We live in a global financial system, but fintech innovation is surprisingly local.

Makoto Shibata, the head of FinoLab, has been leading financial innovation Japan for over 20 years, long before the term fintech existed. We talk about the evolution of Japan’s fintech landscape, and which fintech sectors are facing consolidation and which are facing growth.

And we also explore Japan’s rapid transition from a cash-based society to a cashless one and the startup opportunities that opens up.

It’s a great conversation, and I think you’ll enjoy it.

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Show Notes

  • The critical role of a dedication fintech community
  • Why corporate support is still needed to succeeded in fintech in Japan
  • The government’s push to move society away from cash
  • The likely fate of today’s e-payment startups
  • Opportunities for fintech startups in the next five years
  • How AI is being used in Japanese banks (you won’t like it)
  • Advice for how startups can successfully collaborate with large financial institutions
  • What is preventing Japanese fintech startups from going global? 
  • The kinds of foreign fintech startups with the best chance for success in Japan
  • How to know when you are at the peak of the fintech investing cycle?
  • What foreigners most misunderstand about Japan’s fintech markets

Links from our Guest

 

Transcript

Welcome to Disrupting Japan, Straight Talk from Japan’s most innovative founders and VCs.

I’m Tim Romero and thanks for joining me.

FinTech is a broad and confusing startup sector. It’s a sweeping category that encompasses everything from pragmatic and meticulous applications, like the optimization and risk management of consumer loan portfolios to the most hype driven and outrageously transparent crypto scams.

Of course, at Disrupting Japan, we focus on Japan. And so today we’ll be sitting down with Makoto Shibata, the head of FinoLab and the FinoLab Fund. Now, FinoLab has been central to Japan’s FinTech community for a long time, and today we’re going to take a sober look at FinTech in Japan.

What’s working, what’s not, and what’s likely to blow up in the near future.

Equally important, before running FinoLab, Makoto spent 23 years at a Japanese mega bank and was in charge of their innovation activities. So, he offers some very practical advice on how FinTech startups can partner with financial institutions in Japan. He explains why such partnerships are needed and where they can go wrong.

Makoto and I dig into how Japan is rapidly becoming a cashless society, the opportunities that trend presents for FinTech startups in Japan, and the importance and challenges of Japanese FinTech startups trying to go global and

oh, yes, we also talk about what is perhaps the worst possible business use of generative AI ever to be deployed.

But, you know, Makoto tells that story much better than I can. So, let’s get right to the interview.

Interview

Tim: So, we’re sitting here with Makoto Shibata of FinoLab. So, thanks for sitting down with me.

Makoto: Thank you for having me.

Tim: So, FinoLab is a community. It’s much more than just the fund, but to start things out, tell me about the fund and its thesis. Who are you investing in and why?

Makoto: We started from a business community, we realized that one of the top priority startup is to raise fund. And in their early stages, they may have difficulty, and we thought that it would be good to have our own fund to support these startups. So, basically we would focus on the early stage startup in FinTech related areas. These days FinTech has become quite wide. The territory of FinTech is expanding.

Tim: And the startups you’re investing in, are those all startups from the FinoLab community, or is it a broader, any FinTech startups in Japan?

Makoto: Basically we try to start our conversation when startup joined FinoLab as a member, but we also have some startups in the FinTech community outside of FinoLab.

Tim: And FinoLab for those who don’t know. So, Mitsubishi Estate actually is running a number of these kind of vertical co-working spaces, and I think FinoLab was the very first one.

Makoto: Yes, it was. There were group of people running FinTech pitch contest called Financial Innovation Business Conference. Recently we changed the name to a Fino pitch. But people running this FIBC since 2012, the idea that they need certain place for FinTech startup to form a community to promote the ecosystem. In 2014, 2015, we started to see many community coming out in different parts of the world, and especially in London, particularly level 39 in Canary Wharf. Because not just the FinTech startups, but also the financial institution and also the regulatory authority got together to promote the ecosystem in FinTech area. So, we started knocking on the doors. And since then we have experienced expansion from a few members to now we have like 55 startup members and about 30 corporates and other public type of members.

Tim: One thing I’ve noticed, especially about FinTech in Japan, the corporate support seems to be extremely important for startups to get any traction.

Makoto: Right, one of the reason is that FinTech is area where you need to cope with regulation, and also you need to have certain trusts in order to get traction from end users. It is always helpful to get support from the large financial institution or existing corporate entity.

Tim: So, FinoLab’s been in operation in one form or another for, well, for 10 years now. And FinTech’s always been a big part of the startup ecosystem here in Japan. But over the last couple of years, FinTech’s really exploding in Japan. FinTech week this year was just amazing. It was huge. So, what’s driving this change over the last year or two?

Makoto: In the beginning, the FinTech was only for a handful of people who are interested in making innovation in financial service. But now with the expansion of digital transformation in every industry, and especially in financial service, government is putting emphasis to shift from cash society to digital payment or cashless society. I think that had big impact on the way that people started to get interested in FinTech. And also major financial institution was pursuing open innovation from early days. But now even the small financial institution or regional ones are getting pressure to digitally transform themselves. And oftentimes they are turning to FinTech startups. All these elements put together. People started to get more interest in FinTech area.

Tim: Actually there’s two points you brought up that I want to drill down on separately. The first is the recent uptake in electronic payments in Japan. For decades, really everyone around the world was just saying, oh, well, Japan is a cash based society. They don’t like credit. Electronic payments outside of the train ticketing is almost non-existent, and that’s absolutely not true anymore. What was the tipping point?

Makoto: So, even before the government started to promote cashless society, we have seen uptake in, for example, contactless payment using the railway ticket. And we have seen the circulation of small coin going down from 10 years ago or so, and also small medium sized retail outlets were very reluctant to adopt digital payment. So, people had to carry around cash. And from couple of years ago, the government put pressure on industry even those small retail outlets started to adopt digital payments.

Tim: What kind of government pressure was put on them?

Makoto: First when they introduced this my number card, National Identity Card. They thought that this may be a good opportunity to promote cashless activities. So, they put some incentives. If you introduce my number card and if you use the digital payment, you get some rewards or points. Those who are eager to get these point programs, they applied for these incentive schemes that had impact on retail outlets because many people requested new payment methods. And that’s one element. And another is introduction of QR code payment. It’s interesting that QR code was invented in Japan but it was only used for supply chain management then. So, invented this QR code, but nobody in Japan thought of using this QR code for payment. But someone in the neighbor country came up with the idea of using QR code for payment. And here we saw AliPay and WeChat pay exploded in China. And looking at that, some people in Japan started to import that idea into Japanese environment.

Tim: Consumer behavior doesn’t change rationally. So, what I find fascinating about this is it seems to have swung almost to the other direction where five years ago I paid cash for just about everything. That was just the only option. Now most chain stores and a lot of retail stores will have, they’ll accept 20 different types of e-payments, they’ll have like three or four different payment acceptance devices, payment terminals…

Makoto: And if you go into a convenience store, you would look at 50 different payment…

Tim: Yes, exactly. So, it just seems like too big of a change to attribute to just small government incentives or seeing the success of something overseas. Is there something where e-payments have become significantly more profitable for these companies?

Makoto: Not really. But one of the reason why QR code was successful in small medium outlet was that you don’t need to install a fancy payment reader to accept QR code payment. You can just put the sticker, the storefront. I think that had big impact on the acceptance of QR code among small retail outlets. One of the top QR code payment provider is Paypay and Paypay initially introduced the QR code payment without fee for the retailers. So the hurdle for retailers to in introduce QR copay was very low. And after a while, PayPay started to charge, but still it was lower than the credit card fee.

Tim: So, I guess what we’re seeing, it wasn’t a specific tax incentive or a change to the law. I guess it was just at some point we hit a natural tipping point where network effects kicked in and we have these electronic payment systems everywhere.

Makoto: So, it’s not just one single incentive. Everything came into one place. And also the government started to promote cashless payment and then that had impact on the industry and I think that’s typical of Japan. People initially say to national agenda, that’s nice, but once you reach to a certain point and see other people starting, everybody start to rush in.

Tim: Everyone decides all at once. So, with 50 plus e-payment options in Japan, is there still room for startups to innovate in the e-payment space here?

Makoto: I think it would be difficult to start something totally new on mass payment. I think existing e-payment would go through certain selection process and we might see some of them merge or stop to provide service, and maybe 50 would end up in 10 or something like that.

Tim: Well, what are you most excited about now in FinTech in Japan? Where do you think the most innovation is happening? Where do you see the biggest potential for growth within FinTech?

Makoto: I think we’ve seen almost all of the financial service area covered with certain type of FinTech, but in the past year or two, we have seen a big impact of generative AI coming in. So, we may see how AI can change the process.

Tim: What sort of areas? Because it seems to me that FinTech has to be accurate and right a hundred percent of the time. And generative AI is not, it’s basically right. Most of the time. So, what are the applications of generative AI in FinTech?

Makoto: Initially we have seen the use of generative AI in internal process and also supporting role for customer service. But gradually that will expand into direct interaction with customer.

Tim: Japanese banks and insurance companies are extremely conservative, even by banking standards. Are they willing to experiment with this kind of generative AI technology?

Makoto: They have already started evaluating to what extent they can use generative AI, and many of them have already adapting in their internal process. For example, like making process of paper documents more efficient. Maybe generative AI can come up with a draft, so you don’t have to start from scratch in order to make application or internal documents if you need approval from your superiors. It’s always the case that the documents will move around in the organization, but that process can be…

Tim: We’re using generative AI to improve the ringi process.

Makoto: To some extent.

Tim: Oh, that just seems so wrong.

Makoto: So, it’s quite difficult to change the process totally. So, in the conservative nature of a financial organization, they would try to keep the existing process and try to put the different technology elements here and there.

Tim: And this brings us back to kind of a conversation you and I were having a few weeks ago. So, you were at Tokyo Mitsubishi, UFJ Bank for 20 years, 22 years, a long time.

Makoto: Starting from Bank of Tokyo. I spent 30 years of banker’s life there.

Tim: So, you understand Japanese bank culture as well as anybody does. And you were leading emerging technology and online initiatives when you were there. So, the way FinTech’s evolving in Japan, it seems like we do have this core of conservative banking and that’s not necessarily a bad thing. Banking should be conservative, that is innovating by introducing generative AI to make ringi show faster. And then we have startups kind of innovating around that. Do you see innovation happening by these startups helping the banks innovate or by kind of building a shell around banking services?

Makoto: I think the typical nature of financial institution is relatively long time to innovate. And it is true that these banks have been adopting innovation. So, they introduced online banking, mobile banking, and especially in terms of their delivery channel. They have introduced most of the modern technology, but their internal process remains pretty much the same, even though they are bringing in technology here and there. I think that would change over time. And also with customer facing technology and also service, if you adopt the solution provided by startups, I think that will shorten the process of innovation. I think the management in the large bank started to realize that if you still rely wholly to the existing staff members, it will take quite long time to innovate. So, if they can introduce a new element from outside, they can shorten the process.

Tim: Do you think Japanese banks today have an appetite for innovation? I mean, they’re investing in FinTechs. All Japanese banks have significant innovation teams both on investment and market research. But it seems like for example, the FSA has had to be very aggressive in getting banks to open up APIs and to work with startups. So, the startups see very mixed signals from the banks.

Makoto: I think that’s true. But at the same time, initially working with the startup was a kind of a gesture, trying to look as if they’re innovative. But along the way, they started to actually experiment and also execute actual new products and services with the startup. They have accumulated experience knowledge to work with startups. And now we have seen some cases of actually creating the new product and service between startups and financial institutions. So, I think we started from the competition to a collaboration, but now we are starting to see some co-creation between the startups and financial institution. For example, recently MoneyForward, one of the top FinTech player in Japan announced the joint venture project with Sumitomo-Mitsui Banking Group. Their MoneyForward platform will be implemented into Sumitomo’s platform. That kind of joint venture was not possible 70 years ago.

Tim: And do you think that was due to a change in corporate attitude, or was that due to FSA pressure?

Makoto: Yeah, a little both. And also FSA changed the regulation so that the banks can invest into FinTech startups, not just a minor share, but now it is possible to actually acquire the company. Or in the old banking law, bank had very narrow definition of delivering a service. But that has expanded a little bit. And also I think there’s a strong pressure on the banking industry side to innovate because they’re seeing that population declining, and also they’re losing business to newcomers from retail side or other industries. So, they need to innovate, especially if smaller players like regional banks.

Tim: It’s great. We’ve hit the point where banks and the FinTechs are collaborating, but, it seems there’s also some direct competition going on. One of your portfolio companies, the UI bank is a consumer facing bank.

Makoto: So, UI Bank is digital bank created by a Tokyo Kiraboshi Financial Group, one of the regional bank in Tokyo area. They also got some pressure to digitally transform themselves, especially in Tokyo. They need to compete with mega banks and other financial institution. They thought that it would be difficult to change the bank itself in very short period of time. And instead of challenging that, they decided to create the separate entity, digital bank, with no branch office and limited their service to a smartphone. I think this would show some example for a small regional banks to challenge new innovation to change their business. The idea behind this UI bank is to shift some of their customer to a UI bank, where these customer may not go into a branch office, and if they would like to have a consultation on financial matters, they can come into a branch office. Ideally, they would like to have certain division of labor between the digital bank and the existing branch office network.

Tim: There is an amazing amount of FinTech startups and FinTech innovation happening in Japan. How much of that is uniquely Japanese? And how many of these companies do you think really have global potential?

Makoto: Yeah, that’s always big question. We’ve experienced many things becoming Japanese proprietary standard. For example, Japan started mobile banking from very early days. When NTT Docomo introduced Imode.

Tim: That’s right. We had mobile banking in the nineties.

Makoto: Yes.

Tim: We did.

Makoto: It started from 1999 when Imode was introduced, NTT Docomo thought that if they can put the financial service on Imode, people would have trust in the service. They thought mobile banking was critical element to persuade customer to go on the Imode platform. Major banks started to connect their online banking system to Imode. So, even though it was quite primitive, people can check balance and also send money. So, in the world, Japan was leading a mobile banking at that point. But when smartphone came out, Japanese banks were a bit late because they already had the mobile banking on the featured phone, and they thought the featured phone in Japan had quite luxurious functionality. And they thought that smartphone penetration would take some time, which was not the case. So, just within couple of years, smartphone had a big penetration.

Tim: Yeah. I think Japan, there was a lot of opportunities missed both in the iPhone launch and the delay from switching to the Galapagos feature phones to the mobile phones. But finance — it’s fascinating that the industry is both simultaneously completely global and very local. When I’m looking at the FinTech startups in Japan, there’s very few I see that seem to have the potential to go global. And I’m wondering what your opinion is on that. Do you see what FinTech startups here with global potential?

Makoto: Yeah, I think that is one of the challenge for us at FinoLab. We have something like 12 startups from outside of Japan among 55 startup members. But among Japanese startups, very few of them have challenged the global market. Some players have a technical potential to move into other markets. But one thing is that the Japan has sizable market and they’re too busy to challenge new market, or they’re not willing to create the platform for non-Japanese language. But we need to challenge that in order to really scale up.

Tim: So, of the foreign startups that are in the FinoLab community, what kind of FinTech startups are they? What are they doing?

Makoto: They’re in different areas. Some were in payments, some were in investment area, some were in insurance.

Tim: So, there’s no fundamental problem in a FinTech startup moving from one market to another. If there’s a broad diversity of FinTech startups coming to Japan, there should be just as broad a diversity of FinTech startups going out of Japan.

Makoto: Right. I think that’s true. So, we’re trying to encourage our members to challenge global markets, but still they’re a bit slow. But we’ll see. If we look at our mega banks, they have become quite international and they have started some immersion and acquisition in different markets, especially now in Southeast Asia. They’re quite busy acquiring different financial institution. I think there would be more potential for startups to challenge global market as well.

Tim: I mentioned before how impressed I was at the scale of this year’s FinTech week. Is FinTech growing faster or slower or about the same as the rest of Japan’s startup ecosystem?

Makoto: It’s about the same, but it would catch people’s attention from time to time with the events like Japan FinTech Week. And also it depends on the appetite from financial institution side, especially during the pandemic people won’t go into the branch office and they would totally rely on the online channel or mobile channel.

Tim: And it does seem that FinTech more so than other sectors, tends to be very well, I could politely say thesis driven or impolitely, say hype driven. So, we’ll go through cycles where there’ll be a huge boom in payment startups or blockchain startups or cross border transfer startups, and then it’ll die out.

Makoto: Yeah. I think the financial industry to some extent were hype initiated. As you can see, we’ve seen rise and fall in the financial market, especially it’s led by investors appetite. So once they recognized the opportunity, VCs or especially CBCs started to invest into similar type of startups,

Tim: That sort of hurting behavior again.

Makoto: Yes. Yes. Yeah.

Tim: All right. Japan’s FinTech ecosystem is certainly different than it is in the US or Europe, but what do you think is the biggest misunderstanding that foreigners have about Japan’s FinTech startups?

Makoto: I think people from outside world think that Japan is very different, but I think now it’s becoming more transparent. And also people are starting to realize the need for future investment or international finance is becoming close to us. And also regulatory authorities has become quite keen to make things transparent in terms of regulation. In some areas, Japan has rather strict regulation, but overall, I think it’s quite clear what you can do and what you cannot do. So, understanding all these regulation, culture or language is not so difficult as people think once you’re here.

Tim: That’s a good point.  Japan, overseas Japan definitely is a reputation of being highly regulated and hard to understand. But as you say, it’s not really that complicated. Well, listen, Maloto, before I let you go, I want to have you look into my crystal ball here and tell me what does Japan’s FinTech ecosystem look like in five years?

Makoto: It will gradually evolve, and my hope is that people would not think about the word. FinTech technology would become really a part of a financial service. Now, many people think that starting from internet or blockchain or artificial intelligence is something quite new. And they think that financial service has changed with these technology. But once technology is embedded in the business, people would not really think about the technology.

Tim: So, FinTech will become so common and commonplace that people won’t even think of it as a separate category.

Makoto: Right.

Tim: But then there’ll be no more fin lab and you’ll be out of a job.

Makoto: Well, maybe I’ll start thinking about my next life. Or maybe I can retire in five years’ time.

Tim: Well, excellent. Well, Makoto, thank you so much for sitting down with me.

Makoto: Thank you. My pleasure.

Outtro

And we are back.

It’s really hard to overstate just how fast digital payments have become the norm in Japan.

Makoto’s explanation that it was driven largely by a combination of COVID behavior, government pressure and incentives for adoption, and consumers getting used to paying for things on their smartphone. Now, not necessarily paying for things with their smartphone at first, but just getting used to the idea of doing financial transactions on their smartphone, and starting to see the smartphone as part of their financial life made the transition to digital payments easy and perhaps inevitable.

While that certainly rings true, I think there’s something more here. The return of inbound tourism has certainly also played a role, but an equally important aspect is that recent improvements in contactless payment options and speed improvements in the payment processing networks themselves means that cashless payments is actually faster and simpler than paying in cash. Until recently, that definitely was not the case.

But now digital payment is the default for large stores and many smaller ones all over Japan. In Japanese supermarkets and convenience stores, you may not have self-checkout, but you will almost certainly have self-payment.

Of course, the transition has not exactly been seamless. My local Starbucks has four different contact payment pads connected to each register to support the various kinds of digital payments. And buying something in a convenience store means navigating a touch screen of over 50 different digital payment options.

So, yeah, we are certainly headed for some consolidation and digital payments.

Still, though, as Makoto points out, there is a huge potential for financial innovation in Japan. The FSA is demanding more transparency, and they’re actually getting it. Japanese banks and insurance companies are eager to invest in and partner with innovative FinTech startups. And the barriers to entry are coming down.

As Makoto explained, a large portion of the FinoLab community are foreign FinTech startups entering the Japanese market. And this really is the best kind of startup innovation where startups drive structural and regulatory and attitude changes across the entire market.

The reason startups are an engine of innovation is not simply because they introduce new products and services. No startups lead by example. They show how it’s done, and they push entire industries and societies to embrace innovation.

That doesn’t just benefit startups. That benefits all of us.

 

 

If you want to talk about FinTech in Japan, Makoto, and I would love to hear from you. So come by disruptingjapan.com/show224, and let’s talk about it. And if you enjoy disrupting Japan, please share a link online or just tell people about it. Disrupting Japan is free forever, and letting people know about it is the absolute best way you can support the podcast.

But most of all, thanks for listening. And thank you for letting people interested in Japanese startups and VCs know about the show.

I’m Tim Romero and thanks for listening to Disrupting Japan.