Financial innovation is hog-tied to the past. Regulators are conditioned to view innovation through the lens of current services and rules, rather than to consider it afresh. New services are sidelined into policy silos, where they are 'shoe-horned' into existing rules. Regulators seem reluctant to concede that new services reveal shortcomings in existing models and or that they should drive a change in regulatory approach.
For example, Mark Carney, Governor of the Bank of England, has said that the Bank of England takes "consistent approaches to activities that give rise to the same risks, regardless of whether those are undertaken by "old regulated" or "new FinTech" firms." This is because, he claims, "following a raft of post-crisis reforms, the Bank’s regulatory frameworks are now fit for purpose."
Whose purpose?
Do banks adequately serve their customers?
Do they operate within the law?
Do banks adequately serve their customers?
Do they operate within the law?
The UK's banks are a constant source of scandal, and frequently incur vast fines and compensation bills for misconduct. New problems emerge constantly, and on a giant scale. Their role in Russian money laundering is perhaps the latest example. Many of the post-crisis reforms are also yet to take effect in the UK. The critical "ring-fencing" of retail and investment or 'casino' banking, for example, has been watered-down and won't take effect until 2019 - more than a decade after the financial crisis began - while Donald Trump is busy unwinding such reforms in the US. Whether such national initiatives will even be effective in a global system is still unclear.
Despite its name, "FinTech" represents not only the application of technology but also (usually) a customer-oriented commitment to either improve existing financial services or create alternatives that are aligned with customers' requirements. Yet the Bank of England approaches such innovation in the banking sector by asking:
- Which FinTech activities constitute traditional banking activities by another name and should be regulated as such? Systemic risks associated with credit intermediation including maturity transformation, leverage and liquidity mismatch should be regulated consistently regardless of the delivery mechanism.
- How could developments change the safety and soundness of existing regulated firms?
- How could developments change potential macroeconomic and macrofinancial dynamics including disruptions to systemically important markets?
- What could be the implications for the level of cyber and operational risks faced by regulated firms and the financial system as a whole?
This is not just a UK phenomenon. When it comes to assessing the application of technology to the financial system Sabine Lautenschlager, Vice-Chair of the Supervisory Board of the European Central Bank, also advocates "same business, same risks, same rules."
Sabine says that "customers want to extend their digital life to banking; they want banking services anytime and anywhere." Yet she points to three "potential futures" for 'banking', none of which acknowledges the benefits of innovation. The only 'benign' scenario she considers is the one where banks "team up with" new entrants (or "fintechs"). A second scenario involves fragmentation into regulated and unregulated activity - nothing new, as the unregulated 'shadow banking' sector was already at the vast, pre-crisis levels in 2015. A third is that "fintechs" might be "swallowed up by big tech companies" making the banking market "more concentrated, less competitive and less diversified" (as if banking isn't already!). But the big tech companies already have regulated financial subsidiaries (mainly offering retail payment services under EU carve-outs from the banking monopoly), and their presence in the market automatically makes it less concentrated, more competitive and more diversified.
The ECB's overall concern seems to be that banking will become less profitable, causing existing players to cut spending on risk management. But a preoccupation with the impact of innovation on legacy players dooms the sector to over reliance on legacy firms and inefficient models that effectively require super-normal profits to operate. Mark Carney also points out that concerns about banks cutting corners to keep up with more nimble competitors should not constrain innovation, but is instead a matter for the central bank "to ensure prudential standards and resolution regimes for the affected banks are sufficiently robust to these risks."
The ECB has some strange views on what constitutes risks. It is said to be inherently risky, for example, that P2P lending platforms are "securitising the loans they originate from their platforms". That maybe how such programmes work in the US, but over there a regulated lender makes a regulated loan and sells it to a listed entity that issues bonds under an SEC-registered prospectus. So any problems are happening right under the noses of the relevant authorities. In the UK, the lenders are free to securitise their portfolios - and several have - but that is not the role of the platform operator. Again, however, this involves regulated activity, both at P2P platform level and through the offer and listing of the relevant bonds. The regulators are already implicated.
"Robo-advice" is also said to create the risk of investors 'herding' into the same positions at the same time, yet this already happens among regulated fund managers (and banks).
Risks associated with 'cloud' services and outsourcing of data storage are also cited by the ECB, but these are not new risks at all, or even exclusive to financial services.
Indeed, what regulators seem to miss is that many of the technological advances that are finally being applied to financial services under the "FinTech" banner have been applied to other sectors for over a decade.
This is not to say that new models are necessarily 'good' or effective. It can also take some time for risks to emerge. The 'lessons' of the past and the resulting regulatory 'tools' and solutions must not be forgotten, and the old models need to be managed along side the new. But those old models and the rules they require should not be the only lens through which all innovation is analysed. New services must also be viewed afresh.
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