Technology is touching every aspect of finance, transforming decades-old practices and redefining core tasks. In our Disruption in Financial Services series, we explore how new tools and technologies are changing the business of finance and reshaping how financial professionals do their jobs.
Disruption in Financial Services:
Big Tech’s Move into Finance Is Raising Regulatory Hackles
Given their dominance of digital spaces, it’s no surprise that Big Tech firms like Facebook are eyeing financial services – it’s a logical next step for them as finance becomes increasingly digital. With their enormous networks, huge data troves, and trusted platforms, adding payments solutions and other financial services is an obvious way to boost revenues and enhance their relationships with users. Regulators and politicians, however, have greeted Big Tech’s moves to offer financial services with suspicion. Although these organizations may offer benefits to the financial industry, there are significant risks associated with the growing role these newcomers are playing.
When David Marcus, the head of Facebook’s Libra digital currency unit, went to Washington to testify before the Senate Banking Committee in July, he was greeted by lawmakers and leaders almost uniformly hostile to Facebook’s currency plans.
Treasury Secretary Steven Mnuchin, speaking the day before the Senate hearings, described Facebook’s proposed Libra coin – a blockchain-based digital coin that would be backed with fiat currency and allow Facebook users to freely exchange funds across borders – as a “national security threat.”
US President Donald Trump expressed similar reservations about the coin over Twitter, and the Senate committee said it did not believe Facebook could or should be trusted to create a currency that could conceivably threaten the dominance of the US dollar and US monetary policy. Congress even proposed legislation to prohibit Facebook from operating Libra.
Lawmakers elsewhere have been similarly skeptical about Facebook’s plans. The G7, for example, announced it would plan joint regulatory action to ensure that Libra and other financial innovations by tech giants would not threaten the nations’ sovereignty and the stability of the global financial system.
Why are lawmakers so concerned about Big Tech moves into finance, and what does this mean for financial innovation?
The power of Big Tech
It’s important to distinguish between FinTech – the development of new technologies to deliver financial services and products more efficiently – and Big Tech doing finance, which means technology giants that already dominate some aspect of the market adding either traditional or innovative financial services to their offerings.
While FinTech poses its own risks, lawmakers agree that Big Tech doing finance is a far greater threat. The Bank for International Settlement (BIS) – which is responsible for promoting global monetary and financial stability – recently released a report on Big Tech and finance that shines a light on what regulators fear.
The report acknowledges that tech companies have the potential to make a significant positive contribution to financial services. Thanks to their network scale, platforms like Facebook, Alibaba, Google, PayPal, Baidu, and Vodafone M-Pesa can reach many millions of users. Their extensive technology infrastructure means that they can offer low-cost financial solutions to those users, potentially improving access to financial services among historically underserviced populations.
M-Pesa is a good example of this. The mobile payments platform, which works using the credit users have on their mobile phone accounts, allows its many African users to make electronic payments even though many do not have access to formal banking channels.
Another advantage of Big Tech is that these companies have access to enormous amounts of user data and can use this data to assess creditworthiness. While traditional banks must rely on a specific set of data that users provide, Big Tech companies have access to detailed transaction information and other relevant data points. China’s Ant Financial, for example, engages in extensive lending and BIS research shows that its Big Data approach to credit profiling outperforms credit bureau ratings and analysis based on traditional borrower characteristics.
Their network clout also gives Big Tech firms an advantage when it comes to collection. Platforms such as Alibaba or Amazon, for instance, have a virtual monopoly on third-party vendors’ ability to sell online. If these companies lent money to their vendors, they could ensure repayment by retaining a portion of the business transacted on their platforms. They therefore may need less collateral than traditional banks.
But this monopoly power over networks, data, and user livelihoods also makes the prospect of Big Tech involvement in finance dangerous. If a company with billions of users, like Facebook, were to offer a coin that operates like a traditional currency, it could very quickly become the most widely used means of exchange on earth. Facebook could then use its control over this coin to affect global monetary policy or to destroy rivals by denying them access.
Similarly, Amazon could quickly use its platform dominance to undercut banking rivals and then use its monopoly over financial services to extract rents and overwhelm potential competitors.
Big Tech data monopolies also hold the potential for harm. These companies have already engaged in data practices that have attracted the ire of users and regulators. With access to extensive personal financial data, they would hold even more power. While companies have always used what they know about customers to decide what prices to charge or what services to offer, Big Tech firms’ monopoly over a very wide range of data about users poses significant privacy and fair use challenges.
The BIS concludes that existing financial services regulation will not be up to the task of managing Big Tech’s entry into the finance business. Most existing regulation focuses on issues such as credit risk management, solvency, and liquidity risk, and does little to address the competition and data issues the changing environment creates.
Big Tech companies have the potential to strengthen financial systems. They may offer more accessible and affordable services to those who need them and may use their data processing power to lower systemic credit risk.
However, they also pose a significant threat to competition in the financial system. They could quickly build unassailable monopolies that could stifle competition, increase system fragility, and harm consumers. They also introduce a range of new data security and privacy concerns.
Regulators will need to tread carefully to ensure that new rules strike a balance between encouraging innovation and development and protecting consumers and the global financial system.
Intuition Know-How has a number of tutorials that are relevant to Big Tech and financial services. Click on any of the links below to view an intro video to the same tutorial.
- Bitcoin & Blockchain
- Blockchain Structure & Security
- Smart Contracts & Blockchain Applications
- Cryptocurrencies & Initial Coin Offerings (ICOs)
- Data Analytics
- Artificial Intelligence (AI)
- Transaction Banking – An Introduction
- Transaction Banking – Payments Services
- Financial Regulation – An Introduction