In the aftermath of the Global Financial Crisis of ’08, FinTech startups took the financial services industry by storm. More agile and technologically advanced than their incumbent counterparts, these companies accelerated the digitisation and unbundling of financial services, spurring innovation by competing and collaborating with banks.
The next wave of disruption, led by Big Tech, is likely to augment the roles of both traditional financial institutions and FinTech companies. Whereas FinTech startups have so far focused on employing technology to address particular deficiencies in the traditional financial services stack, Big Techs have the potential to re-build financial services from the ground up.
So, what are the reasons behind Big Tech’s coordinated move into financial services, and what opportunities and threats exist for a finance industry dominated by Big Tech?
Big Tech’s big competitive advantages
Technology companies hold four important competitive advantages that make them ideal candidates as financial service providers.
The first advantage relates to the way in which technology companies operate and create value — almost all Big Tech companies operate through a platform model, meaning they attract users through the ecosystem of services they provide (often for free), and collect fees from advertisers and merchants in exchange for access to their user base. In economic terms, this is known as a two-sided market. The growth of participants in one side of the platform increases its value to those on the other. This symbiotic relationship creates a positive feedbook loop that enables important network externalities and promotes rapid growth.
Platforms that provide a broad range of services are able to better capitalise on the externalities of network effects. As technology companies diversify their businesses (e.g. towards finance), the richness and variety of the data they are able to collect on their users grows. These new datasets, used in combination with existing user data, have significant potential for unlocking fresh insights and creating new opportunities for monetisation.
A second competitive advantage held by Big Techs over banks is their brand value. Financial services are built on trust — and the Global Financial Crisis is only one of a string of financial crises that have proliferated widespread public mistrust in the banking sector. A 2019 survey conducted by Bain of 151,894 consumers in 29 countries found that 54% of respondents consider at least one technology company to be more trustworthy than banks in general. When compared to banks, Big Techs tend to take a more consumer-centric approach to business, offering superior user experiences and maintaining better relationships with its customers. By leveraging their brand image, technology companies have the potential to rapidly steal market share from incumbents in finance.
A third competitive advantage held by Big Tech relates to the benefits of diversification and scale. By expanding into financial services, technology companies have the opportunity to diversify their existing businesses and seek new prospects for growth. The number of global smartphone users is growing by hundreds of millions each year, driven in particular by growth in emerging markets, where mobile banking services likely to comprise a substantial portion of this activity. Platforms that provide a comprehensive and integrated range of services have the best chance of capturing this growth.
Fourth, and from a financial standpoint, technology companies hold important advantages over the competition in terms of their ability to raise capital — their cost of borrowing is lower than that of banks (as a result of their greater profitability) as well as nascent startups (given their scale and deep entrenchment in the market). This allows technology companies to take on greater risk and provide outsized returns to investors.
Not all entrants are motivated by the same strategic considerations
While there are similarities in the competitive advantages enjoyed by Big Techs, not all companies that seek to enter into finance are motivated by the same strategic considerations.
A review conducted by BIS of the competitive landscape of Big Tech’s financial services reveals that players are split between two camps:
- Those seeking to expand into financial services with the aim of diversifying their business lines and enhancing existing service offerings. These are often companies operating in developed, Western markets building services overlaid on traditional financial infrastructure.
- Those seeking to provide financial services to fill crucial gaps in existing infrastructure. These are, most commonly, tech companies operating in emerging markets characterised by poor financial infrastructure and low levels of financial inclusion.
In China, for example, Alipay started in 2004 as a simple escrow service to address the issue of a lack of trust between buyers and sellers on Alibaba, but has since evolved to encompass a full range of financial products across the consumer finance stack, serving as a conduit between China’s underbanked population and its financial markets. In Africa, M-Pesa was launched in 2007 by Vodafone as a peer-to-peer payment services to allow users to deposit and send money using their mobile phones by way of text message. The service grew quickly and, by 2010, became the largest mobile financial service platform in the developing world, dramatically transforming financial participation in the region.
A key reason why these companies were so successful is that they happened to operate in regions characterised by large underserved populations with high demand for more accessible financial services. In the West, the competitive landscape can be quite different — financial services tend to be more immune to disruption in these markets because of their maturity and high levels of market penetration. The existence of complex regulatory frameworks can also pose significant barriers to entry, an issue we will return to later. This may explain why Western Big Techs have so far focused on less disruptive auxiliary services (such as digital wallets) that serve as an interface to, rather than a replacement for, existing financial infrastructure.
That is not to say that Big Tech will continue to play a superficial role in financial services. Behind the scenes, Google and Amazon have been steadily acquiring a string of financial service startups to bolster their capabilities, while Facebook is now seeking to leverage its social network and blockchain expertise to build Libra, a global payments processing system.
One reason why Big Techs have so far preferred to work under the radar may be to avoid provoking regulatory retaliation. Technology companies thrive on innovation and agility, and the compliance requirements associated with today’s highly regulated finance sector stand at odds with these objectives. By working at a slower pace, Big Techs have a better chance of working around regulatory hurdles and working out how best to play its hand over the long term.
Clearly, significant potential exists for technology companies seeking to enter the financial services market. Let us now turn to some of the challenges that Big Techs can expect to face, to understand the case against disruption by Big Tech.
It all comes down to regulation
The regulatory fabric that governs financial services is incredibly complex and varies substantially by region. Policy initiatives are often mandated by organisations operating at different levels of government, and not always aligned towards consistent objectives.
In the EU, for example:
- Open banking regulation known as Payment Services Directive 2 (PSD2), introduced in 2018, seeks to place ownership of personal financial data back in the hands of customers, while making such data more easily shareable through the use of open-source APIs. Aimed at promoting innovation and disruption, PSD2 reduces barriers of entry for new entrants to the finance sector and is likely to benefit Big Tech companies.
- General Data Protection Regulation (GDPR), also implemented in 2018, seeks to apply sweeping restrictions over the right to use or share customers’ personal data. In addition to requiring customer consent, GDPR sets limitations on the ways in which personal financial data can be used and shared.
The overlap in scope and potential discrepancies between these two pieces of regulation (e.g. as identified by Deloitte and other consulting companies) may increase compliance costs and ultimately hamper innovation. Regulatory authorities need to provide clearer direction as to the interactions between conflicting directives.
In the US, federal law mandates the seperation of banking and commercial activities, limiting the scope for non-bank Fintech companies to offer financial services. As embedded finance (the vertical integration of financial services into e-commerce and other non-financial services) increasingly blurs the line between financial and non-financial activities, regulators will need to adapt their frameworks to stay apace of innovative business models in ensuring that innovation is encouraged, not stifled.
Of course, innovation should not be heralded as an over-riding objective at the expense of other policy considerations. Big Techs’ monopolistic or oligopolistic hold over user data has important antitrust implications that must be balanced against the potential benefits of disruption. Recent concerns over the ownership rights and misuse of personal data culminated in a congressional hearing on antitrust on July 2020, during which the CEOs of Facebook, Apple, Google and Amazon gave evidence on the business practices of the companies they lead. How technology companies manage consumer data will ultimately determine whether they are able to sustain their competitive advantage in the market. Just as financial institutions have lost consumers’ trust over the management of their finances, technology companies may stand to lose the trust of consumers over the management of their data.
In the finance sector, the centralisation of power amongst a small number of decision-makers was a major catalyst for past crises. If Big Tech comes to dominate financial services, these risks have the potential to replicate and transfer across to technology companies in ways we don’t yet fully understand. Morever, as new forms of finance proliferate, regulators may become less well-equipped to regulate Big Tech’s financial activities over time.
Finally, there is a potential for the deepening of systemic risks as technology companies move into more complex avenues of finance. As Big Tech become increasingly important providers of financial services — whether in managing customer relationships, providing the underlying infrastructure or underwriting the products themselves, new propagation mechanisms are likely to materialise that magnify shocks and increase the complexity of our financial system. Without the appropriate risk management functions in place, the next financial crisis may well originate from a player such as Google or Facebook.
Our future in the balance
Big Tech’s recent decision to deplatform Trump and the millions of conservative voices on social network Parler have elevated concerns over the dangers of its unchecked power.
As Big Tech moves further into financial services, we should recognise that disruption is a double-edge sword: technological innovation and financial inclusion will no doubt lead to benefits for consumers, but the flipside is that it affords Big Tech the opportunity to further consolidate power and amass influence over yet another aspect of our lives.