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Is Fintech Really Spurring Competition?

The Spanish Competition Authority Report on Fintech's Effect on Competition in the Financial Sector

18 July 2019

There is a lot of hype around Fintech, but what impact does it actually have on competition and incumbents in the financial sector? Based on the market study the Comisión Nacional de Los Mercados y La Competencia, (CNMC) of Spain released in September, Fintech's impact is clearer. The CNMC began with the premise that due to the impact on innovative startups, established companies, and market failures justifying public intervention, Fintech is important to any market sector and focused its analysis on answering the question of to what extent does Fintech improves competition and efficiency. The CNMC study also addressed how Fintech affects the role of regulation in the financial industry.

Opportunities and Challenges

The CNMC provided the viewpoint of a competition authority on Fintech's opportunities and challenges. Opportunities Fintech offers include (i) process innovation resulting in efficiency gains (personalization of financial services) (ii) product innovation through efficient use of information, (iii) the entry of new competitors disrupting markets to traditional financial institutions and (iv) financial inclusion, permitting greater access to finance for consumers and businesses.

Challenges CNMC identified include the risk of Fintech digital platforms (e.g., crowdfunding) acquiring significant market power through indirect network effects and the effect of increased competition on the stability of financial intermediaries. Fintech also raises concerns regarding access to information, the role played by algorithms and big tech companies, and the opportunity for companies to expand market power via leveraging. Because Fintech is based on better exploitation of information, it raises a risk of price discrimination and the extraction of consumer surpluses. Finally, Fintech raises cybersecurity concerns as a highly digitized financial is sector more susceptible to cybercrime.

Fintech innovations

The agency's study focused on the following technologies: distributed ledger technologies, payment systems, asset management and advice, crowdfunding, and Insurtech—all of which relate to one or more of the three main functions of the financial sector, which the agency defined as (i) making and receiving payments, (ii) channeling funds from savers to borrowers, and (iii) managing risk.

  • DLT - Distributed ledger technologies (DLTs) include both permissioned and permission-less ledgers. Permissioned ledgers are closed systems that only allow trusted counterparties to participate in transactions while permission-less ledgers are open to all participants. So far, the most popular use of DLTs in the financial sector has been the creation of cryptocurrencies.  
  • Payment Systems - Payment systems include "instruments, services, procedures and channels needed for economic agents to transfer funds in transactions that do not make use of cash." The CNMC stated that payment systems might be the most "remarkable" feature of Fintech with very promising prospects. Advancements in payment systems include faster payment processing along with lower transaction costs along with numerous other mobile options. One notable innovation in payment systems is the creation of digital wallets.
  • Asset Management and Advice - The CNMC found that Fintech has disrupted the asset management and advice industry for both passive agents (i.e. broker-dealers) and active asset managers and traders. The new innovations in asset management and advice all rely on one or more of the following developments—social media, big data, artificial intelligence, and digital platforms.
  • Crowdfunding - Crowdfunding, which involves peer to peer lending from a large number of backers for a particular project or venture, has evolved from a way to fund non-profit ventures and small project to its current use in equity lending, debt issuance, and invoice trading. Crowdfunding can foster competition and efficiency through allocating resources as well as reducing transaction costs.
  • Insurtech - Among the new technologies disrupting the Fintech sector are automation, artificial intelligence, big data, and mobile apps and connectivity. The disruptions to the insurance industry, which fall under the umbrella of Insurtech include price comparison websites, peer to peer insurance networks, social brokering, which relies on data analytics to segment customers and negotiate more favorable terms for those segments, and microinsurance for specific items or uses. Insurtech improves consumer efficiency and welfare through increased choices and lower costs. Both incumbents and new entrants are making use of tools available in this emerging space.
Fintech's Positive Effect on Competition

The CNMC found that Fintech is likely to increase competition and efficiency in the financial system as a whole. However, the agency also noted that there are barriers to entry and market failures inherent to the financial sector that could hamper some of the benefits of Fintech. For example, information asymmetry can enable incumbents to sustain their position in the industry and ensure it is harder for startups to usurp incumbents or perform more than an ancillary role. Especially in the area of payment systems and asset management, startups need to overcome high switching costs that can lock customers into their current services.

The CNMC noted that financial regulation tends to have four goals for public intervention: efficiency, consumer protection, financial stability, and integrity, the first three of which are connected to market failures in the financial sector. The CNMC acknowledged that in attempting to achieve the three objectives of preventing market failure, the result can be a distortion of competition and the generation of inefficiencies. However, the antitrust regulator proposes that Fintech can help correct this issue by mitigating information asymmetries and providing more transparency, which could reduce the need for regulation. Additionally, more entrants into the market due to the implementation of Fintech can enhance efficiency and reduce natural monopoly conditions in the financial market.

Based on its findings, the CNMC recommended that authorities should embrace Fintech and re-examine the role of regulation and interference in light of the positive effects of Fintech. Of course CNMC's findings note that Fintech does not eliminate all risk of market failure in the financial industry, but Fintech is poised to continue disrupting the financial industry for years to come.

Santiago Roca Arribas contributed to the writing of this article .