Financial regulators have spent centuries working on ways to contain banks, making sure their services are fair and they won’t crash the economy. As big technologies companies like Facebook and Tencent tread deeper into finance, these watchdogs are going to have to expand the way they oversee the financial system.
Silicon Valley’s biggest companies have been making inroads into finance in Europe and North America, but the process has moved much more quickly in China. This makes sense: Technology upstarts have had more success in developing economies where the financial infrastructure, from regulation to bank branches, is less entrenched. WeChat Pay and Alipay, run by technology titans Tencent and Ant Financial, respectively, have gobbled up market share in China, while US-based Google and Facebook have lagged behind in their domestic markets when it comes to financial services.
Now, with the Libra cryptocurrency, Facebook and its 27 partners are looking to radically overhaul how things are paid for online and across borders, particularly in places where financial systems are underdeveloped. Wall Street executives have long worried about data-centric tech business models disrupting traditional banking. A report published today by the Bank for International Settlements (BIS) suggests that this shift could have benefits, by bringing more people into the formal financial system, but it will also require new types of regulation, such as a bigger focus on data privacy.
Tech companies’ platforms can “easily be scaled up to provide basic financial services, especially in places where a large part of the population remains unbanked,” BIS researchers wrote in the report. Big tech firms have vast users networks and immense troves of data that can be used to assess creditworthiness, for example, which could promote financial inclusion. But there’s also the risk that these companies quickly become systemically important.
The BIS said recent research suggests that big tech firms’ credit-scoring processes for small businesses “outperforms” models based on credit bureau ratings and traditional borrower metrics. But it also cautioned that it’s early days and the new lending platforms haven’t proven themselves during an economic downturn. In addition, their use of personal data could result in high-risk groups getting excluded from insurance markets, as even sophisticated algorithms can be imprinted with biases toward minorities.
“Public policy needs to build on a more comprehensive approach that draws on financial regulation, competition policy and data privacy regulation,” the BIS wrote. Europe’s data protection watchdog, it’s worth noting, was among the first regulators to react to the Libra announcement.
Nobody wants to be regulated like a bank
The big tech and finance debate has been talked about for years, in part because of the success of Alibaba affiliate Ant Financial (Quartz membership exclusive), a pillar of the Chinese consumer financial system that was valued last year at more than Goldman Sachs and Morgan Stanley combined. Major tech firms in the US have been more cautious about the financial sector, which invites heavy-handed government regulation. Indeed, after China’s financial watchdogs clamped down on Ant Financial, the company began emphasizing its technology services instead.
Facebook’s unveiling of Libra, slated to launch in mid-2020, renewed the discussion, and regulators around the world reacted quickly. “Unlike social media for which standards and regulations are being debated well after it has been adopted by billions of users, the terms of engagement for innovations such as Libra must be adopted in advance of any launch,” Mark Carney, governor of the Bank of England, said in a speech.
Whether or not Libra is a success, technology companies are increasingly treading on traditional banks’ turf. Six non-banks have connected to the Bank of England’s payment systems, and the central bank says 20 other upstarts want to do the same. Carney said policymakers are considering going even further, by letting tech companies hold interest-bearing deposits at the central bank, something that only commercial banks have historically been allowed to do.
“Commercial banks have to be very much on their toes,” Hyun Song Shin, economic adviser and head of research at the BIS, said in a phone interview. Still, it’s far too early to count out the commercial banks. “For historical reasons, they have been very heavily regulated because they also are the custodians of the retail deposits, and quite often those deposits are guaranteed through deposit insurance,” Shin said. This has given the banks a funding advantage over other sorts of companies trying to break into finance.
The BIS suggested that the playing field could be reset somewhat by broadening access to the data that fuels the big tech business model in some instances, and by restricting data in other cases. (EU competition commissioner Margrethe Vestager has argued that making Facebook share its data could be better than breaking it into pieces.) “Given the network effects underlying competition, the competitive playing field may be leveled out more effectively by placing well designed limits on the use of data,” the BIS said.