There’s no doubt that technological innovation can be a “powerful force for change” in the financial system. It has the potential to improve efficiency and competition and provide benefits for consumers, businesses and Government. However, the Interim Report highlighted the potential risks posed by new technologies and the challenges of developing appropriate regulatory frameworks.
In addition to this well publicised debate, the Interim Report has thrown up some considerations that may affect a broad range of players in the financial services landscape from disruptors to retailers and more established players such as the major and other banks.
The key questions that the FSI and the industry faces is this: Tradition v Disruption - what path will lead to greater efficiency and flexibility while ensuring that consumers are the ones who benefit?
Innovation ranging from contactless payment technology and “mobile wallets” to crypto-currencies has the potential to facilitate the entry of new players in the financial system. These new players are likely to include start-ups as well as large corporate entities (such as retailers) not traditionally involved in the provision of financial services. These developments have the potential to foster competition and broaden the range of services available to consumers, but also raise challenging issues for regulators seeking to maintain stability.
In designing new regulation (or amending existing rules), the Interim Report highlights the desirability of maintaining a technology neutral approach to the extent possible. Technology-specific regulation (eg theePayments Code) should be the exception rather than the norm (and such regulation should seek to adopt a technology neutral approach within the relevant class of product or service).
Because of the fast pace of development of new products, a principles-based approach to regulation using broadly applicable concepts has been advocated in a number of submissions to the FSI. However, as alluded to in the Interim Report, regulation that is broad and general (taking as an example Chapter 7 of the Corporations Act and the concept of “financial product” used therein) tends to require extensive interpretation, a comprehensive exceptions regime and guidance from regulators.
Privacy and Data Security
The Interim Report also highlighted the tension between the benefits flowing from innovation in data storage and collection services and the heightened risks with respect to privacy and data security. For example, the benefits of cloud technology have been widely touted, but such technology also dilutes a firm’s control over information and raises questions of accountability where a breach occurs (with the possibility of additional complexity where off-shore cloud storage providers are used). In the context of increasing threats to cyber security, the Interim Report notes that new entrants with less sophisticated data security protections may sometimes represent the “weak link” in the chain for cyber-security purposes.
The development of “trusted digital identities” would be expected to improve security and efficiency as well as increasing trust. Government could assist in developing a centralised system of trusted digital identities, or could intervene to facilitate the development of such identities by guiding commercial providers, for example by setting standards for interoperability.
Changes to payment products
In addition to the debate above, the FSI touches on issues in relation to a range of payment products which could result in changes that affect a range of market players by eroding the competitive advantage banks have long held in this space. For example, the Interim Report supports lowering the existing interchange fee caps which will further impact on the banks’ ability to earn revenue from credit cards. The Interim Report also indicates that the regulation of certain payment products may be wound back with purchased payment facilities singled out as an area that may be regulated differently in the future than is currently the case for ADIs - this suggests that the provisions relating to purchased payment facilities may also be removed from the Banking Act 1959 (Cth) (the RBA has already announced the removal of Specialist Credit Card Institutions). Such changes could allow non-bank providers of these types of products to offer more competitive and innovative products.
The underlying philosophical questions here are critical. To what extent should regulators be shaping the industry by imposing pricing controls on different parts of the value chain, and against what measures should their performance in this regard be measured? And if less systemically significant products should be subject to a lighter touch regulation from either a prudential or integrity/AML perspective, should that only be the case where they are also provided by a less systemically significant institution?
The area of technology, innovation, payment products and privacy will continue to remain a hot topic throughout the course of the FSI and well into 2015. What’s evident is that a tipping point will be reached when a decision has to be made as to the liberalisation of technologies and the type of regulation needed to govern those participating in this fierce market. If you have a strong view on what path the Australian market should travel down, you best make a submission by 26 August.