Innovation is the engine of progress, since it alters the status quo and forces established players to improve their game. But if it is not handled correctly, it can also be destructive; and in this, innovation in financial technology (fintech) is no exception.
New technologies developed by startups in the fintech sector and large companies in Silicon Valley are making banking and financial services more efficient and accessible than ever before.
In fact, the entry into the market of new players and technologies put the financial industry at a crossroads, and it would not be strange that some traditional financial companies suffer the same fate as Kodak (former world leader in photography). To travel the road ahead, authorities must ensure a level playing field suitable for new products and business models and, at the same time, minimize the risk of disruption becoming destructive.
Fintech startups are based on the profitability of cloud-based information technology services, the lack of legacy IT costs and the adaptability of their business models. And having entered the market later, they can learn from the mistakes of established companies and their predecessors.
This explains why startups have made large inroads into services that improve financial inclusion, such as peer lending and remittance payments and remittances with the mobile phone.
But startups also face intense competition from large technology companies, which have their own advantages: deep IT experience, large customer bases and easy access to detailed data. Combined with a customer-focused strategy, these advantages have allowed large technology companies to offer new forms of financial services.
For example, the Chinese tech provider Tencent included easy payment options in its instant messaging application, WeChat; and Amazon offers lines of credit for sellers who use their electronic market. In this way, large technology companies can, in general, operate with fewer regulatory restrictions than would traditional financial institutions.
Financial market players of all kinds increasingly use artificial intelligence (AI) and machine learning for applications ranging from the interaction with customers to regulatory compliance.
And, in particular, there is much talk of the blockchain technology of distributed accounting records on which cryptoactives such as Bitcoin are based.
But although the use of the blockchain in applications such as sending remittances and financing international trade is promising, it has not yet been widely adopted as a means of payment or by traditional institutions.
The great danger now is that the Fintech revolution will alter business models that serve the common good, without providing viable alternatives. It could happen that in response to the growing competition from Silicon Valley that they face, traditional banks run more risks to cling to a shrinking market share.
And the rush to update business models or adopt unfamiliar, rapidly evolving technologies can weaken internal processes, creating another source of potential losses.
In addition, the high costs of the technological career, the network efficiencies available to larger companies with many customers and the attractiveness of the most used payment solutions could lead to financial services becoming even more concentrated in a few. companies “too big to fail”.
Another problem is technology itself. AI and machine learning can be destabilizing, if applied in ways that encourage herd behavior among investors, increasing the likelihood of sudden crashes in the markets (flash crashes). And the closed nature of these technologies makes human intervention much more difficult if things go wrong.
More generally, the rapid deployment of new technologies leaves less skilled workers little time to adapt, and some may end up losing their jobs. It could happen that individuals benefit as consumers, but injured as workers. The balance of these two effects will vary according to the sector of the society in question, which can lead to an increase in economic inequality.
And as for the cryptoactives, it is difficult to find them any benefit. They lack the basic properties of money, are prone to price volatility and manipulation, and consume huge amounts of energy. Its opacity raises concerns related to the protection of consumers and investors and opens the door to tax evasion and money laundering.
In addition, given that cryptoactives take advantage of the confidence gained by the traditional financial system over many years, if there were a loss of confidence in cryptoactives, it could be transferred to the general financial system.
To limit the risks associated with innovation, it is necessary that the officials in charge of policy formulation, regulation and surveillance be as creative, agile and tech-savvy as new players. They should consider the creation of innovation centers that bring together established entrepreneurs and companies, and protected regulatory frameworks (“sandboxes”), where innovators can test new technologies and products in a safe environment. Both measures would help the authorities to be aware of the evolution of the sector.
To avoid the use (arbitration) of regulatory inconsistencies, regulators should follow the maxim that says “at the same risk, same regulation”. Entities that compete for similar clients or offer similar financial services must respect the same rules, no matter where their base is. Setting clear regulatory limits will reduce the uncertainty and risk of innovators entering gray areas.
But prudential authorities must also monitor the exposure of financial institutions to companies and products outside the regulated perimeter, a task for which they will need new sources of knowledge and data.
In the world of cryptoactives, “same risk, same regulation” implies that companies that use “initial offers of coins” to raise funds must be subject to the same rules and scrutiny mechanisms as those that issue shares. Likewise, large technology companies should not have undue advantages in terms of access and data sharing.
The current privacy regulations have too many gaps that allow practices that are incompatible with ethics, so they must be reformed. The General Regulation of Data Protection of the European Union is a step in the right direction. The question that the authorities should keep in mind is how much privacy a person must give up in exchange for accessing financial services.
Since innovation knows no borders, the idea of “same risk, same regulation” must also apply between countries. It is essential that there be coordination at the national and international levels between the prudential, legal, tax, accounting and telecommunications authorities. Governments must also anticipate the impact of innovation on users and workers; This implies, in particular, creating training programs so that people have the necessary skills to keep up with the changes.
The opportunities and challenges posed by financial innovation are clear. The response from the policy formulation must take into account both.
Also published on Medium.