What impacts do regulations have on FinTech's business model?

What impacts do regulations have on FinTech’s business model?

Tue 06 Oct 2020

FinTechs have based their business model on a very specific value chain positioning: specialisation and focusing on customer service. Handling support activities for operations and administrative completeness is still the domain of banking institutions, who hold banking licences. But regulators are increasingly interested in this new player – so, what changes are in store for them?

The key to success of these new players is their customer-centric approach. In this context, FinTechs are highly dependent on their partners, primarily banking institutions, to establish robust, regulatory-compliant execution mechanisms.

Instead of viewing this dependence as an inconvenience, it can be seen as an opportunity that allows FinTechs to maintain their positioning in the chain and develop a specific economic model. But can this economic model be sustained by an industry that aspires to revolutionise its business sector, and that has also seen its business grow at a speed that challenges traditional players who have not faced competition for a long time?

Since 2010, we’ve witnessed the arrival of many new players in different segments of the financial services market, including:

  • Online banking and Personal Finance Management (PFM) such as ING Bank, Fiduceo, Simple, Moven, and Fidor Bank.
  • Peer-to-peer lending (such as Lending Club, Kickstarter).
  • Credit for very small to medium sized businesses, including Lendix in France, and Kabbage and OneDeck in the United States.
  • Crowdlending such as Zopa in the UK and KissKissBankBank in partnership with Banque Postale in France.
  • More specialised services such as private banking services (Yomoni in partnership with CM Arkéa in France, and Personal Capital and Wealthfront in the US) and factoring (Finexcap in France).

What regulations currently exist for FinTechs?

After seeing the advantages that these new players have brought, regulators have taken a new approach: regulating while being careful to avoid stifling innovation. The aim is to avoid eroding the customer experience, which has been enhanced by establishing trusting relationships based on:

  • Transparency.
  • Simplicity and accessibility of the services offered.
  • A broad range of more attractively priced services.
  • Funding liquidity.
  • Better suitability for those who are poorly served by the traditional banking system.

The governor of the Bank of France said this would include, “a certain proportionality of the rules; in other words, adjusting our requirements proportionally to the size of the entity being regulated” while ensuring that “bringing in new companies will not mean lowering security standards.”

Will the regulatory framework be built while supporting the transformation of the FinTech industry, adjusting to it as it develops? Or will it focus only on safeguarding and controlling the ever-increasing volumes moving through this new industry?

In Europe, regulators have taken several approaches:

  • Practical: FinTech Sandbox in the UK
  • Pragmatic: ‘Same risks, same regulation’ approach in Germany.
  • Precautionary: Tailored regulation, for example, in the Netherlands.

The hard part is knowing how these approaches will be put into practice, especially the Tailored Regulation which is fairly innovative for regulatory authorities.

How will FinTechs deal with upcoming regulatory developments?

The regulatory framework may well be built by supporting FinTechs through stages of development, but their business model will be transformed more through traditional competition and through technological advances. This would allow FinTechs to adopt strategies other than partnerships. They would then be able to reach a level of maturity and profitability that would allow them to absorb new cost centres that they’ll need for the stability of the company and the sector as a whole (develop expertise internally or acquire expertise externally).

Other possible scenarios include:

  1. Maintain the current business model but bypass regulations by positioning themselves within a new, less regulated business structure/technology where regulation is even less developed.
  2. Maintain the business structure but change the business model (for example, by acquiring a banking licence) to deal with regulations.
  3. Be bought out by a traditional, already regulated institution.

For the future as well as today’s traditional financial services sector, FinTechs need to be careful not to decouple strategy from regulatory compliance.

Authors: Emmanuel Dooseman, Partner and head of the banking sector for Mazars globally, in collaboration with Catherine Deeb Ishhab, Manager in the banking sector at Mazars France.

For more articles related to financial services, visit the Mazars Financial Services blog.