Richard Nesbitt is an adjunct professor of finance at the University of Toronto’s Rotman School of Management. Michael King is an associate professor of finance and the Lansdowne Chair in Finance at the University of Victoria’s Gustavson School of Business. They are the authors of a new book, The Technological Revolution in Financial Services-How Banks, Fintechs and Customers Win Together, from Rotman-UTP Publishing.
On the weekend, news broke that Chinese regulators have ordered Ant Group, the world’s largest fintech company, to reorganize its business to comply with regulatory requirements faced by traditional financial intermediaries. This news follows the cancellation on Nov. 3 of Ant Group’s planned US$34.5-billion initial public offering in Shanghai and Hong Kong. Only two months ago, The Economist trumpeted that Ant Group’s blockbuster listing showed how financial technology companies are revolutionizing finance. Given how different China’s financial system is from ours, what can Canada learn from this episode?
The Ant Group example illustrates how banking and financial services are being transformed by technology. In the coming years, Canadians can expect to access more of their financial products and services from non-traditional players by using mobile apps and online portals. It may be an entrepreneurial fintech startup, a Big Tech company (such as Amazon, Apple, Google, Facebook and Shopify), a retailer, a grocery store or someone else.
What these new entrants have in common is that they are not regulated like banks, credit unions and other traditional institutions. Increased competition will lead to a better customer experience at a lower cost, but also creates risks.
This technological revolution reinforces the importance of regulation and risk management to protect consumers. It is critical to preserve and promote trust in financial services. Canada introduced new legislation in November to protect consumer data and privacy by updating and replacing the 20-year-old Personal Information Protection and Electronic Documents Act (PIPEDA).
We also need to enact open banking legislation to provide a secure framework for consumers to share their banking data with third parties. A final leg of the stool is to ensure that new entrants into financial services are held to the same regulatory standards as existing financial institutions.
There is no question recent financial innovations have delivered benefits. Digital banking has provided people at all income levels with access to financial services through their smartphones. Canadians no longer have to go to a bank branch to transfer money, deposit cheques or get basic financial advice. Just log on to your mobile banking app and it is all right there. Technology has also allowed people to manage their financial lives safely from home during the COVID-19 pandemic.
Ant Group is a fascinating case study of the tug-of-war between innovation and regulation. Alipay was launched in 2004 as a division of Jack Ma’s Alibaba Group. Alipay built trust in e-commerce by holding customer payments until the products were delivered by merchants. It had explosive growth and began offering deposits, investments, credit scores, loans, bank accounts and insurance to more than one billion users. The division was spun out of Alibaba in 2014 and later renamed Ant Group.
Ant Group’s success required the support of China’s regulators, who shared its goal of increasing financial inclusion. Alipay operated without an official payments licence until 2011.
But this relationship appears to have soured after comments by Mr. Ma in a private speech this past October. He suggested innovation was more important than regulation. He also argued that China needed to build a healthy financial system, not worry about financial systemic risks. The cancellation of Ant Group’s IPO a week later was a way for Chinese authorities to reassert their authority and punish Mr. Ma for stepping out of line.
Regulations protect consumers and businesses, ensuring a level playing field and promoting financial stability. Consumer confidence cannot be sacrificed to convenience. Regulations must be extended equally to anyone providing financial services to consumers.
This principle is particularly important as Big Tech companies move into financial services. Like Ant Group, Amazon started with payments, before adding small-business loans, cash deposits, consumer credit and debit cards, and product insurance. Google and Shopify are following Amazon’s lead.
As of April, Shopify Capital began offering qualifying Canadian merchants cash advances up to $500,000. Merchants only repay when they make a sale, and there is no deadline on repayment. Similar innovative financial products, powered by data from Big Tech’s huge platform ecosystems, will be offered to consumers soon. Regulators need to be pro-active, not laissez-faire.
One solution to the innovation-regulation conundrum is to encourage new entrants to partner with regulated banks. South of the border, Google has partnered with close to a dozen U.S. banks, including the fourth largest, Citigroup. This month, Shopify revealed it is partnering with the U.S. payments fintech Stripe and a U.S. bank to offer a business bank account to its merchants. Some small regional U.S. banks are specializing in offering back-office support and compliance to fintechs through a product called banking-as-a-service (BaaS).
Canada’s fintechs and challenger banks are seizing this opportunity. Borrowell, which started by providing consumers with their credit scores, is offering its one million members access to loans, mortgages, credit cards, banking and insurance through partnerships with a range of Canadian and U.S. financial institutions. Equitable Bank has partnered with Vancouver fintech Mogo Financial to offer a savings account through Mogo’s app. Each week brings news of similar partnerships.
Canada has a well-deserved reputation for a strong financial system built on principles-based regulation and incumbents that prioritize risk management. We have been slow, however, to adopt innovations such as open banking and paperless transactions.
Faced with rapid technological change, the correct pace may be to be a fast follower and learn from missteps in other countries. In the meantime, we have seen some outstanding successes in Canada, such as Shopify, Wealthsimple and Borrowell, that demonstrate the innovativeness of Canadian entrepreneurs. Canadian consumers benefit from their entry when it is properly regulated.
In our view, partnerships between regulated incumbents and innovative new entrants is the winning combination to balance the dual needs for innovation and regulation in Canada’s financial system. Our regulated financial institutions have the customers and the expertise in risk management and compliance. Our fintechs have the innovative products and customer focus. Combining their respective strengths will lead to a better digital experience for all Canadians while maintaining financial stability and protecting consumer trust.
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