According to Huw van Steenis, the Bank of England’s job of protecting the financial system is never done. In his Future of Finance report, he calls on the Bank to anticipate changes to market structures such as those caused by fintech. He also suggests that policymakers should reflect on how effective major policy initiatives like Open Banking really are.

This is the sixth instalment in our Future of Finance Series, which looks at Huw van Steenis’ Future of Finance Report and the Bank’s response to it.

Looking ahead to market changes

Keeping pace with business models

The traditional banking model is under threat from various sources. The growth of market-based finance is reducing reliance on bank funding. Neo banks are competing for market share. Other fintech firms are providing activities like payment services that used to be the reserve of banks. And the tech giants have already begun leveraging their huge customer bases to provide financial services.

As the FoF report notes, this diversity in the market is welcome. But it can also introduce new risks (or old risks in new forms). For example:

• If market-based finance dries up, there could be a sudden stop in the flow of finance to the economy
• Increased competition could put further pressure on banks’ margins which could, for example, hamper their investment in IT infrastructure
• Dividing up banking activities between different service providers could lead to narrower business models which are more vulnerable in downturns
• This unbundling of the traditional business model may also result in some financial activities being carried out by firms outside the scope of PRA regulation which would limit the Bank’s oversight of risks.

New risks, new policy choices

The FoF report imagines what the future might look like where low interest rates continue but there is a high degree of disruption to the market. In this scenario, the banking industry could become “more modularised with services provided primarily through market place platforms and outsourced activities”. This risks the banks of today becoming “low-margin back-end utilities”. 

The report suggests that in this scenario the Bank may need to ask for its regulatory perimeter – i.e. the scope of its regulatory remit – to be redrawn to take into account the new shape of the market.

Looking back on policy initiatives

The risks of opening up banking

The UK’s Open Banking reforms have required the nine largest banks to develop a common means for sharing customer data with eligible third parties. It was one of the first countries to implement Open Banking although others, like Australia, have followed. The EU Payment Services Directive (PSD2) also requires banks to share customer data although it does not prescribe the method for sharing that data.

While noting the potential benefits of opening up account information, the FoF report refers to some of the drawbacks of Open Banking. These include:

• Cost: according to UK Finance, the Open Banking project has cost the nine original participants £1.5bn to date
• Resilience: the report calls on policymakers to monitor the system’s ability to withstand outages
• Unlevel playing field: under PSD2, data sharing is not reciprocal i.e. banks must share data with third parties but those third parties are not required to share their data with the banks
• Legal liability: under current rules, banks are expected to compensate customers for unauthorised transactions by third parties and then counter‑sue the payment firm – the report suggests that this process is not be scalable.

Learning lessons from regulatory intervention

The FoF report cites research which indicates that the design of Open Banking does not fulfil the most attractive use cases, that only 28% of UK adults were aware of Open Banking six months after it launched and that 80% were concerned about sharing financial data with companies other than their bank. In response, the report proposes a Treasury-led review of lessons learned from the first 18 months of Open Banking.

It also recommends that the Bank establish a dedicated “regulatory evaluation and response” unit to assess the effectiveness of major policies across their life cycles. Separately, the Financial Conduct Authority has recently embarked on public evaluations of its market interventions.

Next up in our Future of Finance Series

In the next instalment of our Future of Finance Series we will look at the digitalisation of supervision and the potential automation of regulatory compliance.

Stay tuned by signing up to our FintechLinks blog.