This post covers Regulations, Landscape, Gaps, and Risk Management in the fintech industry.
REGULATION PARADOX
1. The outcry of the BitCoin community for more regulation is increasing. Many prominent members of the BitCoin community think that more regulation is needed to restore the confidence in BitCoin and enhance its growth.
2. External regulatory and audit expectations, in fact, enhance and catalyze internal regulations and audit capabilities, meaning more external regulation makes FinTech companies ceteris paribus internally, and overall, safer. (This is not necessarily true to organizations that already have a developed internal regulatory and audit system. For the already mature players, much of the external regulation may be repetitive and costly.)
3. One of the difficulties is that FinTech companies are usually outside of the deposit insurance schemes (FDIC in the USA, FSCS in the UK, etc.). This causes some distrust towards them in case any money for any (short) instance is stored, held, handled, owned, transferred or exchanged by them. But, becoming part of a deposit insurance scheme brings regulatory requirements and costs with itself.
4. FinTech companies are not fully licensed banks. A full banking license is a huge prestige, but, of course, a costly burden as well. There are the so called Neo-Banks that are FinTech companies either holding their own license or very closely cooperating with a fully chartered FinServ company. One of the most exciting things Eyes on is the story of the US/UK based company: Standard Treasury. Standard Treasury is currently applying to become an independent UK bank and is working with the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) to become an authorized bank.
DYAMIC LANSCAPE
1. a moderate deregulation of large banks strangled by overregulation is in the foresight. Let’s take the example of the USA: Now that both Houses of the Congress are Republican, there is already a significant movement behind trying to eliminate parts of Dodd-Frank.
2. The regulation of brick and mortar banks are taking a shy U-turn, moving now towards moderate deregulation, while, on the other hand, there is significant regulatory commitment to address BitCoin regulation and the regulation of Crowdfunding. So, the two functions (tight banking regulations easing and deficient FinTech regulations tightening) are probably approaching the same limit but from opposite directions. This is called a ‘Regulatory Convergence’.
3. Some countries and jurisdictions are moving towards a so called ‘Split Regulation Model’. South Korea is the best example, recently putting FinTech on its flag. They have communicated that the South Korean FinTech community has to be strengthened and enhanced, and they think that special, dedicated regulation is one of the tools to achieve this. The definition of the ‘Split Regulation Model’ is when regulation for FinTech companies vs brick and mortar banks significantly and consciously differs.
4. The incumbent financial community has a strong lobby power, while the FinTech community has virtually no lobby power. This difference in the abilities to affect regulations may justify permanently lower regulations for the FinTech community.
COMPREHENSION GAPS
1. FinTech companies don’t have the administrative and legal apparatus to handle many complex rules. Looking at a very simple FinTech company, there is a complex matrix of risk-management and compliance needs: different jurisdictions of registration versus different jurisdictions of operation, the geographic compositions of clientele versus client and service groups. This adds up to be a complex regulation-matrix that is impossible to fully comprehend and handle with limited resources.
2. There are significant differences between FinTech companies doing the same thing in their approaches towards specific compliance, risk and regulatory issues. TransferWise and CurrencyFair are doing pretty much the same, but CurrencyFair – according to our research – is following more rigorous rules. FinTech companies are taking on calculated risks in this arena by not being able to (nor probably willing to) fully comply with all possible requirements.
3. To what extent do the authorities understand cutting edge FinTech? Do they have the right organizational culture and knowledge, skills, capabilities, traditions, task forces, expertise and commitment to become capable of understanding these processes, technologies and their risk, compliance and regulatory implications? And if yes, do they have the capability to follow this fast moving target?
4. Besides their core competence of regulating well-established financial institutions, the authorities have an obligation to keep their eyes on the so-called shadow financial system, or shadow banking. Will these authorities have the ability to balance between the incumbent financial players, FinTech and the dangers of shadow-banking? Will they be able to differentiate?
OVERREGULATION
1.There is a thick wall of overregulation surrounding full license banks. Authorities are often threatening cutting banks into pieces, they have theories about putting additional burden on ‘too big to fail’ institutions and SIFIs (Systemically Important Financial Institutions). Meanwhile, there are huge, growing technical and legal burdens on privacy and data-protection issues and cyber-security. Capital requirements are growing, safe and fair landing regulations are surging.
2. KYC (Know Your Customer) procedures and other compliance requirements are complicated, lengthy and often unrealistic. And amidst this overregulation, the legislative and regulatory risks themselves have grown significantly. These are the risks that changing legal framework or regulatory requirements pose to business.
RISK MANAGEMENT
1. Reputational risk - Large banks have difficulty coming to market with their internal innovations due to the risk that if it goes wrong it can distract important clients from the company. However, a degree of uncertainty and post-event bearing of responsibility is more acceptable from a FinTech startup’s perspective.
2. Operational risk - New systems are uncertain. This is okay if you only have one system. But, if a new innovative system malfunctions at a large bank, it can bring down other connected systems, resulting in huge operational losses.
3. Market risk - Market risks are very significant for FinTech startups. An idea that may sound great and may indeed be great can easily be something that lacks any sufficient demand when it is delivered. Large banks have an advantage in bearing this market risk.
4. Legal risks - Large banks are known for paying significant remedies. And a new solution may not be worth an eight or nine digit fine or customer-compensation.
5. Risk of not acting, risk of falling behind - As there are risks associated with bringing innovations to market, there are at least equal risks in not bringing new things to customers. This is the inaction-risk. Major banks have to evaluate this when they consider innovation.
6. Risk of risk-management innovations - A substantial area in FinTech is the new types of scoring systems. Psychometric and social-media-based scoring solutions are surging. The essence of all these is that they are less strict in blocking loans from being originated than the traditional models. Before 2008, a number of banks mentioning their hyper- advanced scoring and risk-assessment systems that almost never fail.
7. Regulatory and legislative risks - As markets themselves have been unpredictable since 2008, so have regulations. The changing rules are posing a risk. ‘What is coming next?’ Interestingly enough, there is a very exciting dedicated sub-area of banking innovations focusing on new ways to adjust to changing regulations. So there is a wave of “innovative-compliance”.
8. Cross border risks - Regulations and regulators are mostly national. But, more and more of the finance world is becoming international, more so with FinTech companies, often lacking a branch-network and only operating on the web which makes it not only more adequate but also much easier and less costly to go international.
(Source: MarketResearch)
