Even though traditional institutions still control the majority of financial assets across the globe, fintech and big tech competitors are gaining power as enablers of payments, ecommerce, and other financial transactions.
Many younger consumers now have more relationships with fintech than they do with banks. They Zelle money to one another, Cash App to pay for products and services, and Lending Club for loans.
Even businesses are increasing their adoption of fintech apps, looking to companies like PayPal and Square to process payments. And across the digital ecosystem, companies like Plaid provide the infrastructure to connect accounts.
The Fact Is:
Most fintech platforms and applications lack the regulatory scrutiny imposed upon traditional financial institutions and products.
Banks have long complained about a lack of oversight and regulations of fintechs, saying they want a “level playing field.” Chase CEO Jamie Dimon wrote in his 2020 annual letter to shareholders that he was arguing for a fairer basis “both in terms of how products and services are treated by regulators and possibly how competition should be treated across platforms.”
BIS Asks Tough Questions
It’s not just about competition with legacy banks, it’s about consumer protections. The Financial Stability Institute, a division of the Bank for International Settlements, a consortium of financial regulators and central banks, says in a report that while fintech plays a critical role in payments, they should be subject to greater regulations. BIS notes while insurers and banks in many countries are considered systemically important by regulators, few are addressing the “potential (possibly global) systemic impact of big-tech operations and of possible spillover effects to the financial sector and across all of the activities that big techs perform.”
While non-bank payment service providers (NBPSPs — BIS-speak for the likes of Square) offer opportunities to improve inclusion, efficiency, and cost, they also bring new risks in consumer protection, operational resilience, cyber resilience, protection of funds in transit, and market concentration.
BIS notes that these NBPSPs are typically more intensely regulated in emerging markets than in advanced economies. In addition, there are marked differences in how regulators view acquiring payment transactions, e-wallet services, and e-money issuances, with consumer protection often taking a back burner, the report states.
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Fintech Concentration Growing
BIS has a point because as more of the economy depends on fintech platforms, a breach, outage, or disruption in any of these platforms could have dire consequences for consumers. PayPal processed nearly $1 trillion worth of transactions in 2020, and other companies like Stripe, Robinhood, Kraken and Chime process or hold trillions in consumer and business funds.
Consolidation in the industry also reduces the number of players and gives greater scale to those that remain. For example, PayPal’s market value of $325 billion is now the same as Bank of America. Other fintech companies are gobbling up smaller ones, such as Square’s $29 billion acquisition of the buy now, pay later company Afterpay in August 2021.
Case in Point:
The wild ride of GameStop shares demonstrates the potential risks of innovation without oversight.
Eswar Prasad, Senior Fellow of Global Economy and Development at Brookings Institute, says governments must help manage the risks of fintech. Although fintech offers many benefits, it also comes with downside and risk, says Prasad. For example, while computer algorithms can reduce bias by rendering verdicts solely on creditworthiness and loan qualifications, those algorithms are built by humans and benchmarked against data that can reinforce bias.
Financial literacy and digital access aren’t always evenly distributed, said Prasad. The GameStop saga, for example, demonstrated what can happen when unsophisticated consumers use social media to make impulse decisions on fintech trading platforms.
“Governments must still work to protect investors and ensure basic financial literacy so that investors understand the products on offer and risks involved,” Prasad states.
Financial sector specialists at the World Bank also note growing consumer risk in fintech, including operator fraud and misconduct, platform vulnerabilities, consumer disclosure, and business models that may not be in consumers’ best interests.
“Fintech business models may give rise to conflicts of interest not foreseen by regulators or expected by consumers.”
— The World Bank
Regulations that Depend Upon Business Model
Fintech and big tech companies are not completely unregulated by any means, but the regulation varies and depends on their functions and how they operate, according to Sam Regan, Managing Director of Global Regulatory and Compliance and LIBOR Practice Lead of Finance and Risk at Accenture. Fintech companies may operate as a normal tech company or set themselves up as a financial services firm, she says. In most cases, what regulations they may face come from the state level and often involve things like information security, financial crime, and use of technology.
Touch of Irony:
At present, fintechs operate under functional regulation, something traditional institutions have sometimes pushed for.
“Particularly in North America, fintechs have to consider the regulations of the state in which they are conducting business,” Regan tells The Financial Brand. However, there are some areas, such as financial crime requirements, that most organizations have to meet whether they are in fintech or something else, Regan states.
Depending on their activities, fintech companies can be licensed and supervised by local, state, or federal regulators on a functional or activity basis, says Carl White, Senior Vice-President, Supervision, Credit and Learning Division at the Federal Reserve Bank of St. Louis. For example, PayPal has individual money transmission licenses in each state. It is also subject to regulation by the Consumer Financial Protection Bureau because it offers financial services to customers.
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“The consumer protection laws most applicable to fintech firms relate to rules regarding lending and discrimination; the CFPB also has the authority to level civil penalties against fintech firms that engage in unfair, deceptive, or abusive acts and practices,” says White.
A few fintechs and neobanks have taken the extra step to obtain a bank charter. They must meet licensing requirements and submit to state regulatory authorities and federal agencies. On the other side of the coin, the financial institutions that provide banking-as-a-service for fintechs and neobanks often have to meet additional regulatory requirements by banking regulators, White notes.
Yet there remains a lack of clear regulations in fintech to protect consumers, said the BIS report. Its authors recommend that central banks more closely consider the need for specific safeguards. It calls for continuing adaption of regulatory frameworks, especially for cryptoassets and stablecoins.
It will be an ongoing issue. “The concept of emerging risk is emerging faster than we’ve seen at any point in history,” says Accenture’s Sam Regan.