Payments Today – Regulation and Non Market Forces

There are four drivers of non-bank participation in FinTech being:

  • Banks
  • Customers
  • Regulation
  • Innovation

Regulation is a two edged sword for Fintech. The sharp edge for entrepreneurs are the high costs incurred by banks that non-banks may be able to avoid and therefore offer cheaper and better services, focussing instead on the sexy front end while the banks continue to spend large amounts on compliance.  Some regulations such as the Payments Services Directive (PSDII) are opening the industry up to non-bank players, particularly those with digital skills, by standardising access to bank accounts and simplifying the rules our licenses and exemptions to banking licenses

The sharp edge for banks is the high barrier to entry that regulation and compliance incurs and which limit innovation and participation in the industry.

Regulation exits to protect the consumer and reinforce their trust in the system, inferring that their money and data are safe. This has traditionally has made it harder for non-banks to participate but there are a few exceptions.

There is much to protect. As well as fraudulent use of accounts, there is customer data to protect to ensure that customer transaction data, locations and other information is not used by unauthorised agents. It is critical that any funds being held are available which mandates sufficient liquidity be held to honour any withdrawal requests

This protection of the payments systems largely fall upon the central banks (e.g. the Reserve Bank of Australia) and ancillary authorities (such as APRA and ASIC in Australia).  Banks exist to act as an intermediary between those with money (deposits) and those without (loans) and to cover the inherent difference in time between the supply and demand. The primary purpose of regulation is to ensure the solvency of the institutions. On top of that role there are a host of other agencies that get involved in areas such as consumer protection, competition and law enforcement, with the latter being particularly popular post 911 and the attention on terrorism and the associated Ante-Money Laundering (AML) and post Financial Crisis and the attention on knowing your customer (KYC)

As a general role, the holding of funds will require a company to gain a banking license and be subject to banking regulations. Providers of payments services are also regulated by rather than a banking license, a payment service provider license will be required to control how customer funds are handled.

In cross border remittances banks often face higher regulatory requirements than non-banks. This has enabled Western Union, Moneygram and others to build reasonable businesses ahead of banks as it has been easier for them to set up operations in multiple jurisdictions.

As the regulatory and compliance environment increases in size and complexity being innovative has a tendency to become more difficult for the banks and open an opportunity for non-banks to play

Non-banks, unencumbered by the operating procedures of the banks can then arrive with new opportunities for efficiency and customer service. Mobile payments are a very good example here. Anywhere where such non-banks can help banks reduce costs or reach more customers will offer an opportunity for banks to partner with non-banks, as the recent explosion in interest in Ripple has shown. Competition from non-banks is driving banks to offer better services and improve the overall efficiency and therefore safety and reliability of the banking system. It is very much in the interest of the regulator to encourage innovation and participation by non-banks.

Financial Inclusion and Literacy is gathering a large amount of attention at a global policy level. Expanding access to the half of the world’s population that do not have banking access today as well as vastly improving the product knowledge of those that do have access has become a real priority at the UN and World Bank. With regulations being handed down for banks to own this problem there will be increased opportunity for innovators to figure out not only how to deliver banking access to everyone but to ensure they use banking in a safe way and to get ahead.

Key within Financial Inclusion are the rules around signup and account opening. In 2011 the regulators in Mexico altered the rules to allow users to open low risk banking accounts remotely with limited identification. Certain restrictions on account and transaction sizes were put in place to limit money laundering risk keeping the both the financial inclusion and crime agency pundits happy

Competition and innovation is fabulous for consumers. It reduce costs and improves service while limiting the concentration of power and risk with in a financial system. It is therefore incumbent on regulators to ensure that they don’t lock down an environment to the extent that only the big banks can play

There are some very specific areas where regulation will impact innovation and participation of non bank providers:

-Concentration Issues – As banks outsource parts of the back office in particular there is a risk that services are offered by only a small number of players, presenting an operational risk. Regulators should seek to ensure that numerous entities are playing and offering backup so and so reduce systemic failure from one or more players being struck with downtime, for whatever reason

– Stakeholder Involvement. Industry bodies are primarily made up of banks with very little participation from non-banks and particularly start-ups. This means that standards and operating procedures will largely have a bank flavour and lack start-up input. Larger organisations are also more likely to have people dedicated to the task of industry participation while smaller firms will lack the resources to dedicate to industry initiatives. Engaging new players will be challenging for the industry

With these issues in mind it is important that the central banks and regulatory authorities lead the change. They need to use their influence and insight to facilitate and drive change, encouraging innovation and start-up involvement. They might for example identify issues within the system that need solving and bring start-ups and banks together to participate in their solution. As operators of some of the core systems for settlement, inviting start-ups and non-banks to participate in the development of the roadmaps for the future will help drive the innovation at an industry level.

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Digital is rapidly commoditising banking around the world, forcing participants to compete on margin erosion and funding. In the new engagement economy, there is an alternative: Harness the power of game to build digital experiences that deepen customer relationships, provide value and are relevant by supporting customers to thrive with their money.