Alternative finance services ruffle a few feathers

For those interested in the huge disruption underway in financial services, CB Insights’ latest breakdown of Amazon’s financial services campaign is eye-opening. As much for fintech startups as traditional financial institutions.

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First up, Amazon has given no signs it wants to be an actual bank. Why would it? Banks are systemically important institutions and so are very heavily regulated – justifiably – to protect depositors and the stability of the financial system.

“While touted as a fundamental break from traditional finance, the crypto financial system turns out to be susceptible to the same risks that are all too familiar from traditional finance.” – Lael Brainard

That prudential oversight though comes with costs – both financial and in terms of pace of innovation and product delivery. And Amazon doesn’t aim to make money from banking – in CB Insights’ cogent analysis the point is expanding its market ecosystem.

“In aggregate, [Amazon’s] product development and investment decisions reveal [it] isn’t building a traditional bank that serves everyone. Instead, Amazon has taken the core components of a modern banking experience and tweaked them to suit Amazon customers (both merchants and consumers),” CB Insights says.

“In a sense, Amazon is building a bank for itself — and that may be an even more compelling development than the company launching a deposit-holding bank.”

What Amazon is doing is of an unprecedented scale but in essence is not that revolutionary. For decades now the core insight into the future of banking has been along the lines of “banking is essential for a modern economy. Banks are not.”

Amazon doesn’t have to be a bank to fulfil its strategic ambition but for banks it is still a competitive threat. Nor does its strategy allow banking regulators to be hands off.

Indeed, as the internet (Webs 1, 2 and 3), Cloud and now metaverse evolve, it is incumbent upon regulators to understand the implications for and threats posed to the global economy.

Happily, they have been seeking this understanding.

Policy blindspot

The paramount issues are stability of the financial system, controls over government monetary and fiscal policies and protection of depositors and other stakeholders.

In a new paper, “Big Tech Interdependencies – a key policy blindspot”, global regulatory authority the Bank for International Settlements (BIS) noted “big tech interdependencies come with specific risks, in particular to operational resilience, and may require the development of specific entity-based rules for big tech operations in the financial sector.”

The BIS noted authorities are searching for interim solutions to counter potential financial stability risks. The nature of that crucial interdependence between big techs and financial services is profound.

“Big tech business models are characterised by strong internal and external interdependencies,” the BIS said. “Intragroup dependencies arise from the common use by big tech entities of a general payment infrastructure, technological platforms and applications; and from sharing data and insights derived from those data across the services they provide.

“External interconnections arise from partnerships of big tech entities with financial institutions to provide financial services. The financial services industry and regional big techs have come to heavily rely on technological services provided by global big techs, such as data analytics and cloud computing.”

Of course, these interdependencies don’t just involve big tech and banks. Fintechs, startups and the whole concept of “decentralised finance” – DeFi – involve new interdependencies and while not all are systemically significant, many could be.

For example, concerns have been raised about the possibility of national, fiat currencies being replaced by cryptocurrencies which would impact on the ability of governments to raise and collect tax revenue.

Moreover, to the extent central banks use the price of money via official cash rates to manage interest rates, the existence of DeFi currencies and assets potentially blunts and degrades the implementation of monetary policy.

Serious vulnerabilities

US Federal Reserve governor Lael Brainard addressed this in a speech titled, “Crypto-assets and decentralized finance through a financial stability lens.” Her opening remarks implicitly addressed the challenge of interdependency.

“Recent volatility has exposed serious vulnerabilities in the crypto financial system,” she said.

“While touted as a fundamental break from traditional finance, the crypto financial system turns out to be susceptible to the same risks that are all too familiar from traditional finance, such as leverage, settlement, opacity, and maturity and liquidity transformation. As we work to future-proof our financial stability agenda, it is important to ensure the regulatory perimeter encompasses crypto finance.”

Interestingly, few but the most libertarian and iconoclastic new financiers – who often turn out to have more in common with chancers than actual revolutionaries – dispute the bank or financial intermediary of the future must have much in common, in essence, with their traditional - TradFi - antecedents.

QED Investors’ Yusuf Ozdalga provided a particularly insightful take on this in an article for the altfi newsletter titled What will the Bank of the Metaverse look like?

Ozdalga ran through the new realms a Bank of the Metaverse (BofM) would have to enter, such as “foreign” exchange of cryptocurrencies with appropriate risk spreads and the ability to collaterise crypto assets. But there are some attributes even a BofM would have to have which are common with TradFi.

“In no particular order of importance, a successful BofM would have to be able to move money, store money, lend money and invest money,” he wrote.

“To do all these things it would need to have the trust of the consumers that use it, so it would need a strong brand. It would also need regulatory legitimacy, in the long run, hence it would need to be on the right side of the law, so to speak.”

That in essence, is the challenge. In order to challenge the established order it is necessary to become part of it.

A fact of life

It’s tempting to quote Mephistopheles to Faustus on this where he explains the distinction between Hell being a place or a state of being – there is no escaping regulation. But maybe better to paraphrase Cannonball Adderley on hipness: banking regulation is “not a state of mind, it's a fact of life”.

More prosaically the US Fed’s Brainard laid it out bluntly.

“If past innovation cycles are any guide, in order for distributed ledgers, smart contracts, programmability and digital assets to fulfill their potential to bring competition, efficiency and speed, it will be essential to address the basic risks that beset all forms of finance,” she said.

“These risks include runs, fire sales, deleveraging, interconnectedness and contagion, along with fraud, manipulation and evasion. In addition, it is important to be on the lookout for the possibility of new forms of risks, since many of the technological innovations underpinning the crypto ecosystem are relatively novel.”

Whether its Amazon or Google or Meta or Netflix or Tencent or any other big tech looking to participate in the borrowing and lending or transferring of wealth, the regulatory response is likely to be if it walks like a bank, flaps like a bank, quacks like a bank and paddles in the big pond, it’s going to be regulated like a bank.

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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