Competition from large, established technology companies (BigTech) and financial technology (FinTech) could put pressure on the profitability of financial institutions and lead them to take on more risks to protect their margins. As part of its ongoing monitoring of BigTech and FinTech influence on financial institutions, the Financial Stability Board (FSB), today published “FinTech and market structure in financial services: Market developments and potential financial stability implications.” In analyzing the advantages and threats posed by rising technological innovation in the financial sector, a cadre of researchers from all over the world found that a more efficient and resilient financial system could develop due to BigTech and Fintech causing more competition and diversity in lending, payments, insurance, trading, and other areas of financial services. However, if financial institutions have a hard time with this competition, they could increase their credit and market risk exposures in order to remain profitable; taking on more risks without good risk management and high levels of capital, could put global financial stability in peril. More attention is needed from regulators and analysts precisely because BigTech and FinTech might affect financial stability by changing the market structure in financial services. As used in the FSB’s report, “market structure refers to the interrelation of companies in a market that impacts their behavior and their ability to make profits.”
According to FSB analysis, financial innovation could influence market structure in financial services through different channels, including the following:
- The emergence of providers of bank-like services such as FinTech credit or payments, which may impact markets and bank behavior. In the future, FinTech may increase the efficiency of financial services; in part the absence of legacy systems also may favor fintech.
- The entry of BigTech with established networks and accumulated big data have gained a foothold in financial services space in some jurisdictions, particularly in payments, and in some cases also in credit, insurance, and wealth management. BigTech players could offer lower-cost (or even free) services, since they could use the data obtained through these services for a variety of businesses. This in turn could also have a range of effects on existing markets.
- The provision of important services by third parties. 7 Financial institutions rely on third-party service providers for data provision, physical connectivity, and cloud services. The reliance of traditional financial institutions and FinTech firms on third-party service providers may increase over time. Systemic operational and cyber security risks may arise if systemically important institutions or markets do not appropriately manage risks associated with third party outsourcing at the firm level.
FSB researchers found that the relationship between existing financial institutions and FinTech appears to be mostly complementary and cooperative. “FinTech firms have generally not had sufficient access to the low-cost funding or the customer base necessary to pose a serious competitive threat to established financial institutions in mature financial market segments.” However, some FinTech firms have established inroads in providing credit and payments services. FinTech credit is growing rapidly, but is still small as a proportion of overall credit in most jurisdictions. “To the extent that technology permits a further unbundling of profitable services traditionally offered by banks and other institutions, the profitability of such institutions may be negatively affected in the future.”
BigTech’s competitive impact on financial institutions may be greater than that of FinTech. This should not be surprising given that BigTech “usually have large, established customer networks and enjoy name recognition and trust.” Companies such as Alibaba, Apple, Amazon, Facebook, and Microsoft could use proprietary customer data generated through various services including social media and enable them to tailor their offerings to individual customers’ preferences. “Combined with strong financial positions and access to low-cost capital, BigTech firms could achieve scale very quickly in financial services. This would be particularly true where network effects are present, such as in payments and settlements, lending, and potentially in insurance.” The FSB also explained that cross-subsidization could allow BigTech firms to operate with lower margins and gain greater market share. Consequently, while BigTech firms could represent a source of increased competition for existing financial institutions, in some scenarios, their participation may not result in a more competitive market over the longer term. “A greater market share of BigTech may be associated with unchanged or higher concentration, along with a change in composition away from traditional players. A striking example is the mobile payments market in China, where two firms account for 94% of the overall market.”
Presently, the FSB’s report found that financial institutions do not rely very much on third-party data service providers (e.g. data provision, cloud storage and analytics, and physical connectivity) for core operations. According to the FSB report, however, following the trend in other industries, some analysts predict that reliance will increase going forward. However, regulators, policymakers and market participants should be vigilant that if high reliance were to emerge, along with a high degree of concentration among service providers, an operational failure, cyber incident, or insolvency could be very disruptive to multiple financial institutions. “Thus, while increased reliance on third-party providers specializing in cloud services may reduce operational risk at the individual firm level (idiosyncratic risk), it could also pose new risks and challenges for the financial system as a whole, particularly if risks are not appropriately managed at the firm level, and if the complexities and interconnectedness of third parties and their usage continue to grow.” The FSB’s 2017 report on FinTech to the G20 had made this conclusion, and it remains an important issue for regulators and policymakers to be attuned to.
The FSB’s monitoring of third-party data service providers is important not only for all technology companies and financial institutions, but should also be to regulators and legislators around the world. The Basel Committee on Banking Supervision (BCBS), the International Organization of Securities Commission (IOSCO), and the FSB’s Financial Innovation Network (FIN) are monitoring the implications of BigTech and FinTech on financial institutions and financial stability. FIN is analyzing the market for third-party services for financial institutions, including how they manage lock-in risk and cross- border issues. Additionally, FIN is looking into the activities of BigTech in finance, including cross-border activities.
Banks, in particular have long had competitive pressure from technology companies and have faced operation risk. However, regulators and legislators need to be more vigilant because, according to the FSB, these issues may become more acute for three reasons:
(i) The raft of new technologies introduced in the past few years, and the impetus provided by open banking could also change the dynamics of competition quickly.
(ii) Changes in business models may occur more quickly than in the past as BigTech companies actively and successfully push into traditional financial services.
(iii) The technology focus of both new providers and incumbents – particularly where they are closely integrated into firms’ operations – may entail a new dimension of operational risks.