The Case for a FinTech Mentorship Regime

The Case for a FinTech Mentorship Regime Discussant: Mr. Enriques and Mr. Ringe Date: 27 March 2020 Introduction - Introduction - "How to build a fintech ecosystem" • Promote collaboration between fintech and established banks • Banks provide start-ups with access to know- how, reputation, access to markets • Case for an optional regime – “mentorship" – allows fintech to operate under bank license The Fintech Space - Original fear (or hope): fintech will “disrupt" and "displace" - Now: collaboration and interaction with incumbent banks - Advantages of collaboration • Data access • Knowledge transfer • Economies of scale • Synergies • Marketing advantages • Reputational spillovers • Regulatory access and compliance culture transfer Case Study 1 N26 - Partnered itself with Wirecard when junior - Received banking license in 2016 - Now major partner with smaller fintech (e.g. TransferWise, Weltsparen, vaamo (Moneyfarm)) - Partners are integrated into N26; customer transacts with N26 - Perspective: increase product range, flexibility, marketing opportunity The Fintech Space - Three main forms of cooperation, frequently through "application programming interface" (API) 1. "White-label banking" or "Banking as a service" fintech operation is integrated into banking services • Consumers perceive such services as being provided by fintech (unless they read small print) 2. "White label fintech" or "Software as a service" customer uses technology that looks like the bank's 3. Joint ventures and co-branding partnerships Case Study 2 Solaris Bank - Service provider with full banking license - Sole purpose is to partner with new startups and to grant them market access (against fee) - E.g. Tomorrow (banking & lending), Penta (SME lending), QNIPS (payments), SMAVA (e- marketplaces and aggregation) - No or very little customer contact - Other examples: Fidor (D), Sutor Bank (D), SynapseFi (US), Plaid (US), Habito (UK) Legal perspective: "Outsourcing" - Payment services provider includes banking services in the client package but outsources their provision to a bank - Bank outsources the distribution of its services to a payment services provider - Who is the outsourcer and who's the outsource? - Legally, the bank has the license, then it's the outsourcer - But economic substance is somewhat more blurred: client is often unaware of the bank's relationship "Outsourcing" - Banks outsourcing their activities may create risks • Legal limits on Outsourcing: EBA Guidelines 2019 et al. • Outsourcing normally part of bank's risk management; no notification obligation • Additional requirements when outsourcing is "material"  No outsourcing of key managerial responsibility  Bank required to carry out appropriate due diligence  Written outsourcing agreement  Supervisor can monitor the outsource, including access to premises, examination and information powers Outsource Supervision - - Outsources may or may not be regulated entities • Often payment services firms, but not necessarily • And payment services regulation is focused on conduct more than stability Supervisor has information acquisition powers • But no direct oversight of the outsource • No early intervention or sanctioning powers based on the banking services performed by the outsource • Oversees the bank, which is turn has contractual rights vis-à-vis the fintech Problems? - Is the framework fit? Supervisory gaps? - Supervisors seem to encourage trend; "outsourcing" of supervisory function - Potential shortcomings where legal infringement by fintech, but action taken against bank - No direct intervention - supervisor can of course ban bank from outsourcing arrangement, but inflexible and untimely - Bank may have incentives to delay or obscure detection - Status quo allows for contracting out of supervisory functions (technology; outsourcing contract) - -> Can anything be done to nudge/force these players (back) into the supervisory perimeter? • Regulatory sandbox • Fintech license • Mentorship regime Sandboxes - Regulatory sandboxes: "experimentation spaces" where regulators may relax rules to improve market access - Useful but imperfect • Main purpose rather promoting innovation and competition • Limited resources, limited number of firms admitted, limited time • Frequently "symbolic" sandboxes to lure fintech (window dressing) • Risks underexplored Mentorship Regime - The case for a complementary “Mentorship Regime" - fostering bank/fintech partnerships - How would it work? • Optional regime • Bank extends regulatory license to fintech • In exchange for equity, fee, exclusivity, etc. (?) • Communication to regulator which cannot refuse the arrangement • Once "in", the fintech is subject to full regulation and supervision for licensed firms Mentorship Regime - Consequences • Fintech subject to full regulation & supervision • But would be allowed to outsource its compliance and internal control systems to incumbent bank • Responsibility and liability on the bank - therefore ex ante incentive to screening - Advantages? • Mentorship regime would clarify responsibilities • Bring the fintech within the regulatory perimeter • Intermediation of the incumbent  Facilitate communication and culture  Vetting process Conclusion - Mentorship • Strategic partnership fintech/bank, should increase innovation • Fintech can travel on the bank's regulatory ticket (in exchange for consideration) • Responsibility and liability on the bank - therefore ex ante incentive to screening