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Digital Disruption
in Banking
Xavier Vives
IESE Business School
OECD Fintech Roundtable
June 5, 2019
Bank price-to-book ratios
2
Source: IMF, Global Financial Stability Report, October 2018
Impact of digital disruption
• Moves the sector to be customer-centered with an
upgraded customer experience.
• Leaves incumbents with obsolete technologies (e.g.
rigid mainframes) and an overextended branch
network while new generations want to bank with
the mobile phone.
• The industry is facing a deep restructuring.
Xavier Vives 3
FinTech advantages & disadvantages
Advantage Disadvantage
Superior technology free of legacy
systems; leaner operation
Absence of an installed, loyal
customer base
Friendly consumer interface and
new standard of consumer
experience
Limited access to soft information
Focus on activities/business
segments with higher ROEs
Lack of reputation and brand
recognition
More equity funding High cost of capital
Able to attract best talent
Xavier Vives 4
BigTech platforms have the advantages of fintechs with none of the
drawbacks (plus superior data, technology, deep pocket) potential
more severe disruption for the traditional banking business.
Strategies: incumbents and fintechs
• Advantage of partnership
• Incumbents benefit from IT knowledge and regulatory arbitrage.
• Entrants experience lighter regulation, or reach new customers, benefit
from established brand, economies of scale and distribution channels of
incumbents.
Xavier Vives 5
Incumbents strategies
(Discriminate by segment)
Fintech strategies
Accommodate (‘fat-cat’)
• In the presence of high switching costs
• To gain interchange fees paid to them by
new service operators
Commit to remain small (‘puppy-dog
ploy’)
• No banking license
• E.g. with P2P lending that serves unbanked
segments of population
 Form partnership
Fight, prevent entry (´top dog’)
• Shutdown/degrade access to infrastructure
Entry as a (licensed) digital bank
• Less likely given the high compliance costs
involved.
 Consolidate or sell to incumbents
Launch their own fully online banks
Strategies: incumbents and bigtechs
Xavier Vives 6
Incumbents Bigtechs
Accommodate
• Cooperate with partnerships
• Provide specialized unique banking
products and services
Accommodate
• Partnerships
Fight/Compete head-to-head by becoming
platform/marketplace
• Profit from superior trust (?) from
customers and data security
• Better regulatory navigation skills
• Cannot match bigtechs’
bundling/cross-subsidization strategy
with complementary financial and
non-financial products/services
Compete head-to-head
• Become banks/intermediaries bundling
their offerings and exploiting economies
of scope
• Opt not to accept deposits to avoid
regulation
• Multi-sided platform (marketplace)
• Platform envelopment
• Gatekeeper: Monopolize interface with
customers
The future?
Xavier Vives 7
Scenarios
• First impact of digital disruption will
• increase competition;
• erode incumbents margins; and
• increase competitive pressure and contestability.
• Incumbents will have to restructure:
• The current overcapacity together with the need to invest
heavily in information technology in a low profitability
environment will lead to consolidation.
• Long run impact will depend on
• extent of entry of BigTech (modulo regulation) and
• whether a few bigtechs (perhaps including some platform-
transformed incumbents) manage to monopolize the
interface with customers and appropriate the rents in the
business.
Xavier Vives 8
Regulation and financial stability (1)
• Level playing field?
• EBA consultation: more than 30% of fintechs reported to be unregulated
• “Open banking”: asymmetry in information sharing requirements between
PSD2 and GDPR.
• Data ownership, portability, and interoperability are key.
• Market fragmentation and impediment of international operations caused
by cross-border asymmetries in data protection regimes.
• Different compliance burden for dominant players and small entrants (UK)?
• Regulate activities but entities are those that fail:
• Tradeoff between regulating by activity, which fosters a level playing field, and protecting
against systemic risk of failed entities.
• Heightened regulatory pressure fosters shadow (fintech) banking
• e.g. US with GSE guarantee.
Xavier Vives 9
Disposition of mortgage loans
of shadow banks
Source: Fig. 4 in Buchak et al. (2017)
Regulation and financial stability (2)
• Increased competitive pressure decrease profits of incumbents
and increases risk-taking.
• New sources of systemic risk:
• Contamination of bank and non-bank activities in platforms.
• Interconnectedness /“step-in” risk arising from ownership, partnership or
sponsorship.
• Failure of third-party providers and cyberattacks.
• Consumer protection
• Data privacy.
• Integrity of process, traceability of transactions (liability if breach?).
• Price discrimination. Transparency and behavioral biases.
Xavier Vives 11
Digital disruption in financial markets – VIVES – June 2019 OECD discussion
A question of balance
Xavier Vives 13
Other references
• Vives, X. Competition and Stability in Banking: The
Role of Competition Policy and Regulation,
Princeton: Princeton University Press, 2016, pp.
344.
• Vives, X. “Competition and Stability in Modern
Banking: A post-Crisis Perspective”, International
Journal of Industrial Organization, 2019, 64, 55-69.
• http://blog.iese.edu/xvives/
Xavier Vives 14

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Digital disruption in financial markets – VIVES – June 2019 OECD discussion

  • 1. Digital Disruption in Banking Xavier Vives IESE Business School OECD Fintech Roundtable June 5, 2019
  • 2. Bank price-to-book ratios 2 Source: IMF, Global Financial Stability Report, October 2018
  • 3. Impact of digital disruption • Moves the sector to be customer-centered with an upgraded customer experience. • Leaves incumbents with obsolete technologies (e.g. rigid mainframes) and an overextended branch network while new generations want to bank with the mobile phone. • The industry is facing a deep restructuring. Xavier Vives 3
  • 4. FinTech advantages & disadvantages Advantage Disadvantage Superior technology free of legacy systems; leaner operation Absence of an installed, loyal customer base Friendly consumer interface and new standard of consumer experience Limited access to soft information Focus on activities/business segments with higher ROEs Lack of reputation and brand recognition More equity funding High cost of capital Able to attract best talent Xavier Vives 4 BigTech platforms have the advantages of fintechs with none of the drawbacks (plus superior data, technology, deep pocket) potential more severe disruption for the traditional banking business.
  • 5. Strategies: incumbents and fintechs • Advantage of partnership • Incumbents benefit from IT knowledge and regulatory arbitrage. • Entrants experience lighter regulation, or reach new customers, benefit from established brand, economies of scale and distribution channels of incumbents. Xavier Vives 5 Incumbents strategies (Discriminate by segment) Fintech strategies Accommodate (‘fat-cat’) • In the presence of high switching costs • To gain interchange fees paid to them by new service operators Commit to remain small (‘puppy-dog ploy’) • No banking license • E.g. with P2P lending that serves unbanked segments of population  Form partnership Fight, prevent entry (´top dog’) • Shutdown/degrade access to infrastructure Entry as a (licensed) digital bank • Less likely given the high compliance costs involved.  Consolidate or sell to incumbents Launch their own fully online banks
  • 6. Strategies: incumbents and bigtechs Xavier Vives 6 Incumbents Bigtechs Accommodate • Cooperate with partnerships • Provide specialized unique banking products and services Accommodate • Partnerships Fight/Compete head-to-head by becoming platform/marketplace • Profit from superior trust (?) from customers and data security • Better regulatory navigation skills • Cannot match bigtechs’ bundling/cross-subsidization strategy with complementary financial and non-financial products/services Compete head-to-head • Become banks/intermediaries bundling their offerings and exploiting economies of scope • Opt not to accept deposits to avoid regulation • Multi-sided platform (marketplace) • Platform envelopment • Gatekeeper: Monopolize interface with customers
  • 8. Scenarios • First impact of digital disruption will • increase competition; • erode incumbents margins; and • increase competitive pressure and contestability. • Incumbents will have to restructure: • The current overcapacity together with the need to invest heavily in information technology in a low profitability environment will lead to consolidation. • Long run impact will depend on • extent of entry of BigTech (modulo regulation) and • whether a few bigtechs (perhaps including some platform- transformed incumbents) manage to monopolize the interface with customers and appropriate the rents in the business. Xavier Vives 8
  • 9. Regulation and financial stability (1) • Level playing field? • EBA consultation: more than 30% of fintechs reported to be unregulated • “Open banking”: asymmetry in information sharing requirements between PSD2 and GDPR. • Data ownership, portability, and interoperability are key. • Market fragmentation and impediment of international operations caused by cross-border asymmetries in data protection regimes. • Different compliance burden for dominant players and small entrants (UK)? • Regulate activities but entities are those that fail: • Tradeoff between regulating by activity, which fosters a level playing field, and protecting against systemic risk of failed entities. • Heightened regulatory pressure fosters shadow (fintech) banking • e.g. US with GSE guarantee. Xavier Vives 9
  • 10. Disposition of mortgage loans of shadow banks Source: Fig. 4 in Buchak et al. (2017)
  • 11. Regulation and financial stability (2) • Increased competitive pressure decrease profits of incumbents and increases risk-taking. • New sources of systemic risk: • Contamination of bank and non-bank activities in platforms. • Interconnectedness /“step-in” risk arising from ownership, partnership or sponsorship. • Failure of third-party providers and cyberattacks. • Consumer protection • Data privacy. • Integrity of process, traceability of transactions (liability if breach?). • Price discrimination. Transparency and behavioral biases. Xavier Vives 11
  • 13. A question of balance Xavier Vives 13
  • 14. Other references • Vives, X. Competition and Stability in Banking: The Role of Competition Policy and Regulation, Princeton: Princeton University Press, 2016, pp. 344. • Vives, X. “Competition and Stability in Modern Banking: A post-Crisis Perspective”, International Journal of Industrial Organization, 2019, 64, 55-69. • http://blog.iese.edu/xvives/ Xavier Vives 14