Regulators Feel the Pressure as Banks, FinTechs and Crypto Firms Vie for Wallet Share

Why are FinTechs threatening to upend the traditional banking industry?

As is generally the case when an agile David goes up against a lumbering Goliath, the newcomers have a shot at winning largely because the old guard lets them.

So the massive entry of FinTechs and crypto firms in the last few years, and the very large valuations they’re getting very quickly, boils down to things like “a huge potential for efficiency improvements, lower intermediation costs” and, more broadly, “that the incumbents have not innovated,” said Xavier Vives, professor of economics and finance, Abertis Chair of Regulation, Competition and Public Policy, and academic director of the Public-Private Research Center at IESE Business School.

“They have been bogged with legacy systems like the mainframe, they have not been able to use the cloud efficiently, and also they wanted to protect their rents, for example, in payment systems,” he told David Evans, chairman of Global Economics Group, co-executive director of the Jevons Institute for Competition Law and Economics and visiting professor at the University College London.

“And so, this has left ample space for innovation,” Vives said. “The incumbent will have to restructure, or some of them even exit, eventually.”

Feet first, like Goliath.

That said, plenty of FinTechs and neobanks will be carried out as well, Vives noted.

“Bubbles have happened with all technologies,” he said. “There may be excessive entry and even excessive investment.”

Too Hot to Handle

The role of competition authorities, as ever, is to make ensure all of this happens with “low artificial barriers to entry,” he said.

But FinTech and cryptocurrency are very dynamic and innovative technologies, making it hard for those competition authorities to catch up, Vives added.

Unfortunately, they’re fighting on two fronts, as Big Tech is just as keen to shoulder its way into banking. See Google Pay, Apple Pay and Meta Platforms’ Libra/Diem stablecoin, for example.

The problem, he said, “is that competition policy is not effective enough — in particular against the potential competition problems introduced by Big Tech, like killer acquisitions, free service, for example.”

In those cases, competition policy “acts too late or not at all,” Vives said, suggesting that those authorities have figured out they’re not really up to the challenge.

“My impression is that regulation is needed, and obviously it’s a challenge to do it properly,” he said, adding that it’s still doable “if we push the right buttons.”

Pointing to open banking regulation as a good example, Vives said that a lesson is regulation can be made “pro-competitive” so that the Big Tech platforms “have incentives to enter into each other’s turf and compete” without the need to rely on intrusive regulation.

Too New for the Regulators

Evans pointed to the increasing alarm central banks and other regulators are feeling about crypto, particularly decentralized finance (DeFi) and stablecoins.

While these new technologies create new sources of systemic risk, Vives said, he suggested “speculative cryptocurrencies like bitcoin” aren’t the biggest risk out there. Puncturing that bubble would be more like the 2001 dot-com collapse than the 2007-2009 prime mortgage meltdown.

Big Tech is more likely to cause systemic risk, but from a different direction, Vives said. If a big cloud provider with three systemically important banks for clients has a problem, for instance, all three of those banks — and thereby the system — do as well.

As for crypto, the speculative assets like bitcoin can’t be treated — or regulated — like stablecoins, he said.

Banking on Change

Evans put it to Vives that the growing interest central banks have in issuing their own digital assets — central bank digital currencies (CBDCs) like China’s digital yuan — has two faces. Interesting and innovative tech on one side, and potential competitor (Libra/Diem, anyone?) on the other.

Central banks and regulators are interested in fostering benefits like efficient payments, Vives replied. But they also “want to protect control,” he said. “At the end of the day, they would like to introduce competition in payments, but without destabilizing the system.”

From his perspective, Vives said, the right question to ask when considering a CBDC is: What market failure does it address?

One notable potential of private digital currencies is that if they are controlled by very large platforms leveraging their network effect (Facebook, for instance), a way to avoid problems is to introduce order centrally — to wit, a CBDC.

Another big concern is privacy, Vives said.

“While it’s true that in principle you could make [a CBDC] nontraceable, it’s quite difficult,” he said. Central banks “are going to have to crack the problem of making people comfortable that their privacy is going to be respected because, in an awful lot of countries in Europe and in the United States, people are not going to be too thrilled and will take their anger out at the voting box.”