How to Innovate FinTech in Canada

This is an excerpt from Canada 2020’s upcoming report ‘Being Innovative: Canada’s Next Big Challenge.’ The report will be released in early November, 2016.
royal bank _ birds_wp
By Mike Moffatt
Assistant Professor, Western University
Financial Technology (known as fintech) investments are growing rapidly in Canada, with OMERS Ventures reporting that 100 fintech start-ups in Canada have collectively raised more than $1 billion in funding since 2010.
As part of our research for the Canada 2020 innovation project, we held a roundtable discussion in Toronto with representatives from big banks, non-governmental organizations, fintech startups, venture capital companies and government.
We wanted to talk about how Canada can be more innovative in a sector which is so important to our country’s economy. Here’s some of what we heard:
Market structure and incentives:
When asked, “What is the biggest barrier to innovation in Canada’s financial sector?” a common answer was the structure of the industry and the incentives that it creates. Canada’s financial sector is dominated by six big banks. Due to the oligopolistic nature of the industry (caused, in part, by high barriers to entry), Canada’s Big Six are more profitable than similarly sized banks in other countries. Combined, Canada’s six largest banks earned $35 billion in profit last year.
In the view of some start-ups, this creates an incentive for the banks to fight disruptive innovations, as those disruptions put oligopolistic profits at risk. However, the counter-argument was given that the banks recognize that these innovations are inevitable, so the banks have an incentive to be active participants, rather than facing challenges from outside, such as from global players like Google and Apple.
Stability versus innovation:
Innovation is a tricky concept in the financial services industry since innovations are seen as playing a role in the Financial Crisis. The roundtable unanimously recognized that regulators have an important role in protecting consumers as well as in protecting the integrity of the financial system from systemic risks. It was recognized that regulators have the near-impossible task of finding a way to protect the system while not stifling useful innovations and keeping abreast of rapidly changing technologies.
A concern was raised that regulators are judged solely on their ability to prevent “bad things from happening,” which comes at a cost of innovation. One participant gave an analogy of judging road-safety regulatory bodies solely on the number of crashes, saying their response would be to “[make] all roads five miles per hour.” A suggestion was made that financial industry regulators be given a dual mandate of consumer protection and innovation development.
Cultural barriers to innovation:
A concern was raised that Canadian investors and managers may be too risk averse to be full participants in a highly innovative industry. As one participant put it, “[In Canadian MBA programs] there’s not a lot on how to take risk … . In [New York], the mentality of grads out of the U.S. is to take risks. There’s an acceptance that if you do that and fail that’s OK. In Canada, there’s stigma around failure.” A suggestion was made that foreign investors from countries with higher appetites for risk, such as China, may be able to fill some of the financial (but not necessarily managerial) gaps.
Immigration issues:
If there are talent (or cultural) gaps in the system, immigration might offer an answer. However, one roundtable participant noted that it takes so long to bring executive-level talent into Canada under the Temporary Foreign Worker Program that a candidate will have typically moved on to other opportunities by the time their application is approved.
Access-to-capital gaps:
Members of the roundtable stressed the importance of looking at the entire life-cycle of a fintech company when discussing possible gaps in access to capital. The consensus was that seed funding for good ideas was available through angel investors and family members; as one participant put it, “There’s no shortage of people willing to write $50,000 cheques.” The bigger challenge appears to be finding enough money to reach scale, with our fintech roundtable reporting that it is more difficult to find second-round funding than it is first. Canadian venture capitalists were seen as requiring higher rates of return or lower risk than their U.S. and Chinese counterparts, and there was a perceived talent gap between the quality of Canadian and American venture capitalists. Fintech companies partnering with banks was seen as an option, though there were concerns that accessing capital this way would come with too many restrictions.
Members of our roundtable saw increased collaboration as a way to increase innovation in the sector. One participant felt that there were tighter ties between the investment and fintech start-up communities in the United States, which allowed for information sharing and the building of trust and stated, “Interaction, sharing ideas among startups, isn’t something you get a sense of in Canada. We need a safe spot for founder-to-founder, investor-to-investor interactions.”
Final thoughts:
Overall, the roundtable saw fantastic innovation potential in Toronto’s financial services industry thanks to banks that compete on the international stage and a critical mass of skilled graduates between Waterloo and Toronto. Increased innovation would benefit consumers, by giving them additional choices, more convenience, greater access to capital and lower costs when choosing financial products. A failure to innovate would see the profitable parts of the industry swallowed up by large U.S. players, with Canadian banks largely becoming commodity producers.
Mike Moffatt is an Assistant Professor at Western University’s Ivey School of Business.
This is an excerpt from Canada 2020’s upcoming report ‘Being Innovative: Canada’s Next Big Challenge.’ The report will be released in early November, 2016.