On 14 February 2019 the Financial Stability Board (FSB) published its FinTech and Market Structure in Financial Services Report which assessed how technological innovation may affect financial stability (Report). The Report looks at new players entering the financial services market, including Fintech firms, large technology companies as well as third-party providers of cloud computing services.
Key drivers affecting market structure
According to the Report, the use of Application Programming Interfaces (APIs) is on the rise in several areas, including payments. APIs allow different software applications to communicate and directly exchange data. Mobile banking is also becoming increasingly popular and some smart phones are now integrating built-in payment capabilities. Additionally, it is expected that in the near future the use of cloud computing will expand, affecting areas such as consumer payments and credit scoring.
Meanwhile, competition is becoming an important area of focus for financial regulation. For example, several jurisdictions have introduced rules enabling ‘Open Banking’. In the EU, the second Payment Services Directive 2015/2366 (PSD2) seeks to facilitate innovation in digital payments by requiring banks to open up their customer data to new market players. At the same time, changing customer expectations are pushing market participants to provide more convenience, speed and user-friendliness of financial services.
The current landscape
According to the Report, FinTech firms are not currently in direct competition with incumbent institutions. Presently, they focus on relatively niche areas, such as peer to peer lending, and they target previously underserved customers, such as small to medium-sized entities. FinTech firms often form partnerships with established financial institutions, allowing the former to access a broader client-base and the latter to benefit from innovative technologies. However, some FinTech firms are becoming more established in areas such as payments and they could, in the future, impact the profitability of incumbent institutions.
Large technology companies, so called ‘BigTech‘, are also entering the financial services industry. Examples of BigTech include AliPay and Amazon. The Report notes that, unlike FinTech, BigTech firms could achieve scale relatively quickly and significantly alter competition in the market. These BigTech companies have established customer networks, strong financial position and access to low-cost capital. At the same, time they hold a significant amount of customer data, due to their other offerings, that they could potentially use to provide more tailored financial services.
At present, financial institutions do not generally rely on third-party providers for services such as data provision, cloud storage and physical connectivity. However, this is likely to change in the future.
The potential financial stability implications
Changes in market structure may enhance competition, efficiency and resilience in financial services. However, these changes may also impact the profitability of established financial institutions, pushing them towards more risk-taking to remain competitive. Moreover, competition would not necessarily improve, if new players entered the market but concentration levels remained the same. An illustrative example of this is China, where the mobile payments market is dominated by two BigTech firms that account for 94% of the overall market. In addition, reliance on third-party service providers may increase complexity and the interconnectedness in the market, resulting in systemic operational and cyber security risks. For example, a cyber incident or the insolvency of one provider could impact multiple institutions simultaneously.
The FSB will continue to monitor these risks. More specifically, the FSB Financial Innovation Network will assess the market for third-party services for financial institutions and will examine the activities of BigTech in finance.
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