Finance constitutes the core of the G20 — the G20 started as a finance ministers’ meeting in 1997. Innovation and digital are relatively new themes at the G20 — the first innovation theme was adopted by the Think 20 Turkey in 2015, innovation became a priority of Chinese G20 Presidency in 2016, and Germany brought the digital economy ministers together first time in 2017. Now it is time to bring these old and new themes together, and turn the G20 to a premier policy discussion forum around the fintech, which refers to technology-enabled innovation that transforms financial services.
A G20 discussion around fintech is needed because of the emergence of global technology giants as data intermediaries expanding into the financial services industry resulting in regulatory risks and challenges. Here it is important to point out the contrast between a Fintech and a Techfin. While the abovementioned definition of fintech refers to fintech as an activity, as defined by the OECD, Fintech as an entitymeans “a non-bank institution that use advanced technologies to perform traditional banking activities.” These are usually startups started around consumer pain points in the financial services industry. Techfin refers to a company that starts with collecting consumer data for resolving a consumer pain point in a non-financial area, and then utilizing the same data to move into financial services. Fintechs are financial intermediaries, whereas Techfins are data intermediaries. Techfins include American big-tech companies such as Apple, Amazon, Microsoft, Google, Facebook, new unicorns like Uber, as well as Chinese big-tech such as Alibaba, Tencent, and Baidu. Ant Financial, the financial services arm of Alibaba reached 150 billion USD valuation –on par with Unilever or Pepsi — in 2018 by building its services on the e-commerce data of its parent company.
Those being said about Fintechs and Techfins, the backbone of the financial systems is still dominated by the banks. An important principle under which the banks operate is “territoriality.” Although many banks have cross-border investments, each of the national units are regulated locally. Banks are the major tools through which monetary and macroprudential policy-making is conducted.
In contrast, Techfins generally act as if “they are on par with, not subordinate to, the countries that try to regulate them” and in a sense provide a global neutral environment to their users — they are sometimes called “Digital Switzerlands”.The power of Techfins stem from the trust they create in other consumer industries in which they collect vast amounts of consumer data. Amazon, for example, is the second most trusted institution in the United States, after the military, according to a recent research by Georgetown University.
The popular trust to the banking system is so low that on in June 2018, Switzerland’s electorate voted on a referendum calling for the country’s commercial banks to be banned from creating money. Although the outcome was negative, even the fact that the center pillar of modern macroeconomic policy is questioned by the electorate in one of the most important banking hubs of the world is telling. Techfins can increasingly make it harder to conduct financial policy-making and increase the financial risks, especially for the countries that they are born in.
Fintechs, instead of building business models based on existing data repositories, generally start with customer pain points in a nation. Instead of transferring trust from another industry’s customer relations, Fintechs build trust by solving customer problems — usually creating totally new markets that have not been served by the banks so far and creating platforms for other entrepreneurs to tap in and grow. This is true in emerging markets inasmuch as, probably even more than, in advanced markets. One example, iyzico, is a payment services company in Turkey: According to their new impact analysis, by offering payment services to entrepreneurs which cannot get access to traditional solutions offered by the banks, iyzico created a success story in financial inclusion. Small and medium sized businesses that use iyzico, on average, grew 77% in size since 2016. The exports over iyzico grow 9 times larger than Turkey’s average e-exports, and reach on average to a distance of 60% far away.
Fintechs provide a wide range of services to customers that traditionally a bank undertakes — usually in a more innovative and customer-centric fashion and by making better use of technology-enabled innovation. This is sometimes called “unbundling of a bank” as illustrated in the figure above. This is why banks generally perceive Fintechs as competitors.Nevertheless, banks have some of the most traditional institutional structures, putting procedures ahead of consumer pain points, and data and ideas inside siloes of different departments. Given limited agility and the risk-averse culture banks have., it is unlikely that they can win the race of financial innovation with the Techfins. One way for the banks of staying ahead of the curve is, instead of approaching Fintechs as competitors, exploring ways of cooperating with them to foster innovation. Such a strategy would be a win for Fintechs as well, by providing them access to customer scale, brand reputation and domain expertise. Some banks are already pioneers in collaborating with Fintechs. For instance, Bank Santander, which is based in Spain with a significant amount of operations in emerging markets, invests in Fintech companies, including Ripple, a blockchain-based global financial settlement platform, and Kabbage, a leading automated credit provider to SMEs.
Regulatory change and guidance is key incentivizing (and sometimes forcing) banks to cooperate with the Fintechs. Without proper regulatory incentives, banks are likely to act with short-term incentives to keep their balance sheets profitable, until the Techfins step in. It is worth noting that Google got an EU-wide e-money and payment services licenses as of January 2019. Given the need for a balanced approach for the role of Techfins, banks and Fintechs to ensure a functional financial policy-making, better financial inclusion and improved consumer welfare, the G20 can do the following:
· Discuss optimal regulatory principles that would enable banks and Fintechs work together.The new version of the Payment Services Directive in the EU (PSD2) is a case in point. It obliges banks to provide open access to their data and use transparent pricing schemes and avoid price discrimination in infrastructure services they provide.
· Discuss optimal structures and improve mutual learning for Fintech regulatory sandboxes.It is usually not possible to experiment with new Fintech products under the regulations established for the traditional banks. Without the learning from experimentation, innovation becomes limited. Regulatory sandboxes, which now exists in more than 20 jurisdictions around the world, enable Fintechs to conduct certain transactions and services within defined threshold limits, while full compliance is ensured once the testing is completed and the business becomes more established.
· Establish a forum to identify best practices of around government-led infrastructure investments for the development of Fintechs.One such infrastructure is digital identification, which enables electronic know-your-customer applications or payment applications through the ID cards. For example, India’s Aaardhar system provided digital identification to 1.2 billion people. Another relevant infrastructure is Legal Entity Identifier (LEI), a unique global code for legal identities to increase financial stability by tracking the beneficial ownership of companies, mandated by the G20 Cannes Summit of 2011.The privacy and ethical issues should also constitute a part of the G20 discussion around government-led interventions.
This post is a slightly edited version of an article that was originally published on the Gateway House website. This is the link to it: https://www.gatewayhouse.in/fintech-for-the-g20/
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