Summary: New working papers by Bank of International Settlements (BIS) and Financial Stability Board (FSB) conclude that financial institutions are more vulnerable to BigTech companies compared to FinTech companies and the entrance of BigTech companies could significantly alter the financial landscape since they are both competitors as well as third party service providers and have unique advantages from existing user base and dominance of advanced technologies.
Similar to the disruption that technological innovation brought into sectors of retail and consumer business in the past decade (e.g. taxi services and Uber; Amazon and Toys R Us) it was expected that FinTech companies would disrupt banking and financial services also. The premise was that use of technological innovation in mobile money transfer (Paypal); offering financial advise based on algorithms or ‘robo advisors’ (Betterment); digital mortgage underwriting (Rocket Mortgage) and electronic platforms for peer to peer Lending (Lending Club) would disrupt the financial landscape and the financial institutions. However, while FinTech companies have made a few inroads into all of the above categories (e.g. Quicken Loans now originates 8-12% of new mortgages) the disruption has not been significant. What has happened is that most incumbent financial institutions have started to offer similar features that FinTech companies have and/or formed collaborations with Fintech companies as a case in point ‘robo advisors’ are now present in most banks and brokerage houses. The relationship between banks and FinTech at this stage is not of competitors but is complementary and collaborative. Besides this reason, two other key reasons why the FinTech companies were not able to significantly reshape financial landscape was because they lacked access to cheap funding and do not have the customer base that the incumbent banks have.
However there is new competition to the financial institutions since BigTech (Amazon, Facebook, Apple, Google) companies are now entering the financial sector. BigTech companies present a new dynamic force in the financial ecosystem since they are both vendors and competitors due to the dependence of financial institutions on them for key technologies (like cloud services, artificial intelligence) and since they are offering or will soon offer similar financial products. Being vendors to financial institutions is a key difference between FinTech and BigTech and the reliance of financial institutions on them is only expected to increase. Case in point, Amazon Web Services (AWS) is the biggest provider of cloud services worldwide to all companies including financial institutions. In this sense they are a more serious threat and also because they have inherent unique strengths that allow them to overcome the shortcomings of the FinTech companies.
What’s different with BigTech?
The unique advantages of the BigTech companies are the following as per the two papers and they are intuitive;
- Existing network effects (messaging platform, customer interface etc) – this allows the BigTech companies to have a captive user base who generate data in exchange for free services. Also, having an existing user base allows BigTech to present establish trust and present a familiar user interface.
- Technological advantage (artificial intelligence, machine learning) – this allows the BigTech companies to better harness the data generated by customers. BigTech companies are also providers of these technologies to financial institutions.
- Access to cheap funding – the credit spreads of BigTech companies are tighter than most financial institutions and they can issue bonds at lower cost than financial companies although they primarily use equity for funding since the average equity/asset ratio is 50% compared to 11% for banks . In addition, BigTech companies do not have the capital constraints like Banks and can raise capital more freely if needed.
- Lack of Regulation – BigTech companies are not under the rigid capital/Basel, model risk and other regulations (customer protection, privacy, Anti-Money Laundering) and do not have the oversight from the government agencies as financial institutions do.
- Unmet Customer Demand – as financial institutions withdraw from offering services due to capital or risk appetite the BigTech companies can go into those areas to meet the unmet customer demand as in the case of mortgages (QuickenLoans) and student loans (SOFI).
Case Study – China
Studies from BIS and FSB paper show that the BigTech companies usually enter the financial sector through payment processing using their existing networks and then expand into other areas like credit. The case in point is China where the intrusion of BigTech in financial sector is most advanced and mature. In China, BigTech companies took advantage of lack of existing payment infrastructure for credit/debit cards to build their own and used the ambiguity in local regulation to totally capture the mobile payment sector. Now two technology companies; Alipay and WePay account for 94% of all mobile payments and between them they have 1.4 billion users whose transactions account for 16% of GDP; in comparison US mobile payments amount to 0.3% of GDP and Apple, Google and Samsung combined have million users. After payments, Alipay and WePay have expanded into lending, insurance, savings and investment products but in these areas their share is much smaller now (less than 1% of total credit in China) but analysis by BIS and FSB show that through the use of technologies like machine learning and using alternative data sources the BigTech companies are better able to predict defaults and serve unmet customer demand.
What is happening in US?
In US, the offering of financial services/products by BigTech is in the nascent stage but provides early indications of how they will will be shaping the financial sector in the future
- Leveraging their existing network – Amazon has lent over $1 billion to small and medium sized businesses which sell their products on its website; Facebook is offering payment services through it’s messenger feature and is reportedly developing a crypto currency too be used in it’s platform.
- Using the network of financial institutions – Apple, Google are both offering payment services like ApplePay and GooglePay.
- Forming partnerships with Banks – Amazon has formed a partnership with Bank if America to lend to small businesses; Apple has formed a partnership with Goldman Sachs to offer a new credit card.
- Going beyond payments – Amazon in UK has started to offer insurance product for online purchases called Amazon Protect.
There will be benefits from BigTech entering the financial sector as they meet unmet customer demand, go to under served sectors specially in developing countries and bring competition and innovation however there will be additional risks and questions to consider. Due to their existing network and economies of scale and scope in use of data and technologies, BigTech will lead to greater concentration as evidenced in cloud computing whose use is expected to increase. Other areas where BigTech companies dominate in offering third party services are data storage, transmission and analytics and concentration of these services will lead to higher chances of operational failure or cyber-events. Finally, there is regulatory framework to consider in acknowledging the dependence of financial institutions on BigTech companies for certain third party services and how BigTech will impact competition and concentration in financial sector in their roles of being both a vendor and a competitor.
P.S. In terms of distinction, FSB defines FinTech as as firms which bring “technology-enabled innovation in financial services that result in new business models, applications, processes or products" (think Paypal, Square). BigTech firms on the other hand refers here to large technology companies (Amazon, Facebook, Google, Apple) that expand into direct provision of financial services or of products very similar to financial products".