dan murphy is a senior associate at the Milken Institute Center for Financial Markets in Washington.
Illustrations by Oliver Weiss
Published April 26, 2019
Almost a decade after the passage of the Dodd-Frank Act, what keeps bankers awake at night is not regulation by Washington, but competition from Silicon Valley.
At first, competitors took the form of financial technology startups (fintech for short), whose avowed aim was to relegate the banks to the ash heap of history. Fintech startups ranging from LendingClub (credit) to Robinhood (securities trading) got the bankers’ attention, but did not concern them inordinately. After all, banks have significant advantages over fintech startups, such as preferred access to data and capital, not to mention the advantages conferred by the competitive moat of government regulation.
The real threat, the bankers are coming to recognize, is big tech, not fintech. Unlike fintech startups, firms such as Amazon, Google, Alibaba and Tencent have deeper pockets and better access to data than any bank. Most important, big tech firms have uniquely intimate relationships with their customers. These factors turn big tech’s lack of regulatory oversight into a competitive advantage, allowing them to operate on the margins of financial regulation at a much larger scale than a fintech startup.
Rather than brashly setting out to replace banks altogether, big tech’s strategy is to quietly seize the customer relationship one product at a time by offering a seamless digital financial services experience tied to their core platforms. This presents bankers with a dilemma: should they try to beat back the invaders or join forces in order to gain access to their customers?
For policymakers, big tech’s quiet incursion presents a different dilemma. Should they look on the tech giants’ financial ambitions positively, as a means of inclusively spreading the benefits of financial services? Or should they view the entry of these behemoths as a cause for anxiety? To answer this question, policymakers will need to assess big tech’s banking ambitions from the perspectives of competition policy, data governance and financial stability.
The Way of the Ant
In China, tech giants have already demonstrated the upheaval they can wreak on banking. The e-commerce giant Alibaba began its payments platform, Alipay, in 2004 in order to increase trust between buyers and sellers on its online marketplace. From these humble origins, Alipay became a payments juggernaut, and Alibaba has since added an arsenal of complementary financial products to its repertoire.
Just 10 years after starting Alipay, Alibaba consolidated all of its financial products and services under the umbrella of Ant Financial. Today, Ant Financial offers almost every financial service that the average customer needs, including deposit accounts, credit and wealth management.
The scale of this success is breathtaking: Ant Financial’s market cap is greater than that of Goldman Sachs, and its Yu’e Bao money market fund is the largest in the world. Even so, its offerings are rivaled by Tencent, whose Tenpay platform has even more active users than Alipay.
Like Alibaba, Tencent leveraged its core business to grow its footprint in financial services. Instead of e-commerce, Tencent integrated Tenpay with WeChat, China’s leading social media and messaging app. Other Chinese tech giants, notably Baidu and JD.com, are in on the action as well, using their search and e-commerce platforms to offer their own suites of financial services.
After successfully chipping away at the business of banking one product at a time, Ant Financial and Tencent opened China’s first internet banks, MYbank and WeBank, in 2014. At this point, the rise of banking with big tech triggered a regulatory response from China’s central bank, the People’s Bank of China. Today, the PBoC requires China’s tech giants to link certain internet bank accounts to traditional bank accounts and to keep 100 percent of their “float” in reserve at the central bank itself. This arrangement is designed to safeguard the financial system and also solidifies big tech’s place in its customers’ lives as both the face of traditional banking and as a regulated nonbank.
The Bank of Amazon?
While China’s tech giants brashly inserted themselves into banking, Silicon Valley’s superstar firms have taken a more cautious approach. As in China, payments platforms have been their first priority. Apple used the iPhone’s considerable market share to make Apple Pay a market leader in mobile payments, and both Google and Facebook have followed suit with payments products of their own. Yet, while mobile payments are giving cash transactions a run for their money in China, they have been slower to take hold in the United States. For the most part, big tech’s banking ambitions in the U.S. have been commensurately humble.
Amazon is the exception to the rule. Not unlike Alibaba, Amazon has leveraged its e-commerce platform for an ambitious challenge to incumbent financial institutions. Amazon Pay not only services Amazon’s marketplace, but also other retailers who value Amazon’s low credit card fees and customer-centric user experience. Moreover, the biometric technology being tested at Amazon Go stores and the voice recognition technology being pioneered with Alexa could prove to be game changers for payments, and position Amazon as a market leader in the future.
Payments, it’s worth noting, are not Amazon’s only foray into finance. The company offers small business loans to sellers on its retail platform, as well as consumer credit to buyers via partner cards. To reach the unbanked and underbanked, the Amazon Cash program allows consumers to shop on Amazon after depositing cash at partnering retailers and kiosks. At the B-to-B level, Amazon Web Services is now an important technology provider to financial institutions of all stripes. More financial services from Amazon are likely to be forthcoming as well, including a rumored checking-account-like product to be offered in partnership with a large bank.
Yet, like China’s tech giants, Amazon is not rushing to formally become a bank. For now, predictions that the tech giants might apply for the FDIC’s industrial loan company (ILC) charter or the Comptroller of the Currency’s fintech charter have proved inaccurate. Whether or not they apply for one these licenses, however, a discussion about the merits of banking with big tech is brewing inside the Beltway.
Assessing the Financial Inclusion Opportunity
One of the strongest arguments in favor of banking with big tech is the potential to increase financial inclusion. Broadening access to financial services is a top priority for policymakers around the world, featuring prominently in the United Nations’ Sustainable Development Goals as well as being reflected in financial laws like the Community Reinvestment Act in the United States. In the eyes of many policymakers, banks have made insufficient progress on their own.
According to the World Bank, 1.7 billion adults still lack a bank or mobile money account. Many of these excluded citizens lack a credit history or proximity to a brick-and-mortar bank branch, but do own mobile phones and have access to the internet. If a big tech company can bring banking to these citizens, so the argument goes, why not welcome them?
The argument is compelling on its face, and China’s recent progress on financial inclusion appears to offer supporting evidence.
According to a joint report by the World Bank and the People’s Bank of China, the emergence of digital financial services has increased financial inclusion in China in three ways. First, by lessening consumers’ reliance on bank branches, digital finance has made banking services available to consumers in places where banks have little or no physical presence. Second, digital finance has provided more affordable products that are better designed to fit the needs of underserved consumers. Third, the emergence of digital finance has greatly increased competition in financial services, forcing traditional banks to step up their game in serving consumers with modest assets.
The Chinese model as well as other striking success stories in Africa, where telecommunications firms have made great strides in previously unbanked places, may indeed point the way forward. However, consumers and policymakers are becoming increasingly sensitive to the way big tech uses their customers’ data, not to mention the dangers that big tech’s market power may pose to the wider economy.
In 2018, the widespread misperception that social media, search and other services come with no strings attached gave way to a realization that Facebook, Google and others are primarily in the business of selling the data they harvest for targeted advertising. This business model is now under great scrutiny and is extremely unpopular with consumers. According to a survey by Morning Consult, 63 percent of adults in the U.S. say they are unwilling to accept “free” services in return for their data being sold to advertisers. And as consumers learn more about how big tech uses their data, that percentage could grow.
Financial regulators must consider the systemic implications of merging big tech with banking, lest the “move fast and break things” mentality endanger the stability of the financial system.
However, despite growing unease over how Silicon Valley uses personal data, many consumers have indicated that they are open to banking with big tech. According to an international survey by the French consulting firm Capgemini, almost one-third of consumers find the idea appealing. Those who are young and tech savvy, or simply inclined to shop around for the best deals, are most open to the idea.
These sentiments present a paradox. While consumers’ openness to banking with big tech despite their reluctance to gain free services in return for their data may indicate a revealed preference, policymakers should carefully consider its implications for financial inclusion. Big tech firms are surely able to increase financial inclusion by reaching far-flung consumers and making financial markets more competitive, but they are not the only ones capable of producing those effects. Rather, big tech’s unique value proposition lies in its ability to provide affordable financial services that are perfectly tailored to its customers.
In finance as in other industries, big tech is able to offer such affordable services by offsetting the cost with its core business revenue. And, as noted above, those core business models are predicated on selling user data for targeted advertising. Since that way of doing business may be washed away by regulation, policymakers should carefully consider whether it is wise to pin their financial inclusion hopes on its continued existence.
Threading the Policy Needle
To weigh the potential benefits and costs of big tech’s invasion of banking, a three-step approach is needed. First, competition policy must assess the consequences of giving big tech the green light to expand horizontally into financial services. Second, a strong data governance framework must be established for the financial institutions of the future, whose profitability will turn as much on data intermediation as financial intermediation. Third, financial regulators must consider the systemic implications of merging big tech with banking, lest the former’s “move fast and break things” mentality endanger the stability of the financial system.
The Competition Policy Perspective
In 2018, big tech found itself front and center in a revived debate about competition policy, defending itself against calls for antitrust enforcement from policymakers across the political spectrum. The European Union has been the most aggressive enforcer, with Competition Commissioner Margrethe Vestager leading the charge against Silicon Valley’s tech giants. In the United States, the “New Brandeis” antitrust movement sparked a renewed conversation about the dangers of market concentration and the need to look beyond low prices. In response, the Federal Trade Commission hosted a series of high-profile hearings, while the Federal Reserve Bank of Kansas City made market concentration the topic of its annual Jackson Hole Economic Policy Symposium.
This new scrutiny will factor into big tech’s plans to expand into financial services. As regulators weigh the dangers of market power, it seems unlikely they will welcome an expansion into banking by tech giants that have a history of devouring their competitors. Moreover, antitrust action against big tech may inhibit the companies’ ability to provide value in banking in the first place. Should, for example, Amazon be forced to divest the highly profitable Amazon Web Services as part of an antitrust enforcement action, its capacity to cross-subsidize new ventures might be greatly diminished.
Yet even if antitrust does not prove to be an obstacle, big tech still faces a unique hurdle in the United States: the Bank Holding Company Act. Passed in 1956 after antitrust enforcement failed to stop Transamerica from obtaining control of Bank of America, the BHCA established a prohibition on the ownership of banks by commercial firms. This separation of banking and commerce has come to be seen as a bulwark against all manner of anticompetitive excesses. In 2005, Walmart applied for an ILC charter, a type of banking license that circumvents the BHCA’s restrictions. The subsequent pushback from community banks and consumer advocates (among others) was so fierce that Walmart withdrew its application.
By carefully chipping away at the business of banking rather than applying for banking licenses, big tech has avoided the sort of showdown that killed Walmart’s banking ambitions. Nevertheless, the same coalition of forces that drove off the big-box king in 2005 stands ready to fight any big tech firm that tries to become a bank. Consequently, American big tech firms are likely to continue to follow their Chinese cousins’ cautious playbook, providing an unmatched user experience as consumer-facing data intermediaries on the front end, while partnering with banks to manage the messy business of financial intermediation on the back end.
The Need for Data Governance
If big tech’s future lies in data intermediation, the need for a robust data governance framework cannot be overstated. While the opportunity to bank with big tech may appeal to many, consumers’ new-found reluctance to permit their data to be used for targeted advertising suggests they are only beginning to understand the price. As they learn more, policymakers may well put protections in place that make banking a less attractive market for big tech.
The discussion about data governance is well underway in Europe, where the General Data Protection Regulation came into force in 2018. Though imperfect, the GDPR represents a concerted effort to give consumers ownership of their data as a part of a robust data governance framework. Concurrently, the European Union’s Second Payment Services Directive and Britain’s Open Banking initiative have set the stage for a global push for data portability, giving consumers greater control over access to their financial data.
Paradoxically, the emergence of a vibrant fintech market in the United States has led consumers to expect data portability even in the absence of an underlying governance framework. This lack of rules of the road for data use in the United States must be rectified both to protect consumers and to ensure that access to data does not become an insurmountable competitive advantage for any particular firm.
As policymakers debate the recently enacted California Consumer Privacy Act and other data governance proposals, perhaps the greatest challenge will be writing rules that prioritize consumer interests. After years in a regulatory vacuum, big tech companies have suddenly become aware that data governance is of existential importance to their businesses. Already, big tech is lobbying for lighter-touch federal regulation that pre-empts the CCPA, arguing that it throws the baby out with the bathwater. This is not unlike what happened with the GDPR, which has been criticized on the grounds that firms like Google successfully manipulated the law to their own advantage, effectively using the rules to fortify their dominance in advertising.
The Financial Regulation Perspective
A growing number of experts have expressed concern that fintech may trigger the next financial crisis. In a recent paper, Karen Petrou of Federal Financial Analytics wrote that “most tectonic shifts of this magnitude end in earthquakes.”
But in light of its deep pockets and unprecedented access to data, big tech could prove the greater threat. Indeed, big tech’s sheer scale should force a re-examination of the assumptions that have driven the debate over fintech regulation. The principle of “activities-based regulation,” for example, makes intuitive sense in the context of a small fintech startup. There is, after all, no need for a simple financial management app to comply with bank-like capital requirements. The risks that follow from an activities-based approach to a powerhouse like Ant Financial, however, are a very different matter.
China has taken a novel approach, deciding to directly regulate big tech’s banking operations with reserve requirements to protect customers. Other countries may follow suit or develop their own arrangements, and devising regulations to manage risk for data intermediaries is still a work in progress. For example, an important part of the data governance frameworks currently being debated concerns how to assign liability to make customers whole. While this is very much a part of the business of banking, it is uncharted territory for big tech.
Risks and Rewards
As policymakers assess the consequences of big tech’s banking ambitions, they need to be clear-eyed about both the opportunities and risks. Big tech may be a useful tool to increase financial inclusion, but shouldn’t be counted on until the tech platforms reckon with impending limits on the use of consumer data. Otherwise, policymakers risk predicating financial inclusion on practices that are not in the broad interest
Working through these implications for competition policy, data governance and financial regulation will take time and will probably result in a sea change in the way we view big tech. But in order to minimize the potential damage from earthquakes, we must ensure that the future of finance is not built on a fault line.