Big Tech in review: new rules for financial operations worldwide
Big Tech firms - internet giants such as Facebook, Google, Ant and Tencent - benefit from economies of scope and scale to offer basic financial services such as payments, digital accounts, credit and investments. Despite potential benefits, regulators fear negative repercussions for financial stability, competition, and data protection.
Big Tech firms – giant technology companies – are a phenomenon under scrutiny worldwide. The entry of large digital platforms into the payments, credit, investment, and insurance markets was initially viewed favorably by regulators as having the potential to bring efficiency gains to the financial sector and to promote financial inclusion.
Despite the potential benefits, there is currently a global movement to regulate Big Techs, affecting companies such as Facebook, Google, Ant, Tencent, Amazon, and others. Although the first regulatory-legislative cycle focused on Big Techs revolves around issues related to antitrust and personal data protection, it is already possible to see an extension to financial stability concerns.
The entry of Big Techs into financial services
Big Techs are large technology companies that connect millions of users through internet platforms. Unlike fintechs, companies that apply innovative technologies in the financial sector, Big Techs develop technology solutions for a wide scope of economic activities.
The focus of their business model can be on social networks, such as the Facebook group, on search engines, such as Google, or on e-commerce, following the example of Amazon and Alibaba. According to a survey published by BIS in 2019, only 11% of Big Techs’ revenue comes from financial services.
The ability to transform users’ online activity into intelligence through Big Data and the know-how in creating digital services favors the spread of Big Techs to various industries. In the last decade, financial services have been one of the axes of such expansion. The entry occurred mainly through payment services, but also by offering credit to consumers and micro and small entrepreneurs.
In the case of e-commerce platforms, the creation of payment solutions is a natural evolution to generate more confidence in online transactions between customers and merchants. This was the case with Ali Pay, the mobile payment arrangement of Ant Group, the financial spinoff of Alibaba.
How Big Tech changes the financial market landscape
In general, the use of new technologies allows for the expansion of financial, payment, and insurance services with scalable models and reduced costs. The entry of large technology companies promises additional efficiency gains by being able to leverage the large number of users and data generated.
The main competitive advantages of Big Techs over traditional banks are a much larger user base, up-to-date technology that is better suited to offering new services, and greater proficiency in data management and use.
Due to the low additional cost of expanding a digital service to a larger number of people, it is possible to offer basic financial services at a lower price than the traditional banking sector. Furthermore, with the spread of smartphone use and the expansion of 3G/4G mobile data networks, digital services can reach places where bank branches do not. Thus, Big Techs’ provision of services such as digital accounts and mobile payments can contribute to the inclusion of the unbanked or underbanked population.
One of the main areas in which Big Techs change the scenario in favor of financial inclusion is in the provision of credit for consumers and small businesses – either by creating their own credit lines or by joining financial institutions to distribute their products.
As digital platforms collect a high volume of data on users, they have more information to estimate the risk profile of customers and reduce the chances of default, even when they have no formal banking record. Thus, Big Techs are in an advantageous position to offer loans to an audience that is currently outside the formal credit market.
Regulators Respond to Tech Giants in the Financial System
Everything indicates that the presence of Big Techs in the financial sector will follow a growing trend in the future. In addition to having a growth model that takes advantage of diversification of activities, technology companies can benefit from new developments in financial systems around the world in favor of opening up the participation of new players.
Some emblematic examples of Big Techs’ bet in this regard are Facebook’s announcement of a digital currency wallet (Diem, launched in 2019 as Libra) and the record-breaking expectation for Ant Group’s IPO (suspended in November 2020). Against this backdrop, government authorities are watching closely to prevent any disruptions that could arise from the presence of the tech giants and prevent them from reaping the benefits mentioned above.
It is worth noting that not all regulation is aimed at restricting Big Techs, such as Open Banking. While Big Techs will have more access to data through Open Banking, there will be more transparency about the conditions under which customer data is collected and shared. In addition, data portability strengthens competition, as companies large and small will be able to access users’ data, provided they obtain their authorization.
Effects of Big Tech on financial stability
In the platform economy, companies benefit from the so-called network effect: the more users there are at one end of the platform (e.g. number of sellers on Amazon), the greater the value of the platform for the users at the other end (e.g. consumers).
This makes it possible for Big Techs to grow abruptly from one moment to the next. In the case of financial services, especially when we talk about Big Techs offering credit, this can present a risk to the stability of the entire financial system.
There are a number of rules that banks and other financial institutions must comply with in order to mitigate the risk of systemic crises. In principle, these requirements do not apply to technology companies, which means that the issuing of credit by these companies is not necessarily backed by a capital reserve that reduces the risk of default.
Due to their size, Big Techs can become systemically relevant very quickly. The recent restrictions imposed by the Chinese authorities on Ant’s financial operations tackle exactly this problem.
Data protection and abuse of market power
One issue that has already caught the attention of some regulators is the advantage that Big Techs have over other players in obtaining data on potential customers, because of their large user base and different service offerings.
An emblematic example is the case of Facebook, for example, which has varied information about more than 3 billion people through its four main products (Facebook’s own social network, Instagram, WhatsApp, and Messenger).
The German competition authority identified that the company was collecting user data on Facebook products and on millions of third-party websites without users’ consent, which constitutea an abusive practice under German markets law. The case resulted not only in a case against Facebook, but an adaptation of the competition law for the digital world, allowing the regulator to act before the abuse (unauthorized collection and combination of data) happens.
Another point of attention for regulators is to prevent Big Tech companies from taking advantage of their size and scope to establish market conduct that could potentially be considered abusive by antitrust agencies. Some examples are the requirement of exclusivity to participate in the platform, the use of algorithms and Big Data to differentiate prices (estimating the user profile to charge each person the highest price they would pay) and bundling – joint offering of services on the same platform.
Since 2019, a rule in India for foreign investment in e-commerce seeks to prevent Big Techs like Walmart and Amazon from favoring sales of their own products in the marketplace and harming Indian sellers. As Reuters reported, Big Techs have created some subterfuge to circumvent the rule, mainly through indirect stake acquisitions of Indian sellers, which has been motivating regulators to create more restrictions.
Competition and consumer credit: the targets of regulation of Big Tech in China
In China, fintechs have been growing relatively freely. The fact that more than 90% of mobile payments in China are made by two Big Techs (Ali Pay, from the Ant Group, or WeChat Pay, from Tencent) is a demonstration of this.
According to a Bloomberg story, in early 2021, a few months after Ant Financial’s IPO was suspended, the tech giant and financial regulators reached an agreement for the company to assume financial conglomerate status. With the new status, Ant will now have to meet the standards assigned to companies operating in various branches of the financial system, including minimum capital requirements.
In addition, the commission that regulates the financial sector in China set new rules for internet loan issuance in February this year to reduce the risk exposure of the financial system. According to the South China Morning Post, credit issuance by tech giants grew by 42% between 2018 and 2019, and this expansion is based on Big Techs’ partnerships with commercial banks. In this model, Big Tech has the relationship with the customer, but almost the total loan amount is provided by the banks, which assume the risk of the operation.
Among other requirements, the new regulation imposes the “30% rule”, which forces platforms to commit a larger portion of their own capital for each loan made. This measure reduces the chances of Big Techs issuing credit beyond their funding capacity.
The two initiatives move towards increasing the capital requirements that Big Techs operating in the financial sector must meet, bringing the regulation of Big Techs closer to the regulation of financial institutions. The goal is to prevent the supply of credit via digital platforms (Ant, JD.com, Tencent, and others) from growing beyond the financing capacity of the Chinese financial system.
Another action front in China is anti-monopoly policies. In February of this year, the Chinese market regulator, SMAR, published a set of antitrust rules for digital platforms. Among the directives is a ban on exclusivity clauses and price fixing through abuse of data usage. The rules will affect e-commerce giants Alibaba and JD.com, as well as the mobile payments duopoly of Ant and Tencent.
In parallel to these initiatives, the People’s Bank of China (PBOC) is pressuring tech firms that provide loans on its platforms to share data on those transactions. In 2018, the Chinese government created an individual credit scoring agency in the form of a public-private company and gave 8% of the shares to Ant and Tencent each, and other fintechs. In 2020, another agency in the same format was created with the participation of subsidiaries of e-commerce giant JD.com, Xiaomi, and a facial recognition company, Megvii.
The two agencies are overseen by the PBOC. The goal is for the tech companies to share with the new agencies their databases of residents’ risk profiles and loans made. In this way, while the national financial system gains visibility into the millions of unbanked customers served by China’s Big Techs, the PBOC hopes to increase supervision over microcredit platforms, mitigating risks of default and asset portfolio deterioration.
While large digital platforms can bring benefits to society by expanding the supply of basic financial services, such as fast and secure digital payments and credit for small businesses, public authorities already indicate potential risks associated with the entry of Big Techs into the financial market. It is up to regulators to find the balance between fostering the entry of new players into the market and avoiding risks of as yet unknown size. Ultimately, this is a choice that is up to each society and may even change over time – as was the case in China.
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