How Project Finance is Transforming the Tech Industry

Project finance is transforming the tech industry by facilitating large-scale tech infrastructure, such as data centers, through limited-recourse financing via Special Purpose Vehicles (SPVs) and long-term user agreements. The digital transformation also impacts project finance itself by leveraging blockchain, AI, and remote collaboration platforms to improve efficiency, risk management, and decision-making. This integration allows tech companies to access necessary capital for expansive projects without depleting their core balance sheets and helps financial institutions adapt to new technological demands.

For decades, banks and insurers have followed the same relatively static but highly profitable business patterns. However, today they are beset on all sides by entrepreneurs looking to disrupt their businesses. Crowdfunding, peer-to-peer lending, mobile payments, bitcoin, and robo-advisers – the diversity and sky-high values of these “fintech” entrepreneurs appear to be limitless.

However, some may recall hearing this tune earlier. The direct banks and “digi-cash” of the 1990s piqued the interest of journalists and investors in a similar way, but had little impact. In reality, the financial services industry has shown to be incredibly resistant to previous attacks by innovators, thanks in part to the importance that scale, trust, and regulatory expertise have typically played in this space.

However, as the saying goes in investing, “past performance is not an indicator of future success,” and the same might be said of banks’ and insurers’ track record of outperforming innovators.

A new World Economic Forum report examines what the future holds for the business. It is based on more than 100 interviews with industry experts and a series of seminars that brought strategy officers from big financial institutions together with high-flying fintech innovators to debate the issue. Their findings show that this round of innovation may cause the top names in financial services to rethink their business strategies in fundamental ways.

5 ways Technology is Transforming Finance

Here are five characteristics of today’s entrepreneurs that imply this time may be different in terms of disruptive innovation in financial services:

1. They’re deploying highly focused products and services

Previous inventors frequently attempted to recreate the entire bank, resulting in business models that only appealed to the most technologically proficient or cost-conscious customers. Today’s innovators are aggressively targeting the convergence of high consumer unhappiness and high profitability for incumbents, allowing them to “skim the cream” by reducing the value of incumbents’ most valued products. It is difficult to think of a greater example than remittances; banks have traditionally charged exorbitant costs for cross-border money transfers and provided a poor customer experience, with transactions taking up to three days to arrive at their destination.

Transferwise, a UK-based startup, is challenging this method by leveraging an innovative network of bank accounts and a user-friendly web interface to make foreign transfers faster, easier, and more affordable. Thanks to this economic strategy, the company currently handles over £500 million in transfers every month and has just moved into the United States.

2. They are automating and commoditizing high-margin processes

Innovators are also employing their technical skills to automate manual processes that are now time consuming for established players. This enables them to provide services to hitherto untapped customer segments. “Robo-advisers” such as Wealthfront, FutureAdvisor, and Nutmeg have automated a full array of wealth management services, including asset allocation, investment advice, and even complex tax minimization measures, which are all available to users via an online portal. Customers must forfeit the in-person attention of a dedicated adviser, but they obtain many of the services they would provide at a fraction of the cost and without the requirement for $100,000 in investible assets.

As a result, a whole new class of younger, less wealthy people are receiving advice and support in their efforts to save, and it’s unclear whether they’ll ever want to switch to a traditional wealth adviser, even if their savings grow to the point where they qualify for one.

3. They are using data strategically

Customer data has long been a key decision-making aspect for financial firms; bankers base lending choices on your credit score, whilst insurance may examine your driving record or require a health check before granting a policy. However, as individuals and their gadgets become more interconnected, new sources of granular, real-time data emerge, as do innovators who utilize that data to enhance financial decision-making. FriendlyScore, for example, conducts in-depth evaluations of people’s social networking activities to provide lenders with an additional layer of data when assessing a borrower’s creditworthiness. Does your small business receive a lot of customer likes and responds quickly to complaints? If so, you may be an excellent risk.

Read Also: Understanding Debt vs Equity in Project Finance

Are all of your social connections drinking companions “checking in” at the same establishment? That could hurt your chances of getting a loan.

Meanwhile, a new kind of insurance business is looking for methods to generate streams of data that will help them make better pricing decisions and encourage their policyholders to make wise decisions. Oscar, a US-based health insurer, supplies its customers with a free wearable activity tracker. This allows Oscar to observe which policyholders prefer the couch over the gym and to offer monetary incentives (such as premium refunds) to encourage consumers to hit the treadmill.

As the sophistication of these analytic models and wearable devices grows, we should expect to see an increasing number of financial services organizations seeking to nudge their consumers toward better behavior and more responsible risk management.

4. They are platform based and capital light

Enterprises like Uber and Airbnb have demonstrated that marketplace enterprises, which link customers and sellers, can grow revenues enormously while keeping costs relatively steady. This method has caught the attention of financial services innovators. Lending Club and Prosper, the two largest US marketplace lenders, saw their total consumer credit originations in the US increase from $871 million in 2012 to $2.4 billion in 2013. Lending Club alone lent $3.5 billion in 2014. While this represents a small portion of overall US consumer debt, which was $3.2 trillion in 2013, the expansion of these platforms is impressive. Foundation Capital analysts expect that by 2025, marketplace lenders will have issued $1 trillion in consumer loans globally.

Even more impressively, they did so without risking any of their own capital. Instead, they’ve created a platform where borrowers searching for a better rate can meet with lenders (both individuals and organizations like hedge funds) anxious to invest their money.

Crowdfunding platforms have achieved a similar feat, becoming a significant source of capital for many early-stage enterprises. These systems connect individuals wishing to make small investments in start-ups with a variety of prospective investment targets, allowing the “wisdom of the crowd” to select which companies will and will not be supported (while keeping a portion of the funds from those that succeed).

5. They are collaborating with incumbents

This one can appear weird. After all, disruptors are supposed to eat the old economy, not collaborate with it. But this is an oversimplified viewpoint. Smart investors have understood that they can use split tactics to compete with incumbents in their preferred sectors while relying on their scale and infrastructure in areas where they cannot compete. Incumbents, for their part, recognize that partnering with new entrants can help them gain a fresh perspective on their sector, better appreciate their strategic advantages, and even externalize portions of their R&D. As a result, we’re seeing more collaborations between innovators and incumbents.

ApplePay, the most celebrated financial invention of the past year, works alongside payment networks such as Visa and MasterCard rather than disrupting them. Meanwhile, regional banks, such as Union Bank in California, are creating strategic alliances with marketplace lenders to send customers to whom they are unwilling to lend. This allows them to meet their customers’ needs while reducing the danger of them leaving for another full-service financial institution.

Clearly, there is more to this narrative than just disruption. How it will play out remains to be seen, but we can reasonably assume that innovators will compel incumbents to evolve, which should benefit consumers in the long run. However, this does not always imply that the well-known brands will perish very soon, especially those that learn to compete with the newcomers.