Part 2: Big Tech in finance, BIS on the opportunity and risk
A summary of the BIS position on big techs entrée into finance
By Ingrid Abraham, Eternic
On June 23, 2019, the Bank for International Settlements (BIS) released a special chapter focused on big techs’ entry into finance preceding their full Annual Economic Report 2019. The chapter is an analysis of the potential impact of big techs on the financial industry through the eyes of the BIS, followed by the presentation of a regulatory framework and policy recommendations around big tech participation. We see the BIS’s findings and recommendations as highly relevant and significant in the context of their position in coordination and advisory of central banks. So, in this report, we summarise the 21-page Chapter III. Big tech in finance: opportunities and risks to provide the key takeaways.
“Big techs” (large technology firms, such as Google, Facebook, Alibaba, Tencent, and Amazon) are increasingly pushing into financial services. This began with payment services on their platforms, which were underpinned by traditional partnerships with banks. Recent developments have them now making “deep incursions” into money market funds, insurance, credit provisioning, and potentially cross-border payments (eg Facebook Libra). The scale, force, resolve, and means, with which these players are entering the industry cannot be ignored.
The promise of big tech
The entry of big techs into the financial services industry holds great promise for disruption and financial inclusion. This promise is a result of their “DNA” (Data analytics, Network externalities, and interwoven Activities).
Big techs hold vast troves of data on their customers, far beyond what banks can see, enabling better risk analysis, which in turn enables them to offer credit on more competitive terms. Additionally, this data greatly reduces the cost of screening, which allows big techs to offer financial services to customers that would otherwise remain unbanked. In turn, operating in financial services only adds more data to big techs’ repositories, feeding back into their other businesses.
“Network externalities” refers to the manner in which as the number of users on one side of a platform (e.g. buyers on an e-commerce platform) increases the benefit of participating on the other side (e.g. a seller). The number of users big techs are able to access from their pre-existing platform is a huge advantage in this regard, and furthermore building more externalities through financial services will offer similar benefits toward their other services.
Pre-existing activities of the firms provide infrastructure to deploy commoditisable services at near-zero marginal costs, as well as yielding data to support these new services.
Or is it a curse?
The very same features that make big techs competitive, however, also hold great potential for abuse. Once an ecosystem of services is established and becomes dominant, it becomes difficult to impossible for potential rivals to compete. This puts the stewards of the dominant ecosystem in a privileged position, which is ripe for abuse with anticompetitive practices.
Other risks include anticompetitive use of data, with dominant players engaging in price discrimination and extracting rents. They may not use data merely to assess creditworthiness, but also to determine the highest rates and premiums that customers would be willing to pay. Personal data could also be used to exclude high-risk groups, undoing the gains potentially made in financial inclusion. Rich personal data could be used in conjunction with integration into customers lives to influence their preferences and sentiments perhaps without the customers themselves being aware.
“Drawing on their unique combination of vast amounts of data, the power of networks and their diversified activities (their “DNA”), these companies have the potential to make further thrusts into financial services and bring about large efficiency gains. They represent a wake-up call for banks, which need to raise their game in order to compete effectively. But at the same time, the presence of big techs is giving rise to major policy issues.”
– The Year in Review: Short-term to Medium-term Outlook, Annual Economic Report 2019: Editorial, Bank of International Settlements
Same activity, same regulation?
The key starting point for policy around big techs in finance is “same activity, same regulation”. A well-functioning financial system is critical public infrastructure, and so the soundness of institutions central to that system is a matter of public interest. On these grounds, banks are subject to regulation of their activities, strict licensing requirements, as well as KYC (know your customer) and AML (anti-money laundering) regulations. Where big techs’ activities are effectively identical to those of banks, they should be subject to the same rules.
“Same activity, same regulation” is a good starting point, but it’s just that, a starting point. What makes big techs a threat to traditional financial institutions is precisely the differences they bring to the table. Big techs’ entry into financial services can cause rapid structural change that outpaces existing regulations.
For example, in China, big techs have sizeable MMF (money market fund) businesses that play a key role in interbank funding, and mainly invest in unsecured bank deposits and interbank loans with a maturity of less than 30 days. This is concerning because payment links become systemic when banks are reliant on payment firms for funding, and a risk is introduced that a redemption shock to the MMF platforms would be quickly transmitted to the banking system by deposit withdrawals. Authorities in China have addressed this by introducing, and requiring settlement through, a common public platform for all payment firms, and rules on redemptions and the use of customer balances.
The differences brought by big techs can be yet more divergent, however. Consider the interplay between policy objectives of competition and financial stability, traditionally there have been two schools of thought here. One states that the entry of new firms into the banking sector is desirable, as it fosters competition. The other states that it is undesirable, as it undermines financial stability. Incumbents are more profitable and therefore able to build a strong equity base, have a higher franchise value, and therefore typically act more prudently. Big techs turn this on its head, as a result of the DNA feedback loop. Big techs can leverage their control of key digital platforms and existing network externalities to establish and entrench their market power in a dominant position, as such the new entry of big techs could in fact work against competition.
Data Use and Ownership
Preventing big techs’ abuse of data, both in terms of anticompetitivity and consumer protection requires reforms around data ownership, use, and sharing. Traditionally, the ownership of data is not clearly assigned, and so it is de-facto owned by the big techs that gather it. Assigning data rights instead to customers can go some way toward this, as it would allow customers to move their data between service providers, eliminating the data monopolies. This can be combined with limitations on the use and sharing of data, to protect the privacy of customers, and prevent data use running counter to policy goals.
The new interplays brought about around data use and market entry can be modeled and displayed on a regulatory compass [Fig. 1], where the north-south axis represents the promotion/restriction of market entry, and the east-west axis represents limiting the use of data versus endowing data property rights to customers. It is worth noting that policy choices on opposite sides of the compass are not necessarily mutually exclusive. For example, the Indian Unified Payments Interface and the Indian e-commerce law work in tandem, and two aspects of one piece of legislation can be seen on opposite sides of the compass in the case of the GDPR.
Call for Coordination
The report ends by highlighting the importance of coordination between policymakers, both on a global level, and among different authorities within the same jurisdiction, to prevent differences in focus leading to conflicting actions. This becomes more crucial as financial services offered by these players expand cross borders and regulatory frameworks.
“The objective is to ensure that one can reap the potentially large benefits that such technological innovations can bring about while managing the potential risks.”
– The Year in Review: Policy Considerations, Annual Economic Report 2019: Editorial, Bank of International Settlements
In summary, the Bank for International Settlements sees big techs’ entry into finance as a promising potential source of efficiency gains and improvements to financial inclusion, but this is coupled with a warning of the risks of data-abuse and anticompetitivity that might be posed in tandem. The promise is seen in big techs’ abilities to leverage their existing data and network externalities, but this is also seen as the potential source of abuse.
To manage this, the BIS recommends carefully considered policy around market entry for big techs, and use and ownership of data, with attention paid to the differences between big techs and traditional financial institutions, they end by underlining the importance of policy coordination in this area, both on a global level, and between different authorities in the same jurisdiction. In doing so, a level playing field can be created where the innovations of smaller players can still have an impact.
To learn more about BIS positions related to financial technology developments, such as blockchain (DLT) and tokenization, read Part 1: Cryptocurrency, BIS looks beyond the hype.
Ingrid Abraham is a Business Analyst for Eternic. To learn more about Eternic and our solution for global payments and settlement, visit: www.eternic.io