How do FinTechs face up to regulation?
FinTech companies are known for their exciting use of new technology and innovations to create products that give us a glimpse into the future of personal banking. One of the greatest assets for FinTechs is their agility and ability to create banking products that target pain points of traditional banking customers. A major question to ask is: how does regulation impact this burgeoning and valuable industry?
The post-financial-crisis regulatory framework has been targeted at making the financial system more stable and secure. Banks now hold more capital, must ring fence their investment arms from their retail arms, and must undergo stress tests. While these changes did, and still do, provide much needed protection, some regulatory initiatives have stifled innovation. Speaking in a video on leadership, technology and regulation, Lara Wallis, Credit Suisse’s chief compliance and regulatory affairs officer, says excessive regulation has stifled innovation in the banking industry and has slowed down innovative decision-making.
Regulation can aid FinTechs
While there is an argument for regulatory efforts restricting innovation, in some cases regulation has been welcomed by financial players looking to challenge the status quo. Zopa, the online peer-to-peer lender, has actively campaigned for regulation. In supporting the effort to create a regulatory framework for the peer-to-peer lending industry, Zopa has been awarded full FCA authorisation and opened an avenue to obtain a full banking licence. This piece of regulation will now allow Zopa to grow its offerings extensively, the company will now be able to apply to become an ISA manager (and offer Innovative Finance ISAs), and a banking licence will enable the company to expand into the fields of spending, borrowings, saving or investing.
Initiatives like the regulating of the P2P lending industry can support new firm creation and expansion by offering a clear framework to work towards, while ensuring that consumers have some level of protection. Additionally, regulation can boost consumer confidence in newly created and unknown FinTechs by adding an extra layer of legitimacy for their products and services.
Meanwhile, streamlining startup business regulations and reducing the time and cost required for firm registration are all found to increase the number of new businesses and jobs created. Simplified entry regulations may also to lead to the shifting of informal firms to the formal economy. Countries that improve their overall business regulations by making markets fairer and more competitive experience higher rates of business creation.
What all this points to is that regulatory reform has the potential to support and drive growth for the UK FinTech industry. And, in some cases, regulation can even be the catalyst for FinTech opportunity.
On the immediate horizon, major regulatory changes will come through the revised Payment Services Directive (PSD2). The British Fintech industry must start compliance with PSD2 requirements on the 13th of January 2018 – midway through its EU exit negotiations. PSD2 aims to issue a substantial shift in terms of the ability of third parties to access customer financial information. The aim is to drive greater competition that will grow and develop value-added services for private and commercial customers. The good news for those worried by the impact of Brexit on the implementation of PSD2 is that the directive follows UK government objectives and regulatory goals around Open Banking. Diverging from PSD2 implementations would directly affect the growth of Britain’s expanding Fintech sector due to PSD2’s objective of opening up banking via the use of APIs. The use of APIs is a fundamental path to the growth of the FinTech industry as they allow for seamless and secure access to customer’s financial data as a trusted third party.
And banks are already starting to embrace the spirit of PSD2. Spanish bank BBVA has recently decided to make its APIs commercially available by unveiling the BBVA API Market. This will – it is hoped – promote companies, startups and developers by allowing them to build new products and services by getting access to and integrating customer’s data into their applications, after receiving permission from each customer.
The success of proactive regulatory initiatives like PSD2 is measured through their value – how much their implementation will potentially add to the economy and society – and their efficiency. Efficiency refers to the complexity and cost of regulatory processes – the efficiency of achieving regulatory goals such as the fewest number of procedures needed to obtain financial information from banks via API, or reducing the time taken to grant banking licences.
When regulation gets in the way
While some regulation has the potential to introduce opportunities for FinTech firms, not all regulation will help Fintech firms grow. Here are four ways in which regulation can potentially harm expanding Fintech firms:
1. Compliance with some newly introduced regulations can exert a disproportionately large weight on new FinTechs because the fixed costs of adhering to rules can be spread out over more revenue in large firms than in small ones.
2. Domestic regulations could decrease the ability of FinTechs to compete in foreign markets where regulation is less onerous. If open banking initiatives were not undertaken in UK, for example, complying with UK regulations could increase the cost of development through tailoring products to different regions.
3. Changes to regulation create uncertainty, which could put FinTechs off from investing and hiring. Because few business owners can predict the scope or impact of new regulations, they can delay investing in development or adding staff as they wait to see the impact of new regulation.
4. New regulations often have unintended consequences. Unforeseen tax burdens and heavy compliance costs could stall small FinTechs.
One thing remains clear – the modern banking landscape is changing at an accelerating rate, and FinTechs have the potential to reshape banking as we know it. Changes driven by regulation can bring an even greater complexity, but FinTechs must not only comply, but find opportunities to use – and even shape – regulation to their best advantage.