018–2020”.

* "Open banking"

Open API is the provision of open access to the application programming interface to third-party developers. This concept is actively developed by global technology giants (Amazon, Uber, Google, Visa). But there are already successful projects on the Russian market - in particular, the Unified Payment Platform of the VTB Group allows partners to remotely connect to the bank's processing, embed financial services in their own applications, and Alfa-Bank, as part of its event to find promising fintech startups, Alfa Camp, provides participants with open access to its API.

But "open banking" has not yet become widespread in the Russian market. One of the obstacles is concerns about the security of confidential information. "Data on the transaction activity of clients or the amounts of funds in their accounts can be used both for good (for example, to create smart PFM) and for fraudulent and phishing operations," recalls Oleg Zaytsevsky, Director of the IT Development Department of FC Otkritie Bank. "Many companies have not yet found a high-quality strategy for monetization and development of their OpenSource products. This leads to a lack of expected results and disappointment in the technology," says a representative of Sberbank.

And yet, Russia is aiming to develop this area, opening up the legislation for certain scenarios of interaction between banks and technology companies (as the scenarios are tested in practice, the legislative framework also changes). “Since this requires research into a number of new risks, this process takes time. Nevertheless, this approach ultimately allows us to move forward faster than those who first create futuristic concepts of interaction between banks and clients in a “futuristic technological environment” and then face difficulties in implementing them,” says Evgeny Golod, head of the Open API direction at the Fintech Association.

* Trust registry

The Fintech Association has been developing and advancing the Masterchain platform for two years – an open network for the exchange and storage of financial information. In fact, this is the first legal public blockchain in Russia. “An important element of the implementation of the Masterchain is the use of Russian cryptography. This can significantly simplify the creation of common solutions within the entire financial sector,” Chubar states.

There are currently four global projects being implemented on the Masterchain platform – all of them are at the development, trial launch or pilot stage.

Firstly, a decentralized depository system for recording mortgages, the formation of clouds for distributed storage of electronic mortgages and transactions on depository accounts in depositories. Secondly, KYC (Know Your Customer) – exchange of information about individuals between banks – participants of the system while maintaining banking secrecy and personal data in order to prevent fraud. Thirdly, the creation of a digital letter of credit. And finally, a distributed registry of digital bank guarantees – a universal service for issuing and verifying the authenticity of bank guarantees in electronic form.

How Machines Track Us

In September 2017, VTB launched a pilot project to use advanced machine learning algorithms with the participation of the risk department and an external vendor. The project allows for more accurate forecasting of bank client defaults and demand for banking products, explains Chubar. It will be put into operation in the near future. "The project has confirmed the prospects of the approaches used. In the future, we expect to see a positive effect on the bank's financial results," he notes.
Since December 2017, VTB has been implementing a biometric voice identification system for wealthy clients: at the beginning of a conversation, while a call center employee is clarifying the essence of the request, the client's voice is compared with a standard in the background - as a result, the operator sees a "traffic light" of voice matching. It is planned that in the third quarter of 2018, voice biometrics will be implemented for all clients of the bank.
VTB's fraud prevention system is based on machine learning and takes into account not only the details of a specific payment, event or sequence of transactions, for example, by card, but also the client's activity in other channels. For each transaction, the system evaluates the probability of a fraudulent event online, while the model is constantly retrained based on the history of previous transactions, including fraudulent ones.
By the end of 2018, VTB plans to launch a chatbot for retail clients and integrate it with messengers. And now, client conversations with the call center are converted into text and analyzed according to pre-formulated rules - this allows for more effective analysis of feedback (including the emotional coloring of the conversation - for example, to check whether the operator complies with standards).

Digitalization of regulation

Regulation of the financial sector is becoming increasingly complex with the development of technology, which is why there is a demand for technological solutions that allow for the effective implementation of regulatory requirements and risk management. Such solutions are collectively called RegTech (regulatory technology). Thomson Reuters predicts that the RegTech market volume will be more than $120 billion worldwide by 2020.

In February, the First Deputy Chairman of the Central Bank Olga Skorobogatova announced that a working group on RegTech had been created, which should decide which projects to test. According to her, the regulator intends to move in RegTech in the direction of using big data and the application of artificial intelligence within credit institutions, as well as robotization.

At the end of 2017, Thomson Reuters published a study that surveyed more than 100 representatives of banks, non-bank credit organizations, consultants, equipment suppliers and IT systems. 72% of its participants recognize the value of RegTech solutions for their business. But 33% of respondents named the high level of administrative barriers as the main obstacle to the development of this area in Russia, and 26% admitted that the cost of such solutions is too high. But the market will have to overcome all these barriers in any case, because the Bank of Russia has already declared RegTech one of the highest priority areas, including in the "Main Directions for the Development of Financial Technologies for the Period 2018-2020". &

Text: Maria Kuznetsova

Fintech: "Jackets" vs. "Jeans"