Regulators await huge market change as fintech takes on traditional banking services, writes Andrew Cornell.
For business owners looking to refinance, borrow to fund expansion or buy assets, there could be great opportunity in the more competitive market that efficient financial services technology firms are likely to create.
For advisers, their emergence could mean a dramatic reshaping of the financial landscape would be another big change to adjust to in the years ahead. For banks and traditional financial services operations, the challenge could become one for survival.
In fact, ultra-low interest rates and fintechs were two of the major threats to the stability of the financial system identified by the global regulator in its recent annual economic report.
The Australian banking system is highly regulated. We are renowned for our banks stability and security. British and US banks folding under the global financial crisis were examples of the benefits of such governance. The robust nature of our political and economic system attracts international companies looking to invest in foreign markets: lower risk and sustainable profitability are key to investors assessing international expansion options.
Sustainability in banking, aside from profitability, is built on risk, rigour and thorough procedures, which has been under the spotlight in the royal commission. But the immediate challenge of that intense scrutiny will pale compared to the dual challenges of persistently and unusually low interest rates eating away at their net interest margins, and growing competition from new technology-savvy players – bigtech and fintech, the Bank for Financial Settlements stated in its Annual Economic Report 2018.
According to Fabio Panetta, the deputy governor of the Bank of Italy, up to 60 per cent of the profits in retail banking are under threat from fintechs. This is not insignificant in a landscape like Australia that is dominated by the big four.
The Bank of International Settlements (BIS) was focussing on competition, on the probability big tech like Amazon.com and the myriad start up fintechs would eat away at the established players. That’s almost certainly true, up to a point, but there is a further threat to the global system posed by these disrupters: they are outsiders, falling outside the established regulatory and supervisory order.
At this stage of fintechs’ evolution, they don’t have scale, so they’re not systemically important enough to be a focus of securities regulators – those charged with protecting investors and ensuring fair markets.
These regulators, such as the Australian Securities and Investments Commission, have a mandate to provide a fair market for those providing capital in the form of funding rounds – where they are involved at all.
Theoretically, it’s a catch-22 for non-banks wishing to disrupt the established order, once they do have the scale to be disruptive, they will be regulated, just as banks are.
Fundamental structural change on the way
In a little reported speech in Shanghai to a fintech forum, Reserve Bank of Australia assistant governor (financial system) Michele Bullock made precisely this point.
“Traditionally, payment services have been provided by regulated financial institutions through transaction accounts," she said. "These institutions are prudentially supervised to ensure that the public can have confidence that they will be able to meet their financial commitments under all reasonable circumstances.”
That typically means, if the institution failed, retail deposits are protected. However some new entrants are holding client funds on their books as 'stored value'.
“This raises a number of policy questions,” Bullock said. “Should the funds being held be treated like deposits? If not, do the firms holding the funds need to be regulated in some other way to protect consumers?” technology companies, they could potentially hold substantial amounts of value in their closed systems. What are the implications for systemic risk of such a market structure? Regulators are still working through these questions.”
Panetta believes the structure of the financial services sector will change fundamentally in the next decade – although he hardly expects banks to disappear.
“Overall, I do not expect independent fintech firms to be able to replace banks,” he argued. “The value chain of banks includes bundled services like deposits, payments, and lending. Fintechs generally carry out one or more of these activities in an unbundled way. Yet, bundling provides powerful economies of scope.”
Open banking and barriers to entry
Big tech, of the Amazon, Facebook, Alibaba and Tencent size, are fundamentally different. They have scale, they have huge data sets and very sophisticated customer-service models. Like incumbent banks, they are also acquiring promising fintechs to further disrupt the industry.
They pose the threat that RBA’s Bullock sees regulators working through – although the RBA is clearly not out to protect incumbents per se. Something else Bullock says the regulator is paying attention to is whether banks can exploit their existing positions in the market by denying access to new competitors, or “regulators will need to be alert to potential anti-competitive conduct”.
While systemic stability is the prime directive of global regulators they are subscribers to the view that while banking is essential to a modern economy, banks are not. It’s all part of healthy competition and natural evolution fed by the possibilities digital innovation brings.
Bullock agrees open banking plays a pivotal role in competition.
“It is expected that consumers will be able to use this data (their own financial services data) to access better products and services," she said. "For example, consumers could ask their bank to share their credit card transaction history, interest rate, fees and other relevant data with a product comparison website."
"Using this information, the website could provide a tailored assessment of the best possible credit card for that particular individual, including an accurate estimate of potential savings compared with their current card.”
Whilst Bullock accepted ensuring data security and customer privacy were concerns, she believes “these can be addressed”.
“The Reserve Bank is confident about the potential of open banking to deliver benefits for consumers,” she said.
Few informed observers deny the potential of open banking to wreak change upon the system, as ANZ’s Nigel Dobson says.
But whether the new competition is fintech, big tech or digital 'neobanks', Bullock reminds us “an important challenge for regulators is how to limit barriers to innovation while maintaining safe and efficient payments systems”.
Andrew Cornell is managing editor of bluenotes.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
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