Tuesday Team Talks №12
The Complexities of Fintech Regulation
Advances in financial technologies have always been met with stringent regulatory practices. Innovations in the financial sector often pose a challenge for regulators, as laws that were written several decades ago are difficult to apply towards newer technologies. As lawmakers slowly understand new paradigms, it may lead to uncertain times of underregulation (where risky and fraudulent practices leave constituents unprotected) or overregulation (where ultimately the innovators are held back).
Lessons from the East
We can learn a lot by watching China. The desperate need for alternative financing has led to an explosive growth in this market; and we even see local governments utilize shadow banking loans to make up shortfalls. Shadow banking in China makes up 10 Trillion USD, where 10% consists of P2P Lending. Unfortunately, this growth has been followed by mass reports of scams across the nation, and has alerted authorities globally on the dangers that can exist in the alternative lending industry if underregulated.
As a temporary solution, the Interim Measures of Administration Activities of Online Lending Information Intermediaries was put in place to remove bad actors; capping interest rates to minimize predatory lending activities and closing down illegal operators.
With the significant increase in fraudulent cases appearing globally, other jurisdictions have since enforced stricter regulations regarding internet financing to best protect their constituents.
What do regulators look at?
When involved in fraudulent practices, participants may be affected in the following ways:
- Borrowers may face predatory lending practices such as deceptively high interest rates and unfair repayment schedules;
- Borrowers may not actually get the funding they need, when they need it;
- Lenders’ funds may not be invested as stipulated; with funds not going towards the approved credit risk levels;
- Lenders would not realize the company is losing money, if the operation continues to receive cash injections via new investors;
- And when the company does inevitably close down, lenders lose money.
To combat this, regulators typically investigate how the company operates, and asks some of the following questions:
- Does the company directly handle any of the funds?
- Does the company make any decisions on behalf of the participants?
- Does the company give any advice or preference to specific lenders or borrowers?
- Does the company provide in-house credit scoring services?
- Are the lenders involved non-accredited individuals?
So, if the answer to any of these is ‘Yes’, then such businesses would require a license to operate.
Shen Wei, Dean and Professor of Law at Shangdong University Law School, has stated that the main purpose of regulations in China is to restrict P2P lending platforms to be ‘information intermediaries’ while matching borrowers and investors to protect citizens. Under such regulations, the platforms are not allowed to centralize funds from investors or provide any credit services, which most platforms were doing when they first started.
What are the challenges for an aspiring lending company?
So given that there is a clear positive community benefit in adhering to regulatory requirements, let’s play devil’s advocate for a moment. What are the challenges for companies that have answered “yes” to the above questions, yet want to operate within multiple jurisdictions?
- Different jurisdictions would mean different licenses are needed. Licenses cost time (>6 months), money (>1M SGD in administrative and legal fees), and often require extensive governmental connections to succeed.
- Different licenses also may mean different business models — for instance, lending in Muslim countries like Indonesia requires a different system than the Singapore operation. Localization requirements are inevitable, however drastic changes of business models to fit different jurisdictions would require extensive R&D (research & development).
This means that for any companies engaging in such endeavours, there are huge legal obstacles that prevent massive worldwide scaling within a short amount of time; even with institutional backing — because even if you partner with multiple licensed companies across the world, there inevitably would come a jurisdiction would require business model changes.
Additionally, even if you did not answer “Yes” to any of those questions, you would still need to follow regulations in order to access the information you need to adequately carry out your business. For instance, in Singapore, it is necessary to be a registered financial institution to have access to personal credit score details. The process to get such a license, would take 4–6 months, and would require ~50 initial successful and controlled loans with scores from a reputable licensed provider.
Most importantly, dealing with regulation concerns is taxing on the entire organization, and affects development speeds as business processes and workflows may shift overnight in order to comply with newly discovered standards.
So how does an alternative financing company succeed?
The clear answer for me is to become a true marketplace, which would require minimal licensing and potentially no licensing in some jurisdictions; as the platform would be inherently more secure, fair, and transparent to the participants. This means never directly handling any of the funds, not providing advice or preference to specific lenders or borrowers, not providing in-house credit scoring services, enabling borrowers to have the ultimate decision on who to borrow their money from, and only allowing accredited investors to be lenders.
With these principles in mind, we are able to create one business model, process, and workflow that works across different jurisdictions and thus immensely scalable. Adopting the blockchain and other decentralized ledger technologies also plays a role in unlocking trust in such a ecosystem, as all participants are privy to the truth behind the machine.
Hopefully, what this amounts to is faster growth of the small business sector — a major driver in any economy — through greater employment, innovation, and ultimately driving income equality.
About Conrad Lin, Co-Founder and CMO of FintruX: Conrad Lin is a young and dynamic entrepreneur, public speaker, and influencer with a background in neuroscience and psychology from the University of Toronto. He is a proven expert in social media growth hacking, inbound marketing, and marketing strategy — with a specialty in DLT (distributed ledger technologies). In 2018, Conrad spearheaded the marketing efforts to successfully raise $25M USD for his startup FintruX Network.
About us: FintruX Network is the global P2P lending ecosystem powered by blockchain and no-code development. FintruX facilitates marketplace lending in a true peer-to-peer network to ease the cash-flow issues of SMEs that typically face challenges getting loan financing, such as startup companies.
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