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Fintech regulation: how to achieve a level playing field

BIS |  Fernando Restoy | Feb 2021

level playing field - Fintech regulation: how to achieve a level playing field

The disruption created by technological progress in the market for financial services arises from (i) an expanded set of services offered to consumers; (ii) the processes and distributional channels followed by firms in offering those services; and (iii) the arrival of new (technological) suppliers of those services.

These developments are bound to generate profound changes in the market structure, as non-bank fintech2 players are now becoming very active in offering services that in the past were predominantly offered by banks.3 Their presence in the payment service area is already quite significant. However, they are also gaining weight in the provision of wealth management services, the sale of insurance products and loan underwriting. Those services are increasingly being provided within established technology platforms run by large companies (big techs) , where a variety of financial and non-financial products are offered by a plurality of suppliers that may or may not be linked to the platform owner (Frost et al (2019)).

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A growing number of products and players increases supply, lowers the cost of financial services and encourages financial inclusion. However, it may also generate risks for the stability and adequate functioning of the financial system.4

So far, despite remarkable growth in the recent past, the scale of fintechs’ operations is generally limited relative to the overall size of the financial services market. Yet, in some jurisdictions, specific firms (Ant Group in China or Quicken Loans in the United States)5 have already gained leading market positions. Given significant economies of scale, data superiority and the large scope for network externalities, big techs could very well eventually achieve market dominance (De la Mano and Padilla (2018)). There is an ongoing worldwide discussion on what the policy approach should be with respect to those market dynamics. Within that discussion, a relevant question is whether the growth potential of fintech and big tech companies could be, in part, the consequence of lighter regulatory requirements compared with those for incumbent players such as commercial banks. This argument could be based on the observation that financial institutions have specific (entity-based) obligations, such as those related to prudential requirements, which do not apply to other competitors in specific markets such as payment services, wealth management or credit underwriting. Regulation specific to banks entail higher compliance costs and can therefore put them at a competitive disadvantage.

The existence of regulatory distortions could violate the principle of good regulation, which calls for any public intervention to limit market impact to the minimum required to achieve relevant objectives (OECD (2005)). Unwarranted discrepancies between regulatory requirements for different types of market player could also disrupt banks’ activities as intermediaries, thus posing risks to systemic stability (FSB (2019)). Moreover, distorted market developments leading to big tech dominance could threaten competition in the financial services market (BIS (2019)), possibly affecting consumer protection and market integrity.

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The banking industry has frequently stressed (eg IIF (2017)) that regulation could promote a level playing field through the adoption of an activity-based approach, as opposed to an entity-based one. That would mean imposing similar requirements upon all active players in a particular market segment, regardless of the legal nature or other characteristics of those entities and, in particular, whether or not they hold a banking licence.

However, entity-based prudential rules for banks are based on specific policy objectives – such as financial stability – that are not subordinated to the achievement of a perfectly competitive landscape. Therefore, level playing field considerations cannot be enough to support a radical overhaul of the current regulatory framework.

At the same time, it could be argued that fintechs – or, more likely, big techs – can also generate concrete threats to relevant policy objectives such as market integrity and stability or fair competition. If that were the case, the introduction of specific rules for those entities, as they exist for banks, would not only contribute to primary policy goals but would also help promote a level playing field.

This paper discusses how level playing field considerations should affect the definition of the regulatory framework following the emergence of fintechs and big techs. It also analyses the extent to which activity-based and entity-based regulations could help achieve socially desirable objectives.

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The structure of the rest of the paper is as follows. Section 2 outlines the current regulatory framework for banks and fintech players. Section 3 sets out some considerations that may help in assessing the current framework and the scope for a move towards more activity-based regulation. Section 4 assesses possible adjustments to specific regulations that could help achieve a better balance across different policy objectives. Section 5 concludes.

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Download 27 page PDF report on 'Fintech Regulation: How to Achieve a Level Playing Field'--> here



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