February 26, 2019

While speaking at the third annual Conference on Fintech and Digital Innovation in Brussels, Yves Mersch of ECB discussed the impact of fintech on core banking services, particularly the credit business. He highlighted that fintech credit makes up only a very small fraction of overall credit, but it is growing rapidly and could become more dominant in certain market segments. In the United States, for example, 36% of unsecured personal lending was issued by fintechs in 2017.

Mr. Mersch added that globally active technology companies, also known as the big tech companies, are also entering the market. These companies have a competitive advantage because they can leverage their existing customer networks and huge amounts of proprietary data to provide financial services. Moreover, their enormous balance sheets give them the financial capacity to handle credit risks economically on a large scale. These comparative advantages of big tech could, in principle, generate benefits for customers. By using predictive algorithms, machine learning, and a wider range of data, big tech could become more efficient at lending than traditional banks. Moreover, if big tech can speed up loan application processing, reduce transaction costs, and improve credit risk assessments, it could increase the overall degree of competition in credit markets. With their increasing market share, these companies could help diversify the sources of credit to the economy, thus fostering investment and growth.

However, not only could large technology companies increase market concentration by exploiting their network externalities, but they could also create new risks. For example, risks could arise from big tech’s funding models, which often use a mix of internal and external investors to finance loans or repackage and sell them to third-party investors. Such originate-to-distribute models can lead to information asymmetries, incentive problems and financial instability—as was painfully learned from the mortgage lending that led to the subprime crisis. Another type of fintech is the so-called peer-to-peer lender, which offers credit services in a fundamentally different way to banks in that the services are unbundled. Electronic platforms typically match borrowers and investors without taking on balance sheet risks and generate fee revenue rather than net interest. Technological innovation may enable lending platforms to become more efficient and more targeted in terms of how they intermediate between borrowers and lenders and thus put pressure on incumbent banks. He argue that, until lending platforms can replicate the benefits of intermediation, they will not meaningfully challenge the role of banks in the economy because:

  • Lending platforms are unable to perform liquidity transformation on a significant scale—that is, to provide short-term liquidity services for depositors and long-term loans for borrowers.
  • Lending platforms are less resilient during shocks, being more prone to funding freezes and swings in credit risk appetite than banks, as at this stage they are small and not diversified. Also, banks have both insured deposits, which contain depositor runs, and higher levels of capital, which supports lending during downturns.

For these reasons, lending platforms are currently unlikely to threaten banks’ market position in lending. Still, these developments should be continuously monitored. As the competition between fintechs and incumbent banks unfolds, the financial system could become more diverse and competitive. It could also become more concentrated and new risks to financial stability could emerge. According to him to scenarios are possible in the future. In the first scenario, banks rise to the digital challenge by upgrading their technological systems and teaming up with fintechs. Risks to financial stability would be rather low, as financial services provision would remain largely subject to the existing prudential regime. In the second scenario, banks fail to provide the digital financial services demanded by customers. New, innovative, and fast-moving fintechs, or big tech firms with large customer networks, would come to dominate the market and lead to the financial stability risks. Therefore, "we certainly must continue monitoring developments closely and adjust regulation when and where needed to ensure that financial services remain safe and sound. He concludes that legislation and regulation should ensure a level playing field for all market players, incumbents, and new entrants alike.

 

Related Link: Speech

Keywords: Europe, EU, Banking, Lending, Regtech, Fintech, Bigtech, ECB

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