Could regulation play a role in transforming the FinTech business model?

One of the main differentiators FinTechs have is their current positioning within the financial services value chain ecosystem: they focus on customer experience while their operations execution and control activities are often outsourced to banking institutions. However, is this likely to remain given the increasing interest regulators are paying to these new industry players?

While one of the key success factors of these new players relies on their customer-centric business model, they are actually very dependent on the back-office capacities of their partners, mainly banks, to guarantee robust and compliant execution processes for their operations.

However, rather than a downside, this dependency could be seen as an opportunity as it enables FinTechs to develop a specific business model that plays to their customer-centric strengths. Nevertheless, could FinTechs sustain this model if they have ambitions to revolutionise the financial services industry, continue to grow at the same fast pace and become a fierce competitor to the established institutions?

The last few years, if not decade, have seen the introduction of this new set of players shaking up the different market sectors of the financial services industry ecosystem. They offer services spanning from online banking and PFM (Personal Finance Management)^[1], personal lending^[2], SME^[3] financing, crowdlending^[4], to more specialised services such as private banking^[5] and factoring^[6].

Last February, Mark Carney, president of the G20’s Financial Stability Board and Governor of the Bank of England, confirmed the interest and concerns of global regulators stating, “A number of innovations with potentially transformative implications for the financial system […] are now receiving close attention. The regulatory framework must ensure that it is able to manage any systemic risks that may arise from technological change without stifling innovation^[7]”. 

What type of regulation for FinTechs?

Given the number of benefits to the end customer and to the economy in general, regulators are looking to adopt a new approach: regulate while not impeding innovation from exploring its full potential. Meaning the regulatory measures shall not downgrade the improved customer experience; one that is built on trust and transparency, simple and diverse service offerings, more attractive pricing as well as more fluid and suitable financing options available to economic agents so far not well served by the traditional banking network.

The Governor of the Bank of France has called for a “proportionality in the rules, that is to say adapting our requirements to the scale of the player to regulate” and ensured that “the arrival of new players will certainly not result in a dumbing down of security.”

The question is will the regulatory framework actually be built with the aim to support the transformation of FinTechs by adapting the rules to their development stage? Alternatively, will regulation exclusively focus on security and control matters given the growing volume of transactions passing through this new industry?

In this regard, European regulators are testing several approaches:

• Practical: the sandbox in the United Kingdom
• Pragmatic: “Same risks same regulation” in Germany
• Precautionary: tailored regulation in the Netherland, for instance.

The difficulty lies in how regulators will put these innovative approaches into practice and how they will measure which one is best-suited, considering the potential impact on innovation.

How can FinTechs respond to regulatory evolution?      

If the regulatory framework is effectively built in step with the development stage of FinTechs, the transformation of their business model will be in fact the normal outcome of the two variables of competition and technology. FinTechs will then be able to develop strategies other than partnering with established market players because they would have achieved the maturity and the profitability level that would enable them to absorb new cost centers, develop in-house expertise or buy in new capacities and perhaps move up a gear to grow as stand-alone players.

However, if the regulatory framework becomes too much of a burden, FinTechs face three evolutionary scenarios:

1. Maintain the existing business model, but get around regulation by exploring new and less regulated business segments
2. Keep the same activity but review the business model (e.g. acquire a banking licence) to comply with underlying regulations
3. Consider a buy-out by an established financial institution

One thing is certain, regulators should take account of innovation in regulatory policies at national and global levels; and going forward, FinTechs, like any established market player, might need to put regulatory compliance and business strategy on an equal footing.

Author: Catherine Deeb Ishhab, Manager – Banking Consulting, France

[1] ING Bank, Fiduceo, Simple, Moven, Fidor Bank, etc.
[2] Lending Club, Klickstarter
[3]Lendix in France, Kabbage and OneDeckin the United States, etc.
[4] Zopa in the UK, and KissKissBankBank in partnership with the Banque Postale in France
[5] Yomoni in partnership with CM Arkéa in France, Personal Capital and Wealthfront in the United States
[6] Finexkap in France
[7] http://www.fsb.org/wp-content/uploads/FSB-Chair-letter-to-G20-Ministers-and-Governors-February-2016.pdf
Translator’s note: this link takes readers directly to Carney’s letter in English