The Financial Stability Board (FSB)1 has released a report entitled “FinTech and market structure in financial services” (Report) as part of its ongoing work to monitor fintech2 market developments and their potential implications for financial stability.3 As fintech firms, Big Tech firms, and the markets for third-party services continue to develop,4 we expect Canadian authorities will continue to closely monitor these developments and their financial stability implications.
What you need to know
- The report found that the existing relationship between financial institutions and fintech firms appears to be largely complementary and cooperative in nature.
- The competitive impact of Big Tech firms, which typically have large, established customer networks and enjoy name recognition and trust, may be a greater concern.
- Reliance by financial institutions on third-party data service providers (e.g., data provision, cloud storage and analytics, and physical connectivity) for core operations appears to be low at present. However, this warrants ongoing attention from regulatory authorities.
While technological innovation has the potential to lower costs to clients of financial services, in addition to increasing market access, the range of product offerings and convenience, the FSB notes the universe of financial services providers could be materially altered by new entrants into the financial services space, including fintech firms and large, established technology companies (Big Tech). In particular, the Report notes that, despite the benefits to financial stability emanating from greater competition and diversity in lending, payments, insurance, trading and other areas of financial services, heightened competition could also put pressure on the profitability of financial institutions, which could lead to risk-taking by those institutions in order to maintain margins.
As part of the Report, the FSB analyzed the link between technological innovation and market structure (which refers to the interrelation of companies in a market that impacts their behaviour and their ability to make profits) and produced the following considerations.
Cooperation is key
The existing relationship between financial institutions and fintech firms appears to be largely complementary and cooperative in nature. For example, fintech firms have not posed a serious competitive threat to established financial institutions due to a lack of sufficient access to capital and/or a robust customer base, and partnering has allowed fintech firms to viably operate while remaining relatively small (and in some cases, unburdened by financial regulation while still benefiting from access to the customer base of the financial institutions with which they partner).
Alternatively, partner financial institutions have benefited from access to innovative technologies. However, there are exceptions to above, as some fintech firms have made significant inroads in credit provisions and payments, which may negatively affect the profitability of financial institutions in the future to the extent that technology permits a further unbundling of profitable services traditionally offered by banks and other institutions.
Impact of Big Tech firms
Of greater concern may be the competitive impact of Big Tech firms, which typically have large, established customer networks and enjoy name recognition and trust. In addition, these companies may have access to proprietary customer data generated through other services (such as social media) to tailor their offerings to individual customers’ preferences. Given these Big Tech firms have strong capital positions and likely access to low-cost capital, the FSB notes such firms could very quickly achieve scale in financial services. While Big Tech firms could represent a source of increased competition, their participation in financial services may not necessarily result in a more competitive market over the longer term if Big Tech firms were to operate with lower margins (due to cross-subsidization). In particular, the FSB notes that a greater market share of Big Tech may be associated with unchanged or higher concentration, along with a change in composition away from traditional players.
The risks of third-party data service providers
The Report also notes that, while increased reliance by financial institutions on third-party data service providers for core operations (e.g., data provision, cloud storage and analytics) could reduce operational risk at the individual firm level, it could also pose risks and challenges for the financial system as a whole. For example, if high reliance on third-party service providers were to emerge, along with a high degree of concentration among service providers, then an operational failure, cyber incident, or insolvency could disrupt the activities of multiple financial institutions. As a result, the FSB notes that it will be important to continue to monitor these developments.
As a result, we expect that Canadian authorities will continue to closely monitor these developments and their financial stability implications. In fact, on February 7 at the C.D. Howe Institute, Assistant Superintendent Ben Gully said, “[w]ith the growth in third-party relationships, risk concentrations may result when a number of financial institutions begin to rely upon a few service providers. OSFI's concern is that the dominance of a particular supplier in one area could create a co-dependence across the financial services sector. This matters because financial system resilience would ultimately rely on the operations of a potentially small number of non-financial, technologically driven, counterparts.” We also understand that the OSFI is currently drafting a guideline on non-financial risk (with a focus on third party risk and cyber risk).
1 The FSB was established to coordinate at the international level the work of national financial authorities and international standard-setting bodies in order to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies. It was established after the G20 London summit in April 2009 as a successor to the Financial Stability Forum (FSF). The Board includes all G20 major economies, FSF members, and the European Commission.
2 The FSB defines fintech as “technology-enabled innovation in financial services that could result in new business models, applications, processes or products with an associated material effect on the provision of financial services.”
4 According to FT Partners’ 2018 Annual Fintech Almanac, global fintech financing volume in 2018 reached a record high of US$53.8 billion, doubling 2017 volume of US$26.8 billion and far surpassing the prior record high of US$28.7 billion in 2016.
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