Neither Google, Samsung, nor Amazon are banks. Yet they all provide financial services, specifically in the areas of payments and money transfers. Even Facebook is making plans for its own currency, Libra. Financial regulation needs to respond to the challenges of a changing landscape: fintech startups are paving the way for digital ecosystems while the Big Tech are taking steps to penetrate what has traditionally been banking territory.
What should the regulatory response to the new climate be? It should be aligned to the inherent systemic risks as well as with data protection, trans-border and competitive regulation. This is the conclusion published in a report prepared by BBVA’s Digital Regulation group and published by the the University of Deusto’s ‘Bulletin of Economic Studies.’
A few years ago, regulators were already aware that fintech startups were crashing the financial scene and responded with an approach that “sought to guarantee adequate control over new risks, while also promoting competition and innovation.” Now they must evolve “towards a holistic response that guarantees a secure and stable financial sector that continues to be open to competition.” BBVA’s Head of Digital Regulation, Pablo Urbiola, who co-authored the report with Lucía Pacheco explains that “the post-pandemic economy will be more digital than ever, and so the regulatory response will be as important as ever.”
The post-pandemic economy will be more digital than ever, and so the regulatory response will be as important as ever
The authors explain that “it is likely that the magnitude and nature of the risks will change, as will the nature and degree of competition in the financial sector” with the second wave of competition characterized by the integration of financial services in the Big Tech's digital ecosystems.
Data, the big advantage
As the BBVA report points out, Big Tech companies can reach massive scale very quickly in new lines of business because their digital ecosystems already have millions of active users. Second, they have a powerful capacity to create and control adjacent markets. Third, they have access to large amounts of data and are unmatched in their ability to analyze it.
The BBVA study warns that financial services are not an exception, and these services could put Big Tech in a position to further strengthen their ecosystems, collect additional data, and increase the engagement of their customer base. The report also suggests that the regulatory environment might even act as a catalyst for Big Tech's forays into financial services. Such is the case with open banking frameworks, which allow new competitors to have access to banking’s customer data, as well as initiating payments in their name.
A large part of the activities of these companies would be covered by regulations established to address the fintech evolution, such as standards covering payments and e-money. In other areas, however, such as with crypto assets, there are regulatory loopholes. Nevertheless, Urbiola and Pacheco stress that the main risk arises when these activities are conducted on a much larger scale than initially anticipated, not to be underestimated in the case of Big Tech. Financial stability risks could therefore arise if the Big Tech secure a dominant position in segments like payments and loans, transforming themselves into systemic players in the delivery of services that are critical to the economy.
Moreover, regulators have encouraged making the financial sector open to new competitors and lowering the barriers to entry. Regulations about shared access to and use of customer data are particularly relevant to this discussion, the report maintains. In the EU, the PSD2 directive requires banks to standardize open access to their payment data, in real time and without monetary compensation, but there is no equivalent requirement for data from organizations outside the sphere of traditional banking.
This creates a data imbalance: financial companies are obliged to provide easy, standard access to payment data, but the data in other sectors is not available on like-for-like terms. This places the financial sector at a disadvantage when providing digital financial services, and bolsters Big Tech's data advantage. The Financial Stability Board recently stressed this imbalance and the potential implications for financial stability as it supports a greater concentration of financial service suppliers, which could rapidly change the competitive dynamic.
Luckily, the primary regulatory bodies, both globally and in Europe, have put this high on the agenda, as is demonstrated by the European Commission's attention to the topic in their recent consultation document defining their new digital finance strategy
Three ways to regulate Big Tech in digital finance
BBVA foresees three main areas of activity that regulators and supervisors should adopt in order to begin crafting a suitable response to the potential financial stability risks associated with Big Tech’s emergence in finance:
1. Revise the specific regulatory frameworks for each activity. First, to ensure that the licensing and supervisory frameworks established for activities such as e-money and non-bank loans are sufficient to contain the risks associated with large-scale supply. Authorities should also put consumer protection, fraud, and cyber attacks on their agenda. The interest of some Big Techs in the area of crypto-assets — potentially launching their own currencies, as is the case with Facebook — should be noted. Some institutions are already working on these issues, both in the EU and farther afield.
2. Promote innovation with a level-playing field. The principle, “the same activity, with the same risks, should have the same regulation” should be applied. To this end, the approach to regulation needs to shift from being institution-based to activity-based. Similarly, regulation must ensure fair access not only to data, but also to the digital platforms and technical infrastructure needed to deliver financial services.
3. Address the systemic magnitude of Big Tech. Regulatory authorities should weigh whether a response to the financial risks associated with the systemic potential of Big Tech is required. Additionally, authorities should assess if the new Big Tech services, to the degree that they become critical to the global financial system, fall subject to existing standards for the infrastructure deemed critical for financial markets.
As the report lays out, defining a suitable regulatory response to the appearance of Big Tech in the financial sector is one of the greatest public policy challenges facing the authorities. “Luckily, the primary regulatory bodies, both globally and in Europe, have put this high on the agenda, as is demonstrated by the European Commission's attention to the topic in their recent consultation document defining their new digital finance strategy,” Lucía Pacheco concludes.