The Bank for International Settlements (BIS) says that the risks are so complex, it may be difficult for regulators to get to grips with especially as it will involve not just financial regulation, but competition and data regulators too with the risks stretching far across national borders.
The warning is contained in Big tech in finance: opportunities and risks a special chapter of its annual economic report which the regulator has released early.
This view from BIS, often dubbed the regulator for the world’s central banks, has been interpreted in much of the media as a warning about Facebook’s Project Libra – viewed as a move into a type of crypto-currency from the social media giant.
That project is mentioned specifically although only in the footnotes excerpted below.
Facebook is also namechecked at the beginning of the report as one of five giant tech brands with Amazon and Google and two giant Chinese players, Alibaba and Tencent.
Using typically measured regulatory language, BIS also sets out its concerns that the financial system faces a very complex global challenge.
Some finance areas embraced by big tech are covered by banking regulation and thus involve a level playing field between banking, finance and tech.
However, BIS is worried about other activities not covered by banking regulations, but by competition or data authorities – which therefore pose a huge challenge to regulators and countries.
As the report says: “Big techs’ entry into finance introduces new elements in the risk-benefit balance. Some are old issues of financial stability and consumer protection in new settings.
“In some settings, such as the payment system, big techs have the potential to loom large very quickly as systemically relevant financial institutions.
“Given the importance of the financial system as an essential public infrastructure, the activities of big techs are a matter of broader public interest that goes beyond the immediate circle of their users and stakeholders.”
BIS is concerned that that huge stores of data and data feedbacks bring competition and data challenges.
The report says: “Big techs have the potential to become dominant through the advantages afforded by the data-network activities loop, raising competition and data privacy issues. Public policy needs to build on a more comprehensive approach that draws on financial regulation, competition policy and data privacy regulation.”
It outlines the coming dilemma in a YouTube videowith Hyun Song Shin, economic adviser and head of research at BIS and has published a regulatory compass to help global regulators identify and assess the challenge.
It therefore calls for cross regulatory and international cooperation.
The report adds: “The aim should be to respond to big techs’ entry into financial services so as to benefit from the gains while limiting the risks. As the operations of big techs straddle regulatory perimeters and geographical borders, coordination among authorities – national and international – is crucial.”
Global Investment Megatrends has outlined some of the other key areas highlighted by the report below.
Payment services still largely ‘bank dependent’
The report notes that payment services were the first significant area where tech moved into financial activities through services including Alipay (owned by Alibaba) or PayPal (owned by eBay) and M-Pesa with a huge presence across many African countries.
“One key differentiator in this area is whether it is a finance ‘overlay’ which is largely reliant on banks or whether the services offered see the tech platform offer a ‘proprietary’ service,” it says.
The report notes: “While big techs’ payment platforms compete with those provided by banks, they still largely depend on banks. In the first type, directly so; in the second, users require a bank account or a credit/debit card to channel money into and out of the network. Big techs then hold the money they receive in their own regular bank accounts and transfer it back to users’ bank accounts when users request repayment. To settle between banks, big techs have to again use banks, since they do not participate in regular interbank payment systems for the settlement in central bank money.”
Payment services make up 16 per cent of Chinese GDP
It notes that the penetration of payment services is deeper in places where other more traditional finance may be more restricted – thus a market such as China has seen penetration of a remarkable 16% of GDP. It also sees very significant penetration in regions of emerging and frontier markets such as Africa where monetisation has not reached all the population.
In addition, it notes the growth of international money transfer services such as Alipay HK (a joint venture of Ant Financial and CK Hutchison) which transfers money between Hong Kong and the Philippines.
BIS says that for the most part, payment services are still bank dependent at some stage of the process although it adds that this could be changing pointing to the Facebook initiative.
Money market funds offer instant withdrawal
The move into money market funds has seen tech utilise its data to offer instant investment and withdrawals.
The report says: “On big tech payment platforms, customers often maintain a balance in their accounts. To put these funds to use, big techs offer money market funds (MMFs) as short-term investments. The MMF products offered are either managed by companies affiliated with the big tech firm or by third parties.
“By analysing their customers’ investment and withdrawal patterns, big techs can closely manage the MMFs’ liquidity. This allows them to offer users the possibility to invest (and withdraw) their funds almost instantaneously.
“In China, MMFs offered through big tech platforms have grown substantially since their inception. Within five years, the Yu’ebao money market fund offered to Alipay users, grew into the world’s largest MMF, with assets over CNY 1 trillion (USD 150 billion) and around 350 million customers.”
Credit provision depends on wider credit market
The report suggests that big tech may be able to take advantage where there is limited competition or lighter regulation in a national market.
“Building on their e-commerce platforms, some big techs have ventured into lending, mainly to SMEs and consumers. Loans offered are typically credit lines, or small loans with short maturity (up to one year). The (relative) size of big tech credit varies greatly across countries. While total fintech (including big tech) credit per capita is relatively high in China, Korea, the United Kingdom and the United States, big techs account for most fintech credit in Argentina and Korea.
“The uneven expansion of total fintech credit appears to reflect differences in economic growth and financial market structure. Specifically, the higher a country’s per capita income and the less competitive its banking system, the larger total fintech credit activity. The big tech credit component has expanded more strongly than other fintech credit in those jurisdictions with lighter financial regulation and higher banking sector concentration.”
The DNA of Big Tech
The report makes a lot of what it calls its DNA analysis. It sets this out as follows –
“Data analytics, network externalities and interwoven activities (“DNA”) constitute the key features of big techs’ business models. These three elements reinforce each other.
“The “network externalities” of a big tech’s platform relate to the fact that a user’s benefit from participating on one side of a platform (eg as a seller on an e-commerce platform) increases with the number of users on the other side (eg buyers). Network externalities beget more users and more value for users. They allow the big tech to generate more data, the key input into data analytics.
“The analysis of large troves of data enhances existing services and attracts further users. More users, in turn, provide the critical mass of customers to offer a wider range of activities, which yield even more data. Accordingly, network externalities are stronger on platforms that offer a broader range of services, and represent an essential element in big techs’ life cycle.
“Financial services both benefit from and fuel the DNA feedback loop. Offering financial services can complement and reinforce big techs’ commercial activities. The typical example is payment services, which facilitate secure transactions on e-commerce platforms, or make it possible to send money to other users on social media platforms.”
Not all bad news on financial inclusion
The report identifies that to date, the tech firms may be better at assessing data risk and this can help some people and businesses that may not have had full access to credit.
“Big techs can have a competitive advantage over banks and serve firms and households that otherwise would remain unbanked. They do so by tapping different but relevant information through their digital platforms. For example, Ant Financial and Mercado Libre claim that their credit quality assessment and granting of loans typically involve more than 1,000 data series per loan applicant.”
New barriers to entry
The report does see big challenges as the tech firms secure their position and raise barrier to entry.
“Once a captive ecosystem is established, potential competitors have little scope to build rival platforms. Dominant platforms can consolidate their position by raising entry barriers. They can exploit their market power and network externalities to increase user switching costs or exclude potential competitors. Indeed, over time big techs have positioned their platforms as “bottlenecks” for a host of services.
“Platforms now often serve as essential selling infrastructures for financial service providers, while at the same time big techs compete with these providers. Big techs could favour their own products and try to obtain higher margins by making financial institutions’ access to prospective clients via their platforms more costly. Other anticompetitive practices could include “product bundling” and cross-subsidising activities. Given their business model, these practices could reach a larger scale for big techs.”
The rise of the dataopoly
The report also warns about the anti-competitive use of data.
“Another, newer type of risk is the anticompetitive use of data. Given their scale and technology, big techs have the ability to collect massive amounts of data at near zero cost. This gives rise to “digital monopolies” or “data-opolies”. Once their dominant position in data is established, big techs can engage in price discrimination and extract rents. They may use their data not only to assess a potential borrower’s creditworthiness, but also to identify the highest rate the borrower would be willing to pay for a loan or the highest premium a client would pay for insurance.
“Price discrimination does not just have distributional effects, ie raising big techs’ profits at customers’ expense without changing the overall amounts produced and consumed. It could also have adverse economic and welfare effects. The use of personal data could lead to the exclusion of high-risk groups from socially desirable insurance markets. There are also some signs that big techs’ sophisticated algorithms used to process personal data could develop biases towards minorities.”
Could regulatory sandboxes mean unfair playing fields?
The report notes that a number of national regulators are keen to help the development of tech for the perceived economic benefits but there are pitfalls.
“These can take a number of forms, including hubs and accelerators, which provide a forum for knowledge-sharing, and may involve active collaboration or even funding for new players. Regulatory sandboxes (eg in Hong Kong, Singapore and the United Kingdom) let innovators test their products under regulatory oversight. Hubs, accelerators and sandboxes can help to ensure a dynamic financial landscape – one that is not necessarily dominated by just a few players.
“At the same time, their setup requires careful design and implementation, to avoid regulatory arbitrage and to not provide signs of support for new but still speculative projects.”