BigTech in finance - An ‘imperfect’ match

Google, Apple and Samsung Pay, Amazon issuing loans, Vodafone’s M-Pesa, Facebook’s Libra and more. The trend is hard to ignore. BigTech is moving into financial services and this has serious implications for consumer protection, financial stability, existing regulatory frameworks, competition policy and data privacy. 

Why finance?

First things first is to understand why BigTechs are entering this market. The fact is that their core business model provides them with a natural competitive advantage over existing players, namely through the “data-network-activities” loop. Users’ data is stored on centralised databases and is then utilised to offer a range of services that exploit natural network effects, generating further user activity. Increased user activity then completes the loop, as it generates yet more data. In short, more data generates stronger network effects, which elicit more activity, leading to yet more data. This loop has enabled BigTechs to directly interact with millions, if not billions, of users and establish very sophisticated ecosystems with evermore features and services. 

With this in mind, their strategy becomes clear i.e. to promote increasing consumer participation to the point where all their needs can be met within the BigTech’s ecosystem, which will generate evermore valuable data. 

Financial services providers currently stand as powerful intermediaries between the platform, such as Amazon, and the user. While their role is crucial in enabling the BigTech to earn revenue, they also add steps to the customer journey. Mitigating this buying/selling friction is the logical route to strengthening the platform’s market position. 

Challenges

While exploiting existing customer networks and the massive quantities of data is what will give BigTech an edge over its competitors in the financial space, it is also the cause of policymakers’ concerns. 

First of all, there is the financial stability risk. If BigTech are to remove the financial intermediary, and directly deposit customer funds with banks, there are concerns that this will create a parallel payments system that is not properly overseen by the central bank. This could potentially undermine financial stability and shield payments from the scrutiny of authorities guarding against illegal activities, such as money laundering.

Secondly, many jurisdictions’ financial regulatory framework does not adequately cover these newcomers. This could lead to anti-competitive practices. Further, it is unclear whether BigTech would come under the scope of prudential supervision. 

Thirdly, there are questions around data privacy and consumer protection. How will these companies avoid discrimination in credit scoring, credit provision and insurance? Proposals to use artificial intelligence and machine learning algorithms have only exacerbated these concerns. 

Finally, cybersecurity or lack thereof, as big tech firms provide third-party services to many financial institutions (e.g. data storage, transmission or analytics), which could pose a systemic risk if there is an operational failure or a cyber-attack.

Policy Recommendations

Given the new challenges posed by BigTech, public policy should focus on closer cooperation between national authorities, namely competition authorities, financial regulators and data protection authorities. Additionally, due to the ubiquity of these platforms across the globe, jurisdictions should agree to international rules and standards, further enhancing cross-border cooperation. 

In regards to the BigTechs themselves, they should show caution in approaching this space. As Irish author Jonathan Swift said ‘Money is the lifeblood of the nation’. It is therefore perhaps unsurprising that any flow of money, such as in financial services, rank as one the most regulated area of society. The threshold for allowing new business models in this space is very high. Companies such as Facebook need to regain the trust of the public and of the regulators if they are to make a success out of this shift. As Gary Gensler, former co-head of finance at Goldman Sachs and the 11th chairperson of the Commodity Futures Trading Commission, recently said on an expert panel before Congress: ‘All of finance has one foundation. And it’s trust. For some unexplained reason, Facebook has chosen to make these bold proposals when trust is not in good supply.’ 

There’s no question that regulators are concerned of the financial and monetary impact BigTech could have. This can be seen in the somewhat knee-jerk reaction of the U.S Congress with its Draft Bill on ‘prohibiting large platform utilities from being a financial institution’. 

While authorities are right to investigate these large companies’ credibility as trustworthy financial services providers, an outright ban seems counter-productive. Many consumers and merchants have suffered from the big banks’ poor service and legacy systems. Their established market position could do with pressure from newcomers. If adequately regulated, BigTech could lead to more competition and usher in a new era of financial inclusion and efficiency, doing to the transferring of value what the internet has done to the transferring of information.