As a combination and abridgement of ‘financial’ and ‘technology’, the meaning of the term ‘fintech’ is clear.

A number of authorities and international forums have developed definitions of fintech. The standard-setting forum Financial Stability Board (FSB) defines fintech 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.”^[3] See FSB (2021), “FinTech”, Financial Stability Board. Last updated 28 June 2021. Accessed 25 April 2022. [online] Available at: FinTech - Financial Stability Board (fsb.org). The Bank for International Settlements (BIS) has a similar definition: “[…] technology-enabled innovation in financial services.” ^[4] See BIS, “Innovation and fintech”, Bank for International Settlements. Accessed 25 April 2022. [online] Available at Innovation and fintech (bis.org).

The definition we use in this staff memo is reminiscent of the above; that is “[...] financial services combined with new technological innovations”.^[5] See FinTech – increasingly rapid interaction between financial operations and technological innovation. Article in Financial Stability Report, 2017:1, Sveriges Riksbank.

Fintech encompasses numerous activities and entities

The fintech area is broad and essentially includes all the activities that we traditionally associate with the financial system. It concerns for instance payment mediation, lending, asset management and insurance-related services.^[6] The fintech activities that are linked to insurance are often called “insurtech” (a combination and abridgement of ‘insurance’ and ‘technology’). There are also activities that only exist within fintech, such as those linked to cryptoassets (see the section Cryptoassets are digital assets).

There are essentially three types of entities that use fintech in their operations: new firms offering financial services that are based on new technology (hereinafter ‘fintech firms’); existing financial entities, such as banks, which start to incorporate new technology into their service offering; and large technology companies (‘bigtech firms’) that start to offer financial services.^[7] Some examples of bigtech firms are US corporations Meta (formerly Facebook), Apple, Amazon, Netflix and Google. Two Chinese examples of bigtech firms are the corporations Tencent and Ant Group. A common way for banks to incorporate new technology into their service offering is also that they initiate cooperation with, or buy out, the more streamlined fintech entities.^[8] The Rapid Growth of Fintech: Vulnerabilities and Challenges for Financial Stability. Chapter in the Global Financial Stability Report, April 2022, International Monetary Fund.

In this staff memo, the term ‘fintech area’ is used to characterise all the fintech activities carried out as part of the financial system, irrespective of which entity performs them. The term ‘fintech sector’ is used to characterise the fintech activities performed by the fintech firms, including activities linked to cryptoassets.

Fintech can be described using a tree structure

BIS has devised a “fintech tree” that describes different fintech activities and underlying factors enabling them.^[9] J. Ehrentraud et al. (2020), “Policy responses to fintech: a cross-country overview”, FSI Insights no 23, 30 January 2020, Financial Stability Institute, Bank for International Settlements. In this tree, the crown consists of the fintech activities themselves, such as payment mediation, lending, asset management and insurance-related services. In the trunk, there are assorted technologies holding up the fintech activities. This could for instance be distributed ledger technology (DLT), artificial intelligence (AI) and machine learning (ML).^[10] DLT is a technique that supports distributed ledgers (entry and maintenance) of encrypted data. One of the best-known subcategories of DLT is blockchains, on which the cryptoasset Bitcoin is based. DLT is a tool for registering ownership of money or securities, for example. DLT enables, in a decentralised way, proposing and validating transactions and updating ledgers in a synchronised manner between different networks. Access to and the possibility of adding data in the distributed ledger can either be ‘permissionless’ (unlimited) or ‘permissioned’ (limited to a specific group of users). The roots of the tree consist of various policies from authorities which, in different ways, promote the use of technology to enable innovations and activities within the financial system. Some examples of this are authorities’ policies concerning digital identification methods that enable the general public to access and use assorted digital services (in Sweden, for instance, BankID and Freja eID are used), facilitation of innovation and policies such as open banking regulations. In open banking, third-party developers gain access to client data from banks and can thus build various financial services and functions based on it. Innovation can be facilitated by means of authorities setting up innovation centres or regulatory sandboxes, in which new entities can test their products or services on the real market, but in a controlled environment. In Sweden, for example, Finansinspektionen (FI) has established an innovation centre where firms can obtain guidance on how they should organise their operations according to current legislation.^[11] FI (2021), “About the Innovation Center”, Finansinspektionen. Last reviewed 13 April 2021. Accessed 25 April 2022. [online] Available at: About | Finansinspektionen. In the UK, the Financial Conduct Authority (FCA) has set up a regulatory sandbox.^[12] FCA (2022), “Regulatory Sandbox”, Financial Conduct Authority. Last updated 28 March 2022. Accessed 25 April 2022. [online] Available at: Regulatory Sandbox | FCA.

Legislators in various parts of the world have also devised their regulations so as to promote innovation within financial services. An example of this is the Payment Services Directive 2 (PSD2) of the European Union. PSD2 sets requirements for banks to share information with other entities, such as fintech firms.

Network effects can give an advantage in financial services

Network effects are an important factor behind how bigtech firms in particular have gained ground within financial services. In short, network effects mean that the more people who use a service, the more valuable it will be for other people to start using it too. Taking payments as an example, it will be more attractive to use a payment service if more sellers accept it as a payment method, while at the same time it is more attractive for sellers to accept the payment method when more buyers wish to use it. A reason for why not all payment methods are accepted everywhere is that they require certain technical infrastructures to process, clear and settle payments. For example, for a seller to be able to accept a card from one of the major card companies, it must have access to the card company’s network. If few people wish to pay with a certain card, the cost per transaction would be high for the seller. At the same time, it is not particularly valuable for the buyer to have a card that not many sellers accept. Network effects are therefore a reason for why only a handful of very large card companies have established themselves rather than, for instance, all banks issuing their own cards on their own card networks. Network effects are also a reason why banks have traditionally had a major role on financial markets, where they have a large volume of customers and a great deal of data about them.

Network effects are thus a reason for why bigtech firms have started to establish themselves within financial markets, particularly within payment mediation. Indeed, an aspect that is relatively unique for the bigtech firms is that, even before they start to offer financial services, they have numerous users and large volumes of data about them, which they can put to use when offering different services. Because the bigtech firms have so many users, they can capitalise on network effects to gain substantial market shares rapidly. In China for example, the payment market is dominated by two bigtech firms – Ant Group and Tencent. Together, the firms had a market share of over 90 per cent within mobile payments in 2020.^[13] The Economist (2020), “Do Alipay and Tenpay misuse their market power”, 6 August 2020, The Economist.

Digitalisation of financial services is a way of gaining market share

Fintech involves the digitalisation of various services within the financial system. This can enable the fintech entities to take market share from traditional financial entities. In many cases, the fintech firms have newer and more modern systems than traditional financial entities, which makes it easier for them to provide modern solutions for assorted financial services. They can therefore offer, for example, the same or similar services as traditional entities at a lower price or with simpler and faster processes. The fintech entities often have a digital presence only; that is, they do not have any physical branches that customers can visit. This might be a reason why they can offer services at lower prices than traditional entities. Although Swedish banks, for instance, have a relatively advanced digital service offering, they have often kept their physical branches that a customer can visit, for instance to take out a mortgage or use other financial services. At the same time, physical branches can make financial services more accessible to people who, for various reasons, have difficulty in using digital services.

Fintech firms can grow to be big in countries where there is a high level of digital services use and a willingness to adopt more new ones. Sweden is an example of such a country. Here, a number of digital payment services have rapidly emerged for instance, while the same time traditional payment methods such as cash have sharply declined because it is considered to be less convenient to use.

However, fintech can also gain ground in developing countries, where a sizeable share of the population might lack access to the financial system and the services offered within it. This is usually called ‘financial exclusion’.^[14] The opposite to financial exclusion – financial inclusion – is characterised by most of the population having access to financial services such as a bank account. For example, it might be a case of not having access to a bank account. This makes it more difficult to send money easily to other people in or outside of the country, or take out a loan for consumption. In certain cases, fintech could reduce financial exclusion, for instance through assorted services linked to cryptoassets, because all that a person needs is a cryptowallet to have access to their cryptoassets. In order to buy cryptoassets, access might however be needed to traditional currencies in digital form, such as money in a bank account. This is due to the fact that many of the methods for buying cryptoassets are digital. Cryptoassets can also be used to make cross-border transfers, for instance to countries with less developed banking systems.

Also, lending from fintech and bigtech firms can improve the prospects of certain customer segments to obtain loans (see the section Particularly rapid growth in lending from fintech and bigtech firms).