Courtesy of Miguel de la Mano and Jorge Padilla
The entry of Big Tech players, such as Google, Facebook and Amazon, into online banking will fundamentally alter retail banking’s competitive landscape. Big Tech platforms have large, installed customer bases, established reputations, powerful brands, considerable earnings and unfettered access to capital markets. They can leverage superior information on consumer preferences, habits and conduct; control the shopping experiences of many consumers; and shape the distribution and commercialization of their suppliers.
Big Tech platforms are well-equipped to leverage the explosion in big data; advances in artificial intelligence, computing power, and cryptography; and the reach of the Internet. These technologies enable new financial applications around payments, financing, asset management, and insurance.
The impact of Big Tech on retail banking has already been felt in Asia. For example, China’s most prominent online commerce company, Alibaba, launched in 1999 and started Taobao in 2003 as a consumer e-commerce platform. In 2004 they added Alipay as a third-party online payment platform. Since then, Alipay (renamed Ant Financial in 2014) has played a vital role in Alibaba’s success and has built its standalone presence with a wide range of financial offerings, including payments, wealth management, lending, insurance, and credit scoring.
In our recent paper published in the Journal of Competition Law and Economics, we explain why the entry of Big Tech platforms will transform the retail banking industry in radical ways. While it may increase competition to the benefit of consumers in the short-term, within a few years, Big Tech companies may succeed in monopolizing the origination and distribution of loans to consumers and SMEs, forcing traditional banks to become “low cost manufacturers” that merely fund the loans intermediated by the Big Techs. This may harm competition, reduce consumer welfare, and bring about an increase in financial instability.
Our risk assessment is not unduly alarmist or exaggerated. As stated in the recent McKinsey Global Banking Review 2018: “investors appear to lack confidence in the future of banks” due “in part to doubts about whether banks can maintain their historical leadership of the financial intermediation system.” In McKinsey’s view, banks are under threat from other financial services firms, non-bank challengers, and technology companies. They risk being “disintermediated from their customers, disaggregated, commoditized and made invisible.” If that risk materializes, only banks “with strong balance sheets, deep access to low cost funds, and strong financing abilities” may be able to compete effectively.
It is uncertain if Big Tech’s entry will end up fostering competition in retail banking and increasing consumer welfare in the medium and long-term. It will largely depend on the ability of traditional banks to ring fence their loyal and highly profitable customer bases, exploit their informational advantages and reputation regarding data protection, and/or bundle products with the current accounts of their customers. If they manage to do so, they may mitigate the exodus of customers from traditional banks. It will also depend on the degree of competition among the Big Tech platforms that choose to enter the banking industry and the response of regulators to Big Tech banking.
It is in society’s interest that traditional banks find a way to compete with digital-based competitors, but this may prove hard given the data advantages enjoyed by Big Tech companies. These advantages allow Big Tech firms to cross-subsidize banking operations with the high profits obtained in their traditional platforms. Big Tech firms may be willing to suffer losses in their banking operations – for a time – in order to gain access to the valuable customer data that comes with it.
As banking business models and their underlying technologies evolve dynamically, the choice of the appropriate regulatory framework presents difficulties. The wrong choice may unduly stifle beneficial innovation, while being too accommodative may lead to a highly concentrated banking with the accompanying moral hazard and adverse selection problems that threaten financial stability.
We have considered alternative ways of maximising the benefits of Big Tech banking while limiting the risk of monopolization. In particular, we highlight methods to limit the data superiority of Big Tech platforms in order to create an informational level playing field. Our preferred option is to mandate data sharing. While other alternatives, such as antitrust intervention and privacy regulation, are available and could be useful complements to data sharing, they may prove insufficient on their own.
We cannot ignore the risk that mandated and reciprocal data sharing may prove de facto insufficient to prevent the monopolization of the most profitable banking markets. Big Tech platforms, free from capital requirements and the many other regulations constraining the ability of traditional banks to experiment with new products and business models, may out-invest and thus out-compete banks. Banks may become dependent on the Big Tech platforms, which may become “gatekeepers” to markets and consumers. Competition authorities should therefore be vigilant to avoid borrowers that are systematically “steered” towards the Big Tech proprietary (or affiliated) services, especially if they are more expensive and of lower quality. They should also be prepared for the possibility that mergers and acquisitions may be useful for banks to achieve the scale needed to remain competitive in the technological race that has begun. In fact, better technology was offered as the primary reason behind the recently announced SunTrust and BB&T merger.
Competition law may not be able to address the risk of monopolization on its own and antitrust policy is not good at formulating specific rules for particular industries. However, other policies should complement the rules of competition (and consumer protection). Banking regulators may have to modify the status quo and reconsider existing regulatory constraints, especially those that have an asymmetric impact on established banks. They may also have to facilitate innovation and business model experimentation by traditional banks, using “regulatory sandboxes” for example. Banking regulators may also have to consider whether Big Tech firms should be brought within the regulatory perimeter.
When Big Tech platforms enter the market, they often remain outside the scope of existing regulations. By functioning as a mere conduit between clients and financial institutions, they are not subject to all the laws applicable to financial institutions, even if these institutions come to depend upon Big Tech conduits. Big Tech firms may not be subject to client/customer/investor protection rules that maintain market integrity. They are also not subject to measures that limit or control the level of interconnectedness between financial intermediaries, thereby preventing the build-up of systemic risk.
In principle, existing financial regulation is designed to mitigate these risks. For instance, issues associated with shelf fees for mutual funds in the US are well-known and have prompted regulatory responses, including mandatory disclosure and outright bans; while in the EU, following adoption of MiFID II, financial services firms must disclose whether their preselection of financial products is independent and neutral (or dependent and potentially biased by kickbacks paid from third parties). Fees received by the investment firms must not impair compliance with the investment firm’s duty to act honestly, fairly and professionally in accordance with the best interests of their clients. As to predatory lending, financial regulation often imposes fair lending policies and charges supervisors with enforcing these rules. However, Big Tech platforms often operate outside the perimeter of these regulations and there is limited legal certainty as to whether these regulations apply to platforms that rely, for instance, on algorithmic preferencing.
The conceptual legal question of to whom Big Tech platforms owe duties also matters. US and EU laws assign to financial advisers, asset, and fund managers the status of a fiduciary, which means all their business activities must be aligned with the interests of their clients. Similar safeguards may typically be missing for customers, clients and investors when dealing with Big Tech platforms, at least in the initial stages after entry into the provision of retail banking products and services to end consumers or SMEs.
Big Tech platforms’ data-driven micro-segmentation could generate profits by exploiting customer weaknesses. For instance, they could adjust prices upward for customers insensitive to price or unwilling to switch products and providers. While exploitation of brand loyalty, inertia, or willingness to pay would violate typical financial law requirements to treat customers fairly, the inapplicability of financial regulation in this respect grants Big Tech platforms undesirable incentives and opportunities.
For this and other related reasons we believe it is time to consider closing the “regulatory gap” between incumbents and Big Tech entrants. For example, if a Big Tech platform has discretion in selecting potential borrowers or portfolios of borrowers for their clients, then they should be regulated as portfolio managers. And when the platform provides payment services without resorting to a third-party payment service provider, it should be subject to payment services regulation. Finally, if platforms develop secondary markets for their products, and issue tradable and non-tradable securities, they should be subject to securities regulation.
Experience shows that regulatory decisions can have long-lasting impacts on nascent products and industries. Thus, it is important to identify the right regulatory framework early, in order to address the potential adverse impact the entry of Big Tech platforms will have on retail financial markets. If we do nothing, systemic risk may build up unobserved, unmitigated, and uncontrolled, and the next global financial crisis may come from Big Tech platforms rather than authorized financial institutions.