The sharp rise of bank stocks in recent months conceals a worrying reality in the financial services industry, which is in the process of being severely disrupted.
Although the sector continues to act as a store of value in 2017, its role as the "central nervous system" of the economy is increasingly being challenged by the growth of emerging companies which are intensely focused on technological development: financial technology firms or "fintechs".
While the majority of Canadians continue to cash their paychecks, deposit their savings and use credit to finance their lives through traditional institutions, across all these segments, fintechs offer fully digitized alternatives.
Obviously, not all banking activities are as vulnerable to this disruption. Certain activities such as payments, personal credit and private wealth management are among the first to see serious competition from fintechs. Whether it is from PayPal or Square, Lending Club, Borrowell or WealthSimple, the promise of value from these companies is relatively similar: manage your money without a bank, in a fully automated manner.
Of course, although these companies have developed their agility and offer their mastery of technology, not everything is so straightforward for them. One of the key competencies of contemporary banks is their ability to monitor and act on regulators' requirements and to comply with ratios prescribed by lawmakers. This is particularly challenging in the case of multinational companies and therefore hits fintechs, which had thus far managed to evade the law.
While this facet is not very visible to bank clients, the stability of the banking system depends precisely on these elements. Investors therefore tend to be particularly interested.
In the U.S., Lending Club learned about it the hard way in May 2016, when irregularities surfaced, leading to the resignationNOTE - This link will open in a new tab. of its president, Renaud Laplanche. The company's shares, trading at $25 shortly after its IPO, dropped 34% that day. Listed on the stock market since 2015 and offered at $15 in its initial public offering (IPO), the shares are now trading at around $5.
Other players like Square perform much better in this segment. Founded and currently headed by Jack Dorsey, founder and still head of Twitter, the company systematically exceeds investor expectations. While the social network is experiencing difficulties, the payment company is reaching new heights. Over $16 billion US flowed through the application in its last fiscal year, a 32% growth over the previous year.
In short, where the banks' challenge is to achieve more flexibility and agility in their technological transition, the challenge of fintechs is the opposite and consists of building systems and processes that are strong enough to withstand the greatest pressures from auditors, legislators and regulators.
Somewhere between these two objectives, it is generally bank clients who benefit. For investors, the outcome is less certain. But that is the whole appeal of these innovations: they offer a little more risk, much more innovation, and potentially greater margins.