FSB flags financial stability concerns over Bigtech in finance and over-reliance on third party service providers

The Financial Stability Board (FSB) has published a report assessing fintech market developments and their potential implications for global financial stability. The report focuses on the impact that new market entrants - in the form of fintech firms (Fintechs) and big tech companies (Bigtechs) – are having on the financial services market structure and the potential resulting destabilising effect on the financial system as a whole. It considers that Bigtechs have the greater disruptive potential due to perceived competitive advantages over both Fintechs and traditional banks. Overall the FSB recommends ongoing “vigilance” by supervisors.

The changing landscape of the financial services market

The FSB - which makes recommendations to the G20 on financial regulation – published its Fintech and market structure in financial services report last week. “Market structure” here refers to the “interrelationship of companies in a market that impacts their behaviour and ability to make profits” as affected by factors such as the number and size of market participants, barriers to entry and exit and accessibility of information and technologies to all participants.

The report assesses the global fintech landscape, looking at:

  • financial innovation and links to market structure: focusing on supply factors in terms of new technology and  regulation – such as open banking - and demand factors such as changing customer expectations, and 
  • the current landscape: focussing specifically on the impact to date of fintech, big tech and third party service providers and how firms utilise cloud computing, 

and going on to draw some general conclusions on the implications for financial stability.

The FSB’s key concerns

The FSB also considers that new entrants into the financial services space have the potential to bring benefits to financial stability, such as efficiency and resilience. However, at the same time, they introduce new risks – in particular, they can put pressure on traditional players’ profitability and thus encourage greater risk-taking to maintain margins.

Specific conclusions

In particular, the FSB examines three different global fintech related developments which are altering, or have the potential to alter, the current financial market structure – with potential implications for financial stability: 

(1) Cooperation between fintechs and traditional banks

The FSB's analysis of the link between technological innovation and market structure considers that to date, the relationship between incumbent financial institutions and Fintechs appears to be “largely complementary and cooperative in nature”. 

The FSB concludes that smaller fintechs have not had the anticipated competitive impact on financial services because they have not had access to low-cost funding or a wide customer base as would be necessary to disrupt the traditional banks dominance. The financial stability implications of Fintechs have generally been “judged to be small” although “this could change quickly” with the deeper involvement of Bigtech in the fintech space and the move towards open banking around the world.

(2) Bigtech providing financial services

Developing the theme of various commentators in recent months (see our previous blog post BIS throws spotlight on big tech in finance, (Dec 2019) the FSB agrees that competitive impact of Bigtech may be greater than that of fintech firms because Bigtech firms typically have large, established customer networks and enjoy name recognition and trust.

The FSB notes that Bigtechs have the competitive advantage of “cumulative big data” - being able to use and process large amounts of customer data acquired through the provision of non-financial services, such as social media, to help understand their customers’ behaviour and lifestyles which could them help them customise their offerings to meet individual needs.

The FSB suggests that by combining these competitive advantages with strong financial positions and access to low-cost capital, Bigtechs could “achieve scale very quickly in financial services”, particularly where network effects are present, such as in payments and settlements, lending, and potentially in insurance.

However, the FSB also notes that the incentives and barriers to entry for Bigtechs into financial services are not yet well understood and therefore warrant attention from regulators.

(3) Reliance by financial service firms on third-party service providers

The FSB also focuses on the reliance by financial institutions on third-party data service providers (for example data provision, cloud storage and analytics, and physical connectivity) for core operations.

Whist this level of reliance is estimated to be low at present there is potential for much higher reliance and the resulting market concentration between service providers could create the potential for an operational failure, cyber incident or insolvency to impact the ability of multiple financial institutions to provide services at the same time.

The FSB recommends that this concern be given ongoing attention from authorities and regulators.

What happens next?

The report follows up on issues raised in the FSB's Financial Stability Implications from Fintech report (June 2017) on the financial stability implications of Fintech. This identified 10 areas that warranted attention from regulatory authorities’, with 3 priorities for international collaboration:

  • managing operational risk from third-party service providers;
  • mitigating cyber risks; and
  • monitoring macrofinancial risks that could emerge as fintech activities increase.

Given the fast-changing landscape of the financial markets the FSB highlights the importance of ongoing monitoring of developments and their financial stability implications without making any specific recommendations. It also pointed to work being done with respect to the third party dependencies issue by the Basel committee on Banking Supervision, the International Organization of Securities Commission and by FSB Financial Innovation Network which is “looking into the activities of Bigtech in finance, including cross-border activities.

We will update you with developments in this space as they occur.