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FinTech and market structure in financial services: Market developments and potential financial stability implications 14 February 2019 The Financial Stability Board (FSB) is 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. Its mandate is set out in the FSB Charter, which governs the policymaking and related activities of the FSB. These activities, including any decisions reached in their context, shall not be binding or give rise to any legal rights or obligations under the FSBs Articles of Association. Contacting the Financial Stability Board Sign up for e-mail alerts: fsb/emailalert Follow the FSB on Twitter: FinStbBoard E-mail the FSB at: fsbfsb Copyright 2019 Financial Stability Board. Please refer to: fsb/terms_conditions/iii Table of Contents Page Executive summary . 1 1. Background and definitions . 3 2. Financial innovation and links to market structure . 5 2.1 Supply factors technological developments . 6 2.2 Supply factors regulation . 8 2.3 Demand factors changing customer expectations . 10 3. The current landscape . 11 3.1 Impact to date of FinTech firms . 11 3.2 Impact of BigTech firms . 12 3.3 Third-party service providers (e.g. cloud computing and financial market data) . 16 3.4 How firms utilise cloud computing . 16 4. Conclusions on financial stability and implications . 17 4.1 Summary of findings . 17 4.2 Implications . 19 Glossary . 21 Annex 1: The use of cloud computing by financial institutions . 22 Annex 2: FinTech credit in China, Korea, and the UK . 24 Annex 3: The impact of Yue Bao and other non-bank payment institutions online money market funds on market structure in China . 27 Annex 4: Non-bank payment institutions in China . 30 Contributors to the report . 32 iv 1 Executive summary Technological innovation holds great promise for the provision of financial services, with the potential to increase market access, the range of product offerings, and convenience while also lowering costs to clients. At the same time, new entrants into the financial services space, including FinTech firms and large, established technology companies (BigTech), could materially alter the universe of financial services providers.1This could in turn affect the degree of concentration and contestability in financial services, with both potential benefits and risks for financial stability. Greater competition and diversity in lending, payments, insurance, trading, and other areas of financial services can create a more efficient and resilient financial system. Notwithstanding these clear benefits to financial stability, heightened competition could also put pressure on financial institutions profitability. This could lead to additional risk taking among incumbents in order to maintain margins. Moreover, there could be new implications for financial stability from BigTech in finance and greater third-party dependencies. While markets have developed differently across jurisdictions, there are commonalities that warrant international discussion. While these commonalities may be global in scope, their impact on each jurisdiction depends on the state of development of the financial services industry and the regulatory environment. Some key considerations from the FSBs analysis of the link between technological innovation and market structure are the following: To date, the relationship between incumbent financial institutions and FinTech firms appears to be largely complementary and cooperative in nature. FinTech firms have generally not had sufficient access to the low-cost funding or the customer base necessary to pose a serious competitive threat to established financial institutions in mature financial market segments. Partnering allows FinTech firms to viably operate while still being relatively small and, depending on the jurisdiction and the business model, unburdened by some financial regulation while still benefitting from access to incumbents client base. At the same time, incumbents benefit from access to innovative technologies that provide a competitive edge. Yet there are exceptions to this trend, as some FinTech firms have established inroads in credit provision and payments. FinTech credit is growing rapidly, but is still small as a proportion of overall credit in most jurisdictions. To the extent that technology permits a further unbundling of profitable services traditionally offered by banks and other institutions, the profitability of such institutions may be negatively affected in the future. The competitive impact of BigTech may be greater than that of FinTech firms. BigTech firms typically have large, established customer networks and enjoy name recognition and trust. In many cases, these companies could also use proprietary customer data 1The 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.” FinTech firms is used here to describe firms whose business model focuses on these innovations. BigTech firms refers here to large technology companies that expand into the direct provision of financial services or of products very similar to financial products. The glossary provides an overview of terms used in the document. 2 generated through other services such as social media to help tailor their offerings to individual customers preferences. Combined with strong financial positions and access to low-cost capital, BigTech firms could achieve scale very quickly in financial services. This would be particularly true where network effects are present, such as in payments and settlements, lending, and potentially in insurance. Cross-subsidisation could allow BigTech firms to operate with lower margins and gain greater market share. Hence, while BigTech firms could represent a source of increased competition for incumbent financial institutions, in some scenarios, their participation may not result in a more competitive market over the longer term. A greater market share of BigTech may be associated with unchanged or higher concentration, along with a change in composition away from traditional players. A striking example is the mobile payments market in China, where two firms account for 94% of the overall market. Reliance by financial institutions on third-party data service providers (e.g. data provision, cloud storage and analytics, and physical connectivity) for core operations is currently estimated to be low. However, following the trend in other industries, some analysts predict that reliance will increase going forward. If high reliance 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. Thus, while increased reliance on third-party providers specialising in cloud services may reduce operational risk at the individual firm level (idiosyncratic risk), it could also pose new risks and challenges for the financial system as a whole, particularly if risks are not appropriately managed at the firm level, and if the complexities and interconnectedness of third parties and their usage continue to grow. This was noted in the conclusions of the FSBs 2017 report on FinTech to the G20,2and remains an issue for authorities to consider. As FinTech firms, BigTech firms, and the markets for third-party services continue to develop, it will be important to continue monitoring these developments and their financial stability implications. Further efforts on third-party dependencies are ongoing in the Basel Committee on Banking Supervision (BCBS) and International Organization of Securities Commissions (IOSCO). The FSB Financial Innovation Network (FIN) is further exploring the market for third-party services for financial institutions, including how they manage lock-in risk and cross-border issues. Moreover, FIN is looking into the activities of BigTech in finance, including cross-border activities. 2FSB (2017a), “Financial Stability Implications from FinTech: Supervisory and Regulatory Issues that Merit Authorities Attention,” June. 3 1. Background and definitions FinTech might affect financial stability by changing the market structure in financial services. As used in this report, market structure refers to the interrelation of companies in a market that impacts their behaviour and their ability to make profits. Market structure is characterised by such factors as the number and size of market participants, barriers to entry and exit, and accessibility of information and technologies to all participants.3In certain speculative scenarios, these in turn may have an impact on the stability of the financial system. Financial innovation could influence market structure in financial services through different channels, including the following: (i) The emergence of providers of bank-like services such as FinTech credit4or payments, which may impact markets and bank behaviour. The greater efficiency of new players may enhance the efficiency of financial services in the longer term. The absence of legacy systems also may favour new entrants.5These trends could have an impact on the revenue bases of banks and other incumbent financial institutions, making them potentially more profitable in some instances, or potentially more vulnerable to losses and reducing retained earnings as a source of internal capital. This could have an impact financial sector resilience and risk-taking. The speed at which new providers enter the sector could be a critical factor in determining how well incumbents adjust. (ii) The entry of large, well-established technology firms into financial services (BigTech).6Non-traditional institutions with established networks and accumulated big data have gained a foothold in financial services space in some jurisdictions, particularly in payments, and in some cases in credit, insurance, and wealth management. This too, could be a source of increased competition with established financial institutions. New BigTech players could offer lower-cost (or even free) services, since they could use the data obtained through these services for a variety of businesses. This in turn could also have a range of effects on existing markets. (iii) The provision of important services by third parties.7Financial institutions rely on third-party service providers for data provision, physical connectivity, and cloud services. The reliance of traditional financial institutions and FinTech firms on third-party service providers may increase over time. Systemic operational and cyber security risks may 3 See FSB (2016), “Fintech: Describing the Landscape and a Framework for Analysis,” March; and FSB (2017a). 4CGFS and FSB (2017), “FinTech Credit: Market developments, business models and financial stability implications,” May. 5See e.g. Kai Riemer, Ella Hafermalz, Armin Roosen, Nicolas Boussand, Hind El Aoufi, David Mo, Sudhir Pai, and Alex Kosheliev (2017), “The FinTech Advantage: Harnessing digital technology, keeping the customer in focus,” Capgemini and Sydney Business School, for a description of these factors in the Australian financial sector. 6 See Dirk Zetzsche, Ross Buckley, Douglas Arner and Janos Barberis (2018), “From FinTech to TechFin: The Regulatory Challenges of Data-Driven Finance,” New York University Journal of Law and Business, Forthcoming; Agustn Carstens (2018), “Big tech in finance and new challenges for public policy,” speech at FT Banking Summit, 4 December. 7For an overview of such dependencies prior to the global financial crisis, see Committee on Payment and Settlement Systems (CPSS) (2008), “The interdependencies of payment and settlement systems,” June. For a more recent perspective on risks from such dependencies for banks, see OCC (2017), “Semiannual Risk Perspective,” Fall, pp. 14-15. 4 arise if systemically important institutions or markets do not appropriately manage risks associated with third party outsourcing at the firm level.8Meanwhile, a shift in regulation towards open banking,9facilitated by changes in both technology and consumer preferences, could mean greater competition in certain services while also posing new risks. The combined effect of these developments may be far-reaching. This report considers changes in market structure in financial services due to technological innovation, and explores the potential impacts of these developments on financial stability.10Key elements of market structure for the purpose of this paper are concentration (the extent to which the industry is dominated by a small number of large firms), contestability (the extent to which the threat of new entrants leads to behaviour that resembles a more competitive market), and composition (the characteristics of market participants). Market structure is most often considered with reference to its effects on competition, but it may also be relevant to financial stability. Some studies find a non-linear link between competition among financial institutions and financial stability. In pa
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