BigTech in Financial Services

IMF News, June 16, 2021

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BigTech in Financial Services

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Bibliographic details

• Authors: Tobias Adrian
• Published: June 16, 2021

The Challenges of BigTech

• BigTech firms are large technology conglomerates with extensive customer networks and core businesses in social media, telecommunications, internet search and e-commerce, present in all continents and in most – if not all - IMF member jurisdictions.
• BigTech business model leverages:
  • the data they already have on consumers;
  • advanced analytics to deepen customer understanding;
  • reliance on strong network effects from large consumer bases.
• Expansion into financial services is rapid because network effects drive interaction, user activity and generation of more data.
• BigTechs tend to “reverse” fintech unbundling by rebundling financial services based on large global user bases, cross-subsidization and economies of scale and scope.
• Potential benefits:
  • Use knowledge of consumer preferences (consumer spending habits and credit worthiness) to offer services to underserved customers.
  • Economic and social benefits of financial deepening can be compelling.
• Concentration and criticality concerns related to cloud services:
  • Bank of England (2020 survey) estimated that more than 70 percent of banks and 80 percent of insurers rely on just two cloud providers for IaaS (Infrastructure as a service).
  • Globally, 52 percent of cloud services are provided by just two BigTech entities, while more than two-thirds of services are provided by four BigTechs.
  • Failure of one firm or service could create a significant event in financial services, negatively impacting markets, consumers, and financial stability; in some respects, BigTechs may already be ‘too-critical-to-fail’.
• Financial Stability Board (FSB) identified three potential ways BigTech could affect financial stability:

(1) even if their isolated financial activities might not be systemic, they could but cumulatively generate significant financial risk, especially because these could be scaled-up very rapidly, (2) risks could be magnified by their interlinkages with regulated financial entities, such as partnerships to originate and distribute financial products, and (2) they could generate risks as they carry out a systemically important activity ancillary to financial services, such as cloud services.

• BigTechs can gain competitive advantage from not being subject to comprehensive group regulations or oversight, creating an uneven playing field and room for arbitrage.
• Fragmented international regulatory frameworks for data governance, operational resilience, and group-wide risks create regulatory arbitrage, policy gaps and cross-border build-up of financial stability risks.

Regulating entities, regulating activities

• Two main regulatory approaches:
  • Entity-based approach:
  • Regulations applied to licensed entities or groups that engage in regulated activities.
  • Requirements at entity level may include governance, prudential and conduct requirements.
  • Built on principle-based regulations allowing flexibility and continuous engagement between supervisors and supervised firms.
  • Supported by supervisory activities (off-site monitoring, on-site inspections) and early supervisory steps to modify behavior.
  • Activity-based approach:
  • Regulations applied to any entity or individual engaging in certain regulated activities.
  • Typically prescriptive, used for market conduct purposes, compliance ensured by fines and enforcement.
  • Many BigTech firms already subject to activity-based regulations (e.g., AML/CFT and consumer protection rules).
  • Challenges: must define activities precisely (creates regulatory arbitrage opportunities), less room for early supervisory action, heavy reliance on enforcement, limited effectiveness for cross-border activities without consistent global regulation and cross-country enforcement.
• IMF recommendation (consistent with its Global Financial Stability Report of 2014):
  • Mixed approach: monitoring and risk identification focus on economic functions and activities; regulation and supervision focus on entities.
  • Mixed approach based on entity-based regulation but tailored to activities specific to the entity or group.
  • Supervisors would have supervisory tools, licensing and enforcement means to monitor risks and modify behavior.
• Practical application depends on home vs host jurisdiction roles:
  • If BigTechs are systemic, home supervisors likely need an entity-based approach and possibly a bespoke regulatory framework for BigTechs, coordinating with data, privacy, competition, consumer protection and financial integrity agencies.
  • Host jurisdictions may use activity-based regulations supplemented by group-wide supervision tailored to entity-specific risks.
• Jurisdictional examples:
  • China: home supervisors moving to an entity-based approach, bringing BigTech into supervisory perimeter within a framework applicable to financial conglomerates.
  • EU: “host” jurisdiction stance using the Digital Services Act and Digital Markets Act with targeted powers covering many BigTech entities (measures: mitigate abusive market practices; improve disclosures and complaints handling; mitigate risks from combining end-user data without consent; no self-preferencing; data portability; interoperability of ancillary services).

Realism and Pragmatism

• Not all home jurisdictions have mandates to rein in BigTech; not all host jurisdictions have leverage to apply requirements to foreign BigTechs.
• Most host jurisdictions could consider:
  • Activity-based regulations supplemented by group-wide supervision tailored to BigTech entity-specific risks.
  • Use existing regulatory frameworks to implement supplementary group supervision and prudential requirements across BigTech groups’ financial activity.
• Challenges to home supervisors:
  • Designation of BigTech as systemically important groups may take substantial time; Nonbank SIFI designation has faced strong industry pushback.
• Short-term pragmatic measures for many countries:
  • Apply activity-based regulations to the extent possible.
  • Engage with BigTech firms to understand activities in-country.
  • Encourage development of codes of conduct and disclosure requirements akin to securities market regimes to identify and monitor risks, improve governance and oversight, and build regulatory understanding with limited resources.

Easier Said Than Done

• Bali Fintech Agenda (2018, IMF and World Bank) provides framework to harness benefits of financial innovation while mitigating risks.
• Rapid cross-border and cross-sectoral expansion of BigTech into financial services creates significant risks in some emerging economies and concentration risks in advanced economies.
• Longer-term solution: mix of entity- and activity-based approaches, likely based on home/host supervisor split, relying on a robust entity-based regulatory framework implemented by home regulators.
• Realistically, implementation of robust home-based entity frameworks may take several years.
• Interim host-jurisdiction actions:
  • Use existing powers: indirect supervision through regulated entities; activity-based regulations when feasible; development of codes of conduct and disclosure to better understand business models and risks.
• Support for international coordination:
  • Welcome G7’s call for further discussions to mitigate regulatory fragmentation and facilitate coherency of emerging technology ecosystems.
  • International consistency in BigTech operations across borders would help address broader membership concerns.

Key statistics and exact figures preserved from the source

• Bank of England 2020 survey: more than 70 percent of banks rely on just two cloud providers for IaaS.
• Bank of England 2020 survey: 80 percent of insurers rely on just two cloud providers for IaaS.
• Globally, 52 percent of cloud services are provided by just two BigTech entities.
• Globally, more than two-thirds of cloud services are provided by four BigTechs.
• IMF Global Financial Stability Report of 2014 recommended a mixed approach for systemic risks posed by shadow banking.

Source: Tobias Adrian, “BigTech in Financial Services,” European Parliament FinTech Working Group, June 16, 2021.

References

• Tobias Adrian
• People's Republic of China and the IMF
• Speeches
• PRESS CENTER
• [IMF Global Financial Stability Report: Risk Taking, Liquidity,

and Shadow Banking: Curbing Excess While Promoting Growth](https://www.imf.org/external/pubs/ft/gfsr/2014/02/)

• https://www.imf.org/en/home