A new report from the Bank for International Settlements (BIS) claims that fintech can improve both financial stability and access to services, but requires significant changes in regulation in order to flourish.
This sector has exploded in recent years, with banks, regulators and VCs throwing their weight (and money) behind a huge range of start-ups. The BIS has waded into the debate with a well-researched paper assessing the potential impact of fintech on the financial services industry.
Despite financial services readily adopting technological innovations which have transformed other industries (such as the internet and automation technologies), the cost of managing assets has stayed almost unchanged in 130 years.
In a working paper entitled ‘The Fintech Opportunity’, the BIS explores why operating costs in finance remains so surprisingly high, and how regulation creates barriers to further innovation which could bring down costs.
The fintech opportunity
While there is substantial analysis about how regulation has impacted the financial services sector over the past decade, we think the most interesting section of this report relates to how a new breed of fintech companies can be nurtured.
Fintech startups seek to disrupt the status quo with innovative solutions to new and existing problems. The paper argues that regulators could take advantage of the fintech movement to achieve some of the goals that have so far remained elusive.
There are huge opportunities to be gained from this. The key advantage of startups is that they are not held back by existing systems and are willing to make risky choices. In banking, for instance, successive mergers have left many large banks with layers of legacy technologies that are, at best, partly integrated.
The provides the opportunity for fintechs to build the right systems from the start. Moreover, they share a culture of efficient operational design that many incumbents do not have.
There are, however, many challenges to overcome. This includes the ability to correctly forecast the evolution of the industry, encouragement or interest from potential customers that can result in viable, widespread adoption, preventing a new company being swallowed up by incumbents and making sure that the new system does not create new inefficiencies or suffer from the flaws of incumbents.
Four guiding principles
The onus is on regulators to provide the right environment and incentives if they want fintechs to flourish.
The paper suggests four guidelines for regulators to consider:
- Encourage entry and beware of a narrow approach to level-playing-field
- Promote low leverage from the beginning
- Keep incumbents in check with high equity ratios and be mindful of acquisition
- Perfect is the enemy of good
These guidelines are discussed at length by the author, and we encourage you to read about them here.
But what’s interesting is that the guidelines do not require regulators to forecast which technology will succeed or which services should be unbundled, nor require regulators to force top-down structural changes onto powerful incumbents.
The reality is that no one knows when the ‘Uber’ of wholesale financial services will emerge or what it will look like. What we do know, however, is that a combination of restrictive regulations and powerful incumbents can certainly prevent entry.
While there have been promising fintech companies emerging across a range of sectors, creating and maintaining an environment that fosters creativity and innovation, and balancing this with systemic risk controls, is crucial for both financial stability and access to services.
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