The Potential Of Artificial Intelligence In Finance

The world of finance is changing, with digitalization penetrating all areas of our lives, including finance. This is called FinTech, or Financial Technology, which is now at the stage where we can start talking about financial applications of artificial intelligence. Financial digitalization ranges from extensive processes, through back- and front-office applications, all the way to the customer. We channel a lot of data into BigData. The amount of data stored here on a daily basis can no longer be processed manually. This is where solutions such as automation, ma chine learning, and ultimately artificial intelligence come in. In this paper, I will introduce the concept of FinTech and its relation to financial applications of artificial intelligence.

The evolution of the FinTech phenomenon

The evolution of FinTech can be basically divided into 3 stages. The beginning of Fintech 1.0 is in the summer of 1866, when the first telegraph cable was laid across the Atlantic Ocean – in fact, this was the beginning of the first era of financial globalization, and it was an invention that enabled the transmission of information not only regionally but also intercontinentally (Arner et al., 2015). A very most important part of this era was the spread of the use of the telex machine (Asketa Biot-Pequot, 2018). In 1933, Germany began using teleprinters. By the end of World War II, they had grown into a network that covered most of Europe and, by 1957, was present in 39 countries. The next major event of the Fintech 1.0 era was the launch of the first general-purpose credit card in 1950, co-founded by Diners Club co-founders Frank McNamara and Ralph Schneider (Diners Club International, 2022).

A breakthrough innovation marked the beginning of the second era of Fintech Ashta-BOT-Pakarot, 2018. The idea was based on a feature of the post-war world: the widespread use of checks. This meant greater convenience compared to cash transactions, con ducting carrying and counting change. On the other hand, banks had to do a lot more expensive accounting work, and the reason for this was economic development, as, of course, rising wages made it more expensive for them to employ more staff. Higher wages increased the demand for leisure activities at the expense of weekend work. In addition, customers increasingly requested cash on Saturdays and even Sundays. Taking these factors into account, they tried to create a system that minimized accounting costs, but, at the same time, allowed them to provide a high level of banking services. The solution to these problems was the introduction of ATMs in 1967. Initially, customers could withdraw money against vouchers on any day for 6 months, but this system required manual bookkeeping. The scope of banking operations was reorganized and the work of retail branches was taken over by central offices. With this move, banks wanted to reduce costs, but the implementation was not as successful as expected.

The next initiative that defined FinTech 2.0 was the implementation of SWIFT (Society for Worldwide Interbank Financial Telecommunication) in 1973 (Asketa Biot-Peukerot, 2018). As with most of the solutions already mentioned or to be mentioned below, its development was initiated in the hope of working more efficiently and providing a higher level of service. In the 1960s, several major US and European banks invested in private networks and various computer equipment to enable cross-border banking. In these international transactions, effective communication between them played a key role, but free text messages often contained minor or major errors, which unfortunately hindered the process. The solution was the standardization of internal banking processes. In 1973, at the initiative of European banks, SWIFT was established in Brussels as an international financial organization (initially with 239 banks from 15 countries). It is now an indispensable part of international transactions. More than 11,000 financial institutions in 200 countries are members of this infrastructure. Other notable examples of the FinTech 2.0 era include the first commercially available mobile phone in 1983, and the launch of the so-called “program trading” in 1987, which acted as a catalyst for algorithmic trading of securities (Arner et al., 2015; In addition, the emergence of community finance in the 2000s, as mentioned earlier, also had a significant impact on the development of financial technologies (Ast-Bot-Peukerot, 2018). The spread of the Internet played the biggest role in the financial market (Lee-Shin, 2018).

The beginning of the economic crisis in the year of 2008 marked the end of the previous era and the beginning of the current one (Bussmann, 2017). Banks are busy dealing with the crisis and complying with various regulatory requirements after the recession, which has given the green light to small start-ups and various innovative solutions.

The launch of Bitcoin in 2009, along with the emergence of other cryptocurrencies, has also been a major catalyst for the development of financial technologies (Ast-Bot-Peukerot, 2018). The latter, fundamentally changed people’s concept of money, and has been one of the most important milestones of Fintech 3.0 (so far). In the early 2010s, smartphones appeared on the market, allowing virtually anyone, anywhere, anytime to make payments over the Internet. This phenomenon led almost immediately to the widespread adoption of mobile payment solutions (Johannes, 2022).

The beginnings of FinTech 3.5 also go back to 2008, with the difference that it refers to the financial technology of the developing world (Arner et al., 2015). These regions have not been able to develop a high level of banking infrastructure (e.g. Bangladesh), partly due to the fact that the money spent on IT-related improvements is far below European and North American levels, and most data protection regulations are also less strict (EnergyCatalyst, 2020; Arner et al., 2015).

Another obstacle is that financial awareness is below Western standards, wages are low, and cash transactions prevail over card payments, since, unfortunately, many people do not have access to financial services (such as opening a bank account) that are considered basic in Europe (EnergyCatalyst, 2020). In these some underdeveloped countries, the banking system is state-supervised, but trust in it is very low, partly due to its failure and partly due to several corruption scandals (Arner et al., 2015). Because of this, the public is open to various FinTech solutions provided by non-banks, giving them a chance to further develop and catch up with Western financial systems.

The Impact of FinTech Innovations on Traditional Finance

Payments are one of the most used and least regulated financial ser vices (Lee-Shin, 2018). There is a strong focus on this topic, it is developing very dynamically and there is a lot of room for innovation in this area. It focuses on two main areas, one for retail payments and the other for retail and corporate payments. I intend to highlight several solutions in the field of retail payments. One of them is mobile wallets. A great example is Barion, a Hungarian com pany, but of course we can mention Google Wallet or Apple Pay when it comes to FinTech services from the BIG4 companies.

P2P mobile payments, represented by PayPal, (bypassing the big credit card issuers) also play a major role in F IELD. It is also important to mention QR code-based mobile payment systems, real-time payment solutions and international transfers in various foreign currencies, the latter of which offers sensible favorable options for payment. Mobile payments offer significant advantages for both providers and users (Li -Shin, 2018). FinTech companies in this sector offer customers a modern, fast and convenient pay mental experience, while mobile payments allow companies to collect as much useful data as possible about users, which can later be used as a basis for innovation (Bussmann, 2017; Pintér, 2022).

The next important area to mention is crowdfunding. As its name implies, it enlists people to help start-ups, providing financial support for a po tental breakthrough or revolutionary idea (Li-Shin, 2018). The system involves three participants: the entrepreneur, who initiates the fundraising; the contributors; and the so-called moderating organization, which acts as an intermediary between the funder and the funded, and whose websites provide information about the different projects that can be funded and the type of support available. There are 3 main types of community funding, the first of which is the reward-based method.

This type of support can be a good option for start-ups and start-up entrepreneurs aiming to develop an innovative product or service. The idea is to deliver the result expected by investors, within a predetermined time frame, however, contributors are not returned the money they offered, but instead the promised product (European Commission, 2022a). Popular companies in the field include Kickstarter and Crowdfunder. Donation-based funding has a similar basis to the previous form of crowdfunding, except that those who help the entrepreneur do not receive a monetary reward for their support (Li-Shin, 2018). One of the most well-known organizations in this field is considered to be GoFundMe.

The main idea of equity-based financing is that firms sell a share to an external party in exchange for an investment, which can be a popular option in the SME sector (Lee & Shin, 2018). This form of assistance usually involves a significantly larger contribution than the previous two, and therefore the risk is naturally higher. T herefore, it is essential that a solid business plan is in place, that the con dic tions for return are clarified in advance, and that the entrepreneur is aware of the rights of shareholders and other aspects (European Commission, 2022b). Several companies, such as Crowdcube or AngelList, are involved in equity-based f inancing. The role of fintech in the capital market does not end with crowdfund ing. Several companies (such as Robinhood) offer investors the opportunity to trade various stocks and commodities and monitor potential risks in real time (Lee -Shin, 2018).

P2P lending is also an important, core area of the fintech sector. Organizations in this field, such as Funding Circle, allow individuals and companies to lend and borrow money to each other easily and efficiently at low interest rates (Lee-Shin, 2018). However, unlike banks, these companies are not involved in the process, but help the lender and borrower find each other and charge a fee for using the service. The credit risk assessment is not based on the usual procedure AP by banks either (e.g. they also use data accumulated on social media for this purpose) (Bussmann, 2017; Deutsch-Pintér, 2018). These FinTech companies represent strong competition for banks and credit institutions, as they are not yet subject to capital requirements regulations, and thus the total amount of lending is not limited, which gives them a significant competitive advantage in this field (Lee-Shin, 2018).

One of the most frequently mentioned areas in the world of FinTech, the concept of blockchain was coined by Satoshi Nakamoto in 2008 (Bassman, 2017). Ini tially this technology was used as a public ledger for the first cryptocurrency, Bitcoin, but nowadays it is applied in many areas (such as smart contracts). The original objective of the project was to create a P2P system that would allow transactions to be made between two parties, bypassing traditional banking institutions.

The above parties do not know each other, they do not have the trust to trade, so one of the most important goals when creating a blockchain database was to eliminate this problem. To do this, they have developed a technology that allows all parties to see the accounting lines on the blockchain, so that if there are any changes, everyone is notified, thus preventing fraud.

One of the most popular fintech areas is robo-advice (Li-Shin, 2018). Robo advice consists of computer algorithms that can provide investors and traders with instant information about news affecting the capital markets, including social media trends, to help them make decisions (Bussmann, 2017). On the Futuread Visor platform, for example, due to this technology, the desired asset allocation can be developed (e.g. taking into account risk appetite), which the robot keeps in balance despite constant market changes (Bussmann, 2017).

The insurance sector has also been influenced by FinTech, as in many of the sectors already mentioned, the business model of this industry is based on direct interaction between parties, in this case the insurer and the customer, and flexible, modern service delivery (Li-Shin, 2018; Pintr, 2008) Individual premiums for health, accident or even life insurance. In the case of vehicles, a great example is pay-as-you-drive insurance, which requires vehicle usage data and analyzes them to calculate the premium to be paid (Pushman, 2017). Major players in this sector include, e.g. Clearcover and Next Insurance.

AFR, the instant payment system, was implemented in Hungary based on TIPS (Target Instant Payment Settlement), and was launched on 2 March 2020 with the participation of GIRO ZRT., the National Bank of Hungary, and 35 commercial banks (all domestic banks were required to participate in the AFR (National Bank of Hungary, 2022c; Takarékbank, 2022). The euro was to be introduced in Hungary, as well (EPC, 2020). , was created to support the monetary policy and unity of the European Central Bank.

TIPS was launched on 30 November 2018, courtesy of the EU Rossystem, following the standards of ISO 20022 and the common set of rules of SCT Instant (SEPA Instant Credit Transfer – a pan-European instant payment system) (Belle, 2018). It is a market infrastructure service, established as an extension of Target 2, which allows PSP customers to transfer money 24/7 and make it to the account of the receiving party within seconds, in order to preserve the unity of the European payment market. The aim of TIPS is, among other things, to process transactions within a maximum of 10 seconds and to ensure security and continuity (ECB, 2022). Payment service providers can make these instant payments through an account opened for this purpose at their central bank. One can join TIPS as a participant, as an available party or as an instructing party (Belle, 2018). Participants have a number of X’s in the TIPS, and recea ble parties are eligible for settlement with participant accounts of these X’s number, however, they do not have such accounts themselves. Transfers can be made between credit institutions, so-called structural parties (such as clearing houses).

In Hungary, the Interbank Clearing System operated by Giro ZRT. can be considered the directive party (National Bank of Hungary, 2022b). Currently, the system only supports domestic transfers, such as regular or value date transfers, and it is also possible to send and receive payment applications in serious al financial institutions, also domestically (Vrajasovits, 2022a; 2022b). The relevant requirements are that no settlement date shall be specified and that the payment amount shall not exceed the ceiling of HUF 10 million (EPC, 2020). Accept the rules, the transferred amount is irreversibly credited to the beneficiary’s account within 5 seconds, and the payer receives a message if the transaction is declined. If the money does not arrive at the desired account within 5 seconds, 20 minutes are available to complete a successful transaction (Vrazsovits, 2022a). In addition to their account number, account holders can also assign a secondary identifier to their account, such as their phone number or email address (EPC, 2020).

The National Bank of Hungary has recently published the Planned L ements of the AFR Development Concept, as reported by Lajos Bartha, Managing Director of the National Bank of Hungary for Financial Infrastructure and Banking Operations, and I would like to highlight some of them (Turczo, 2022). All banks will be obliged to accept payment applications, as well as to read QR codes. The codes will be based on a centrally certified standard, which will be a huge step forward in security. After the standardization of QR codes, the focus will be on NFC (Near Field Communication Standard Collection) as well as AFR via Deeplink. The upper limit for transactions will be set at HUF 30 million instead of HUF 10 million, and a message will be required after each transfer to confirm its success.

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