On June 23, 2019, the Bank for International Settlements (the “BIS”), the international institution of central banks whose mission is to promote global financial cooperation, published its Annual Economic Report 2019 (the “Report”) featuring a chapter on the opportunities and risks of large multinational technology (“Big Tech”) companies’ inroads into financial services. The Report examines the potential benefits of Big Tech presence in financial services, as well as the risks and regulatory implications it entails.
Big Tech’s Expansion Into Financial Services
The BIS observes that the activities of Big Tech companies in finance are a subset of broader financial technologies (“Fintech”) innovation. While Fintech companies are set up to operate primarily in financial services, Big Tech companies offer financial services as part of a large set of activities. The Report notes that their entry into finance reflects strong complementarities between financial services and their core non-financial activities.
An essential by-product of tech companies’ business is the large stock of user data, which they use as input to offer a wide range of services that generate further user activity and yet more data. Building on the advantages of this “data-network-activities loop”, Big Tech companies have ventured into financial services including payments, lending, insurance and money management (see for example Facebook’s recent Project Libra). As illustrated by the Report, financial services represent only about 11% of Big Tech’s revenues, as its core businesses remain focused on information technology and consulting. Nonetheless, given their size and customer reach, the BIS conceives that large tech companies’ entry into finance has the potential to spark rapid change in the industry.
As noted in the Report, Big Tech’s move into financial services has been most extensive in Southeast Asia and other emerging market economies (“EMEs”). Payments were the first financial service large tech companies offered, mainly to help overcome the lack of trust between buyers and sellers on e-commerce platforms. Services like PayPal and Alipay are fully integrated into existing e-commerce platforms. Big Tech payment platforms currently fall under two distinct types:
- Overlay systems, which rely on existing third-party infrastructures, such as credit card or retail payment systems; and
- Proprietary systems, where payments are entirely processed and settled on a system proprietary to the tech company.
The Report’s findings suggest that overlay systems are used more commonly in advanced economies, as credit cards were already ubiquitous there by the time e-commerce companies came to prominence. Proprietary systems are more prevalent in economies where the penetration of other cashless means of payment is lower.
Expanding upon their e-commerce platforms, some Big Tech companies have ventured into lending, mainly to small and medium-sized enterprises and consumers. Loans offered are mainly credit lines and small loans with short maturity. The Report points out that Big Tech credit provision has made its most significant advances in EMEs, where a considerable proportion of the population remains unbanked. The BIS recognizes that, despite its substantial recent growth, Fintech credit (including Big Tech) still constitutes a very small proportion of overall credit.
Potential Benefits of Big Tech Presence in Finance
Data analytics, network externalities and interwoven activities are key features of Big Tech companies’ business models. According to the Report, those features could lower barriers to provision of financial services by reducing information and transaction costs, and thereby enhance financial inclusion.
To limit losses in cases of default, banks monitor borrowers’ business activities or require collateral, which can be costly. Large tech companies’ access to and reliance on big data can reduce the costs relating to monitoring activities and the taking of security over collateral, and improve the efficiency of providing financial services.
In the case of credit assessment, information costs can sometimes be so prohibitive that banks refrain from offering services to borrowers who, in some cases, lack basic documentation like audited financial statements. The Report suggests that, by taking advantage of information relevant for credit quality assessment available through their digital platforms, Big Tech companies could serve enterprises that would otherwise remain unbanked. Recent BIS research also indicates that tech companies’ credit scoring, when applied to small vendors, outperforms models based on traditional credit bureau ratings, but it is still too early to draw definitive conclusions.
The Report summarizes Big Tech and banks’ competitive advantages and disadvantages as follows:
- Big Tech companies have access to data on a large number of users and have access to technology built to collect and merge such data, while banks have data on a smaller number of users and are occasionally hampered by legacy IT systems they use to process their data. On the other hand, banks have more verifiable customer data and have access to longer data history;
- Big Tech companies enjoy significant network externalities due to the broad set of non-financial activities they engage in, while banks are subject to strict regulatory limits on the activities they carry out as well as the use of the data at their disposal; and
- Big Tech companies can provide services at lower marginal costs to a larger number of users, but are limited in funding sources and risk management expertise compared to traditional financial institutions.
Risks and Implications on Financial Regulation
The BIS signals that Big Tech’s expansion into financial services provision raises various competition risks, as platforms that will have consolidated their dominant position could raise entry barriers into the sector by increasing user switching costs, hence excluding potential competitors. Another risk is tech companies’ potential anticompetitive use of data, which gives rise to “digital monopolies”. Big Tech companies could engage in price discrimination and use their data not only to assess a potential borrower’s creditworthiness, but to also identify the highest rate the borrower would be willing to pay for a loan. User data review could also lead to the exclusion of high-risk groups from credit and insurance markets.
The Report advocates that Big Tech’s activity in finance warrants a more comprehensive approach that encompasses not only financial regulation but also competition and data privacy concerns. The Report advocates for a functional approach to financial regulation (“same activity, same regulation”), noting that “if big techs engage in activities that are effectively identical to those performed by banks, then such activities should be subject to banking rules.”
The BIS also suggests that new regulation may also be necessary where Big Tech’s activities have resulted in significant structural changes that take them outside the scope of existing financial regulation. In addition, regulators ought to examine to what extent they should encourage new entry of Big Tech companies into financial services and how user data should be treated in light of property rights.
As policy choices in connection with the entry of Big Tech in financial services involve decisions by various financial regulators, competition authorities and data protection authorities, effective achievement of regulatory objectives will be challenging. The Report envisions that coordination among different regulatory authorities, at both the national and international level, will be essential to avoid conflicting actions and regulatory arbitrage.