This is not in itself a novel situation. It’s an old saw in the banking fraternity that it’s only when the tide goes out we can see who’s not wearing bathers. Unpalatable as the aphorism may be, the literal truth is proved in every turn of the cycle.
Of the revolutionary mortgage originators who forever changed the Australian mortgage market in the 90s, using securitisation and low cost distribution models to tackle incumbent banks, none remain in their original forms.
Some – such as RAMS – failed. Others – such as Aussie Home Loans – were bought by an incumbent. Others radically changed their models to survive.
The challenge for the regulators is really analogous to the non-bank sector in general: credit risk shifts from the regulated sector to the unregulated or lightly-regulated sector. It’s a concern in Australia as property developers in particular look for alternative funders as regulators introduce measures to lower risk in the banks.
It’s a large and largely unmeasured problem in emerging markets, especially China. There’s also an element of the too-big-to-fail conundrum here.
With TBTF policy makers must grapple with the trade-off between systemic stability – which is easier to supervise with fewer, larger, highly-regulated institutions – and competition – which tends to be driven by attacker brands with less vested interest in the status quo but higher inherent riskiness.
So too with fintechs: the promise of innovation they bring needs to be balanced against the instability to the system.
Even in the hybrid model, where banks and fintechs work together – probably the most likely scenario – the issue of risk does not disappear.
One of the most promising areas for the consumer is the push to so-called ‘open banking’ where a lot more customer information and transactional data is made available to fintech. The promise comes from the consumer receiving more tailored, cheaper products.
The threat though is the security of that information is less certain – every extra party with access introduces new opportunities for illicit use.
Some things don’t change, no matter who offers a banking service. Confidentiality, integrity and availability of information remain paramount.
Again, in theory these challenges are surmountable but one of the cultural issues is start-ups, by their very nature, are antipathetic to the status quo. They don’t necessarily want to work with banks, they don’t respond well to regulation, they don’t want to be part of the system.
Regulators globally are trying to introduce ideas like the ‘sandbox’, the infantile analogy presumably encouraging the toddlers of the start-up community to use plastic models of the real world to get used to fitting in with the adults.
Well intentioned yes but regulators are hardly being bowled over by eager nippers. The Australian Securities and Investments Commission reported this week that just one fintech had opened the child-proof gate and entered its sand box in the six months since it was launched.
Meanwhile, regulators are also grappling about who should be supervising the adults as the FinTechs grow up. In a worrying repeat of what was happening in the run up to the financial crisis, US regulators can’t agree about who is responsible for different players in different markets.
As The Financial Times’ Lex column noted, “in the US, state regulators have historically set the guidelines that govern how non-bank financial services companies, such as money transmitters or online lenders, conduct business (but) rules can vary drastically”.
“The Office of the Comptroller of the Currency, which acts as federal regulator for some banks, wants to create a national charter for supervision,” Lex says.
“That could bring significant compliance and capital burdens for fintech groups. But it would allow them to lend, take deposits or pay cheques like a conventional bank. At present, they need a bank partner or state-by-state registration to do so.”
“Devising a unified framework to assess risks and compliance standards makes sense for primarily web-based groups, which by their nature often defy geographic supervision.”
This all raises the issue of regulatory arbitrage, where business domiciles and business models are shaped according to the easiest or most flexible regulatory regimes. Smart from a business sense but potentially corrosive of systemic security.
As the FSB noted in its report: “At this stage, the small size of FinTech credit relative to credit extended by traditional intermediaries limits the direct impact on financial stability across major jurisdictions”.
“However, a significantly larger share of FinTech-facilitated credit in the financial system could present a mix of financial stability benefits and risks in the future… among the risks are a potential deterioration of lending standards, increased pro-cyclicality of credit provision, and a disorderly impact on traditional banks, for example through revenue erosion or additional risk-taking.”
Like the non-bank challenge more broadly, “FinTech credit also may pose challenges for regulators in relation to the regulatory perimeter and monitoring of credit activity,” FSB says.
FInTech may not have reached the scale its boosters predicted over the last few years but it has reached sufficient scale for regulators and policy maker to pay serious attention.
Andrew Cornell is managing editor at bluenotes