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Seven years ago, Taavet Hinrikus, the first employee of Skype, moved to London from the free internet telephony company’s base in Estonia. However, he faced a problem. Every time he transferred money to his UK bank he incurred charges of 5 per cent per transaction.
Kristo Käärmann, a fellow Estonian living in London, had the opposite problem. He wanted to transfer local currency home but he was paid in pounds. In the end, the pair struck up an informal deal. Mr Hinrikus would transfer cash from his Estonian account to Mr Käärmann’s Estonian bank account. Mr Käärmann would move money from his UK account to Mr Hinrikus.
As the money did not cross national borders, they did not trigger a bank’s international transfer charges, saving them some £10,000 over the two years the arrangement lasted.
Their experience prompted them to found TransferWise, a “peer-to-peer” money transfer system that lets individuals and businesses send money between countries, charging a small fee for each transfer.
Since launching in 2011, the company has raised $33m from investors including Richard Branson and Index Ventures, a venture capital firm. In June, the company said it had processed payments worth more than £1bn.
This example is part of a wave of financial technology start-ups that are nibbling at the fringes of banks’ business model, the undervalued parts of a financial institution’s operations that are inefficient or that can be undercut.
“Banks are relying on the old interbank system for making international payments,” said Mr Hinrikus. “They don’t have any incentives to innovate.
“For banks, the service is a convenient cash cow . . . If you think about it, making international payments is really no different from sending an international email. It would be absurd if an international email cost 5 cents a letter.”
Investors are pumping cash into fledgling “fintech” companies. According to Accenture, global investment in financial technology ventures has risen from under $930m in 2008 to $2.97bn in 2013.
Fintech groups say their advantage over banks is an ability to concentrate on a small market sector and their better understanding of how to use technology to their advantage.
Hiroki Takeuchi is founder and chief executive of GoCardless, a London-based enterprise that allows small businesses and individual entrepreneurs to set up direct debit payments from customers, targeting groups that have difficulties setting up recurring payments.
“Banks do lots of things at once,” he says. “Fintech companies take one area and laser-focus on it. Banks can’t do that.
“We also see ourselves as a tech company. We’ve hired loads of engineers who will build robust new technologies. Banks, by contrast, typically use fairly old technologies, building systems by hiring consultancies.”
Some banks are attempting to head off the threat. Barclays launched the Pingit mobile app two years ago, allowing customers from any UK bank to send money to another person using only a phone number. The Payments Council, the UK industry group responsible for payment mechanisms, has launched a similar mobile system called Paym.
Barclays, MasterCard, Rabobank and Lloyds are among older financial groups attempting to turn into investors, helping to fund “accelerators” – environments for would-be entrepreneurs who exchange equity in their fledgling enterprises for cash, mentorship and office space.
Others have partnered with fintech companies, believing it may be better to collaborate than be to compete.
In June, Santander announced a deal so customers it cannot serve may use Funding Circle, a UK peer-to-peer lender specialising in corporate loans.
In return, Funding Circle, which has lent some £290m to 5,000 businesses since it began trading in 2010, will promote Santander’s current account and cash management services.
“It will by no means be our last partnership,” says Samir Desai, chief executive of Funding Circle.
In the US, San Francisco-based Union Bank announced a similar deal to sell some personal loans via Lending Club, an online marketplace.
Mr Desai says that, although fintech companies are taking a bite out of banks’ revenue streams, they are also helping expand the financial services sector.
He says about a third of his customers have told him they would not have been able to raise finance without Funding Circle, so creating customers outside the orbit of traditional banking.
Though fintech companies expect to work with banks, their efforts will lead to a more fragmented financial services marketplace.
Mr Hinrikus comments: “We may see that a one-size-fits-all universal bank no longer works.”