The financial system has been undergoing an unstoppable revolution for years. New technologies have enabled the emergence of new competitors and business models related to traditional financial activity that are unbundling financial services and shaping a new competitive environment. This is the Fintech revolution, which arises from applying increasing technological innovation to financial services and provides many benefits for the user, but also generates new risks.
Monitoring what happens in such a dynamic market with so many new players is becoming a complex task for financial supervisors and also for regulators, who must find the ideal regulatory toolkit to capture and neutralize new risks. Beyond competition-related issues, which are also a concern, authorities are focusing on risks to consumer protection and financial stability.
If we speak of risks to the consumer, it would be appropriate to start by asking whether the user of financial services understands, in most cases, the type of entity or the legal personality behind a new innovative brand and, therefore, what legal protections they have in the event of a failure or error.
In this context, the use of terms such as “neobank” or “digital bank” is quite widespread to refer to some of the new companies that, in many cases, do not have the status of a credit institution and cannot carry out the activities legally reserved for them.
The same applies to the products that some of them offer, or have offered, to their customers under generic names, such as “accounts,” which do not have the status of deposits and, therefore, their balances are not covered by the Deposit Guarantee Fund.
The Bank of Spain explains the term “neobank” very well, which has proliferated in the media but is not backed by any legal regulation. “With the colloquial term neobank, we refer to emerging financial companies characterized by the intensive use of technology (fintech).” Therefore, some of these entities may be banks, but others are not, and may adopt other types of licenses—usually “payment institutions” or “electronic money institutions”—which determines the activities they can provide and also the level of protection for customer funds.
Last May, the UK conduct authority went so far as to issue a letter to “e-money” companies—some of them well-known “neobanks”—requesting that they write to their customers to explain how their money was being protected in a clear and non-misleading way, highlighting the benefits of operating with these companies, but also the risks.
On the other hand, it is also observed that some companies offer innovative products and service delivery mechanisms that the customer likens to standard financial activities, but which are not fully classified as such in the current regulatory framework, something quite common in the cryptocurrency universe.
Furthermore, there is concern regarding the increase in lending activity outside the safety net of prudential regulation; in other words, the increase in non-bank lending is a concern. Although diversification in the financing of companies and households is positive, an increase in non-bank loans can damage financial stability if operators reach sufficient scale but remain outside the regulatory and supervisory radar.
A greater appetite for risk from non-bank lenders or a less strict governance and oversight framework could lead to a relaxation of lending criteria. This may be more pronounced in those jurisdictions where lending activity is not reserved and can be carried out by individuals or legal entities other than credit institutions.
In summary, some of the new risks of the Fintech revolution for the consumer can be resolved with clearer communication or information from the new operators, as well as from the authorities, while others will likely require more forceful regulatory intervention.
International and European authorities are in a process of deep reflection on changes to the current regulatory and supervisory framework to adapt it to the new financial services environment, in such a way that innovation and competition are encouraged, but without compromising the necessary protection of financial users. This is a very accurate approach that undoubtedly requires the greatest possible agility to keep up with the unstoppable revolution the financial system is experiencing.
Lorena Mullor, Digital Banking Advisor at the Spanish Banking Association (AEB)
