“The challenge for non-banks is to build the kind of trust that convinces consumers and regulators that heavy restrictions are unnecessary,” says Giles Willams.
As alternative banks grow in size and importance, can they win customer trust without the need for tougher bank regulation, which could also stifle financial services innovation and competition?
The emergence of new, alternative banks and fintechs in banking is gathering pace. Since the global financial crisis, increasingly tough capital requirements are forcing banks to take fewer risks and scale back their lending, opening the door to fresh competitors and non-banks, many of whom have enjoyed relatively light touch financial services regulation. Once new entrants reach a critical mass, however, and become designated as “systemically important financial institutions,” their activities will be under far greater scrutiny from consumers, the media, government and financial regulators.
If such reassurance cannot be found, there is a strong temptation to deliver the same strict levels of regulation that apply to banks, which could ultimately deter banking competition and diversity. The challenge facing non-banks, as well as alternative banks, is to build the kind of trust that convinces consumers and, more importantly, regulators, that heavy restrictions are unnecessary. In an age where the smallest error or incident goes viral over social media within minutes, this is no easy task.
We are becoming accustomed to new ways of making payments, with numerous peer-to-peer mechanisms surfacing, yet few countries have created regulatory frameworks. For example, in many mature markets, mobile payments are still in their infancy and regulators are adopting a “wait and see” position. In the developing world, however, the concept is taking off much faster, most notably in Saharan Africa, Southeast Asia and Latin America.
Kenya’s M-Pesa system, run by the country’s largest mobile phone operator, Safaricom (part of the Vodafone group), is an interesting example. M-Pesa is now a part of daily life for Kenyans, with services including money deposit and withdrawal, remittance delivery, bill payment and microcredit.
Despite occasional glitches, where the system comes down, Kenyan citizens and businesses continue to use M-Pesa. Although not a fully-regulated financial institution, M-Pesa has always sought to behave like one, by meeting the same levels of reporting, anti-money laundering, information technology (IT) security and know your customer (KYC) processes. Crucially, Safaricom’s management has engaged closely with Kenyan regulators from the outset, to provide necessary assurance.
In virtually every country, existing mobile payments providers are not categorized as banks, so are not obliged to hold capital. As these payments innovations start to take up a greater share of the wallet and include larger value transactions, the potential for losing significant sums of money rises, which will almost certainly arouse the interest of regulators.
Governments will likely also soon consider new regulatory frameworks for emerging alternative lending activities, such as crowdfunding and peer-to-peer lending, as well as greater oversight of online and branch-based alternative banks that are launching in many markets.
In spite of financial crises, a widening choice of banking options and a new generation of consumers raised on online commerce, a substantial proportion of consumers remain loyal to banks. The added security of higher capital levels and tighter risk management processes may have soothed the nerves of customers and people are still wary of putting their money into alternative institutions.
While few doubt that additional regulation was necessary to curb the worst excesses of recent years, some question whether such regulation places a stranglehold on banking innovation? The decision by GE to sell much of its hugely profitable GE Capital financial services arm highlights the dilemma facing non-banks or any new entrant to the arena. As bank regulations get stricter, other, similar companies might follow suit, which could reduce the flow of credit.
If the systemically important financial institutions (SIFI) regulatory bar is set too high, it could deter new businesses from entering banking, thus preserving the status quo and creating a two-tier system of established banks and (relatively) unregulated peer-to-peer lending. Regulators, therefore, must consider how to temper the worst excesses of recent years, while leaving growing room for new banking competitors.
New entrants, on the other hand, could do worse than to adhere to the time-honored principles of banking: secure deposits; fast, safe payment systems; prudent lending that borrowers can repay; transparent savings and investment products. If new disruptors can meet these demands, while providing innovative services and can win – and maintain – a high level of trust and consumer confidence, they may be able to thrive without such a heavy regulatory hand.
In response to technological and market-driven developments, the focus of payments regulation has clearly shifted.