FinTech : How to foster innovation in the financial sector?

July 19, 2019

Abstract

 

The financial services have been central to people’s life for centuries, with many of the same banks dominating the market and its development. Yet, the past 10 years have seen the birth of a new sector – the Financial Technology or FinTech which contradictorily requires traditional banks to exist, while also externally fuels innovation and competition in finance. Understanding better the role and importance of FinTech start-ups across the globe, we must consider innovation in the banking sector as a whole. This article entails to do just that by examining the relationship between law and FinTech innovation. Seven relevant areas – commercialisation, intellectual property (IP), public policy, open innovation, economic development, competition law and proactive vs reactive approach, are presented in order to identify what practices are needed for sustainable, client-oriented banking innovation to be fostered.

 

 

Introduction

 

The banking sector has existed for centuries, but never has it faced so many different uncertainties. From the 2008 financial crisis, to the rise of the financial technology[1] start-ups, today more and more diversified factors are driving change within the industry. The post-2008 world is marked by a fall in consumers’ trust in the big banks. This has gone hand-in-hand with rising consumer expectations. Millennial demand more personalised and simplified services, while giving less loyalty. More importantly, for the first time in the banking’s development, technology has penetrated every aspect of the financial services. This entails that the context in which the financial sector must develop is evolving at an extremely fast pace (EY, 2018). On the one hand, such changes make, for instance, the need for a bank account numbers, cash machines and bank branches feel obsolete (Lyons et al., 2018).  On the other hand, this means that banking firms are forced to continuously innovate or be left behind.

Today, FinTech innovation grows at an intensely high pace. Between 2014 and 2015 the sector grew by 212% in the United States (US) and by 92% in Europe (Hernæs, 2018). Due to banks’ inability to foster innovation, the FinTech sector is seen as a separate industry which fuels innovative practices amongst traditional banking institutions, but also necessitates their existence. To understand better the FinTech development, this essay will examine innovation in the banking sector.  It will present the relationship between law and FinTech innovation to identify what practices are needed for sustainable banking innovation to be fostered. To do so, the essay will discuss seven relevant area – commercialisation, intellectual property (IP), public policy, open innovation, economic development, competition law and proactive vs reactive approach.

Translation and Commercialisation Innovation is expensive and timely to develop. The creation of a novel product or service is related to higher risks, as success is hard to predict. Many innovative products struggle to commercialise due to lack of finance, governmental support and legal, business and market knowledge. To begin with, I will discuss how the commercialisation of financial innovation could be facilitated.

The financial sector is almost as old as contemporary society itself, and even though as any other industry banking has been continuously innovating, the penetration of technology throughout every aspect of the financial services is a novel phenomenon. It has mostly been driven by a newly formed sector dominated by start-ups, called FinTech, aiming to solve old-school financial problems with new-fangled technological solutions. This sector has caused disruption in the traditional banking sector and has put extra pressure on big banks to digitalise and adapt in order to satisfy their clients. As such, FinTech innovation is bringing societal benefits by improving the speed and price of some of the world’s most essential services. In fact, it is predominantly consumers’ rising expectations, fuelled by the personalised, simplified and consumer-centric services big tech companies, such as Google, Amazon, Facebook, etc. that drives the change. It is then not surprising that most FinTech innovation is done in consumer banking and payments (PWC, 2016).

For that reason, to be successful at commercialising their innovation, FinTech start-ups should recognise the personal spot finance holds in people’s lives. This makes the subject extremely personal, and thus, security and privacy should be taken very seriously. Here, the status quo has the advantage in commercialisation of pre-existing trust. Nevertheless, this is declining, following the 2008 financial crisis mostly being blamed on the big financial institutions. In order for FinTech innovations to successfully translate to the real world, they must respect pre-existing data-protection laws and invest in cybersecurity. Otherwise, they risk facing public opposition. An example of how damaging security beaches could be to FinTech technologies is that when Bitfinex, a Hong Kong-based digital currency exchanged was hacked in 2016, the price of bitcoin fell by 20% overnight (Nunns, 2016).  

For FinTech innovators to be successful in the development of their novel approaches to finance, they should take into account the needs of consumers. Their effective launch depends on the market, as well. Hence, for successful commercialisation, it is vital that the FinTech sector is given access to consumer and financial data. How this could be facilitated will be discussed under the open innovation section of this essay.   

Additionally, after the 2008 financial crisis, financial services have been labelled as irresponsible. Yet, compared to other innovation areas such as biomedicine and biotechnology, financial innovation is rarely discussed together with the term responsibility – in the sense of corporate social responsibility (businesses self-regulating to follow ethical and regulations standards) and socially responsible investment (for instance, environmental responsibility). Thus, an engagement with responsibility before the commercialisation process could ensure the innovation receives the public support and reaches critical mass quickly. One way to guarantee new services are compliant and responsible is through the creation of New Product Committees or New Product Approval. These are processes through which opportunities and risks are assessed, and legal compliance ensured before the innovation’s launch in the market. This could protect FinTech start-ups from societal backlashes. For FinTech start-ups however, going through such a process might be harder due to limited finance, knowledge and time. Receiving a green light from outside committees might impair innovation when technology is not well understood, too (Muniesa and Leglet, 2013).

Moreover, innovation will be successful only when commercialisation is promoted throughout the whole ecosystem of traditional financial institutions, research facilities at academic instructions, governments and entrepreneurs. How can academia help FinTech innovation and what steps should universities take to incentivise commercialisation? Top-tier research on technology is done in academic institutions, but to promote its translation into the financial sector and further commercialisation, supportive FinTech culture should be created within academia. Education in financial innovation could also give young entrepreneurs the knowledge and confidence they need to launch their FinTech start-ups. Lastly, it is within academia that technology talents are nurtured (Accenture and McMillan LLP, 2017, 23). The Massachusetts Institute of Technology’s (MIT) involvement in FinTech innovation is an example of how FinTech should be fostered and academic commercialisation motivated. MIT offers a module on financial technology, mentorship scheme and a FinTech club. The university hosts an annual conference and a financial technology hackathon with $13,000 in prizes (Burton, 2017). Another positive example is the University of Edinburgh’s innovation incubator, which offers support to students with novel FinTech ideas (Cyrus, 2018). These two universities show what is needed for new ideas born in academia and students’ minds to be translated into the financial market successfully.


Just as universities struggle with the problems of not only coming up with an innovation, but also commercialising it, so do entrepreneurs. FinTech start-ups lack expertise and money to launch their ideas, to protect their IP and to ensure regulatory compliance. To facilitate the translation of their products, FinTech start-ups have the incentive to cooperate with other stakeholders. Next, I will discuss why cooperation with big financial institutions and the public sector will aid FinTech innovators in the commercialisation process.

 


The two PPPs: Private-Private partnerships and Public-Private partnerships


The financial status quo has the advantage of critical mass and larger financial networks, but this could stop them from innovating and being consumer-centric. A main aspect that prevents this innovation is their outdated culture. In its research on financial innovation in New Zealand, PWC (Symons, 2017) emphasises the importance of culture in promoting the innovative process. A sector that wants to innovate must support innovation and talent. Corporations which want to improve their innovation to meet consumers’ expectations should have a top-down approach to technology, accepting new developments throughout its structure and ensuring there is an understanding of the stakes and opportunities by all employees so opportunities are not missed (PWC, 2016). For instance, Scarbrough and Lennon’s (2010) research evidence that the lack of IT knowledge throughout the Bank of Scotland resulted in limited ability to spot innovations needed. Overall, today’s financial services providers are faced with increasing consumer expectations but lack the culture of technological innovation placed at the centre of their corporations.

Therefore, big banks cannot solely rely on innovation created within their teams. This is where FinTech companies could be useful (PWC, 2016, 12). Big financial institutions are unable to innovate by themselves, so they need cooperation. In fact, 40% of the banks worldwide have already recognised this necessity (BNP Paribas, 2016). Similarly, FinTech companies are struggling with the scaling-up of their projects as they are unable to get as many users as they need for efficiency. Furthermore, they do not have enough knowledge of the law and regulations to use those to their advantage. On both points, big banks can help. Hence, both sides benefit from working together (Burton, 2017). For instance, in 2016, the French bank BNP Paribas started its cooperation with a Silicon Valley FinTech start-up incubator - Plug-and-Play. This open innovation initiative allows for the bank to have its issues addressed by the start-up sector and for some of the best international FinTech companies to gain access to the French market. In this situation, the banking partner offers financial and information resources, as well as clients to the FinTech innovators. Meanwhile, the incubator participants solve the bank’s problems, bringing an external, young, and innovative view-point. These partnerships might also take the form of Public-Private Partnerships in countries where the biggest banks are still private. Yet, only 20% of the global banks have engaged in similar practices.  Such collaboration clearly benefits commercialisation by providing direct access to the market for innovators. It also advances Research and Development within whole financial sector, both on a start-up and on traditional levels. Thus, it should be further promoted by government.

Secondly, Public-Private Partnerships (PPPs) could too  facilitate the success of FinTech innovations on the market. Governments worldwide necessitate financial services to execute many of their activities. However, in this area, many of the services they provide are falling behind. Not to mention that if corporations are struggling with creating innovative culture, then governments have barely even started discussing the question. Partnering with the FinTech industry, the public sector could solve the troublesome service gap, increasing citizens’ satisfaction with the services offered, as well as lowering its operation costs. Take for example Bahrain’s FinTech Bay, a government-sponsored incubator, which besides providing financial support for FinTech start-ups, connects government agencies with the FinTech innovation (Summers, 2018). Such PPPs permit public entities to discover new ways for innovation or find a technological solution to a financial problem they face. They help the innovators in a similar way as Private-Private Partnerships, giving them backing and clients. Lastly, PPP could take the form of RegTech cooperation. These are agreements between the private sector and a FinTech company, where the latter provides the former with the data needed for the creation of a certain regulation.

Nevertheless, for both types of collaborations a similar problem might appear. According to PWC (2017), the majority of FinTech start-up partnerships with the traditional banks fail because the latter are not flexible enough to adopt the changes. This is once again a result of the missing innovative culture. Similar challenges apply for the Public Private Partnerships. Finally, this sort of collaboration entails data sharing amongst different entities. This in itself poses security and privacy risks which will be discussed in the Open Innovation Section.    

 

 

Intellectual Property (IP)

 

Traditionally, innovation and commercialisation are incentivised by the possibility to receive exclusive patent/IP rights on one’s invention which guarantees a financial benefit in the long run. IP also permits for the innovation knowledge to be shared with all other interested parties to further advance R&D in the sector. However, the IP process is complex. This is especially true for the FinTech sector.

Firstly, IP laws often cannot keep up with innovation. To facilitate FinTech development, they should be effectively enforced, should give clearly defined rights to the IP owners and should protect the inventor for a longer period (Shiao, 2017).[2]  If an inventor believes that their creation would not be protected under the law and thus they will not benefit financially from it, they are less likely to undertake the research or want to commercialise it in the first place. Moreover, they are less likely to apply for patent protection and share their knowledge with the industry. By offering the possibility of IP protection, corporations, incubators and academic institutions could attract better talents, too. Therefore, to incentivise FinTech innovation, better IP laws should be introduced. The creation of those should benefit from discussion between all stakeholders – from lawyers to entrepreneurs, from governments to corporate partners.

This leads to the second problem with contemporary IP rules – often they designate FinTech inventions as unpatentable. As they rely on technology, FinTech creations are often characterised as ‘business method patents’, making them non-patentable subject matters (Hinton et al., 2017). Hence, IP laws must be revised to clarify what FinTech inventions are patentable and what not. They should also make the IP-application process more hassle-free (Medeiros and Chau, 2016). For example, after the Alice Corp v. CLS Bank (2014) US Supreme Court case, in the US a software patent application goes through a two-step applicability-evaluation system. First, the invention should fall within one the statutory categories. Then, it should be decided if the claim involves an abstract idea, which is traditionally not patentable. If so, it should be decided whether the patent offers “significantly more” than the abstract idea. However, US patent law does not provide a clear definition of what qualifies as more than abstract. Consequently, huge inconsistencies in the application of software patents granting in the US FinTech sector have appeared (Singer, 2014).

Similarly, Medeiros and Chau (2016) point out that although the Canadian IP office (CIPO) has provided guidance documents, attempting to clarify the patent office’s practices, Canadian IP laws have stayed very unclear. In fact, after the text was released, even more inconsistent decisions were produced. Even though the guidelines underline that business methods are not excepted from patentability, the CIPO still imposes a very strict approach when granting IP to FinTech/software inventions. The inability of IP laws to clearly define what protection software inventions qualify for, as well as the immense insecurity and complexity of the patent-granting process dis-incentivises IPR applicants and ultimately innovators. It also puts FinTech start-ups in a disadvantageous position because they lack the knowledge needed to fight for patent protection in the sector.

Furthermore, FinTech innovations are struggling with finding locally the demand needed for their successful scaling up. Yet, international IP laws’ disparity hurdles global expansion (Burton, 2017). Here, better international cooperation between international IP offices and the introduction of standardised protocols on IPR protection in the FinTech sector could help. In the US although difficult,  a software could be grated patent rights. Europe, on the other hand, offers much weaker copyright protections for digital inventions. This could be problematic as only the text, but not the process of the code is protected. Thus, if someone else offers the same function with slightly different code, they will not be infringing on right of the IPR-holder (Arrowsmith, 2017). This EU-US difference in itself signifies that patents are weaker internally, too. To address the complexity of the patent granting process for digital inventions and set a positive example to be used in the standardisation the Singaporean government has set its IP Hub Master plan (GoS and IPOS, 2013). The programme entails simplifying, refining and strengthening the software protection process by 2023.

Finally, as mentioned, many FinTech innovators are small start-up which do not have the resources and knowledge on how to protect their IP rights. Academic and private partners must provide more incentives, subsidies and information to inspire an increase in participation in the IP commercialisation community.  Standardisation of international IP offices’ practices in relation to FinTech could simplify the process for the smaller players and give them the opportunity to compete on the same level as bigger competitors. Additionally, this is where incubators and partnerships might benefit the innovators. The former could give their IP knowledge and expertise in exchange for a part of the invention’s future success. Governments, too, should assist entrepreneurs and innovators in extracting value from their IPs. Finally, another challenge which might cause FinTech partnerships fail issues from conflicting IP rights interests (Bobeldijk and Agini, 2017). Hence, it is key for policy-makers and IP offices to encourage and facilitate IP cooperation. Consequently, all stakeholders in the FinTech sector will be incentivised to cooperate and innovate, and there will be better trust between the partners.

 


Public Policy

As shown, IPRs offer the benefit of financial gains to innovators and could be used to attract talent, innovation and promote cooperation. If properly constructed, IPR could incentivise innovation itself. In addition, IP law could be a policy approach of governments which want to attract more FinTech innovation. For example, as part of its IP Master Plan in 2018 the IP Office of Singapore launched an initiative for FinTech patent applications to be fast-tracked and received within 6 months instead of the usual two years. The FinTech Fast Track programme allows faster monetary gains and scaling-up opportunities for FinTech innovators. It also enables the Singaporean government to attract more FinTech innovation and the economic benefits it brings to the country (Fintech Innovation editors, 2018).

Furthermore, FinTech innovation lowers financial sector’s operation costs, B2C costs and B2B dynamics. Business-wise, it diversifies the services provided, brings in new clients and improve consumer retention. From a governmental perspective, FinTech creates new jobs and income. For instance, according to the Scottish government, the FinTech sector has the potential to create as many as 15,000 jobs in the next decade (Cyrus, 2018).
Additionally, the FinTech sector has been recognised as beneficial for Small and Medium Enterprises (SMEs). SMEs are usually riskier to invest in and since they go through the same lending application processes as big companies, SMEs have a lower chance of receiving a loan from the traditional banking institutions. Studies in the UK and the US show that almost four-fifths of the SMEs attempted to borrow money from a bank, but only a fifth were successful. This could get in the way of their development or even their creation (FSB and BIS, 2017). Thus, the FinTech which makes loans more accessible for SMEs could facilitate business development. FinTech innovation in the credit market has the potential to bring about better financial inclusion, lower prices for borrowers, better risk-adjusted returns for investors  and diversification of credit sources.

Motivated by the economic benefits which would result from blooming FinTech sector, governments could finance incubators which support FinTech start-ups financially and legally, and facilitate the conversation between corporate world and the startup world. For instance, in 2016 the Australian government financed the establishment of the Sydney FinTech incubator – Stone and Chalk[3]. The not-for-profit assists FinTech start-ups throughout the launching process. Such initiatives also permit the state to give the information FinTech start-ups need to comply with regulations.


Policy-makers could also provide direct subsidies to the sector. For instance, once again the Singaporean government has combined its FinTech fast-track IP programme with a S$225 million Financial Sector Technology and Innovation (FSTI) funding scheme (Fintech Innovation editors, 2018). Similarly, countries like China, France and the UK have allowed preferential tax policies for the FinTech sector [4].

However, FinTech practices bring with them certain risks, too. In terms of the lending market, FinTech start-ups have lower liquidity than big banks and questionable ability to evaluate properly the credit risks. They might cause a reduction in lending standards and a credit rating system dependant on investors fad-like behaviours, risking the system’s stability. Moreover, since FinTech does not face the same regulations as banks they could have lower respect for individual’s privacy and are more prone to cybersecurity mistakes. Due to lower regulations, authorities have limited knowledge of the dealing of FinTech companies. As a consequence, they are less capable of monitoring their activities, enhancing the information asymmetry within the banking system. In fact, this obscurity is bound to deepen. Popular approaches to FinTech, such as blockchain and RegTech[5] essentially remove the possibility for monitoring, by solely relying on confidential algorithms. Consequently, the sector is exposed to unmitigable and unregulatable risks (Ducas & Wilner, 2017; Magnuson, 2018). Current approaches to policy-making would not allow for these risks to be monitored because of the automation of the compliance process.  

Likewise, PPPs and Private-Private collaborations entail data-sharing which might put at risk the privacy of the individuals. FinTech do not access public safety nets either, so are more likely to crash if an economic crisis hits the industry again (FSB and BIS, 2017). Lastly, similarly to IP law, financial regulations lack clarity on which laws apply to FinTech and which do not.

So, the FinTech sector advances consumers’ and the market’s interests, but the regulators must balance those benefits and the incentives for innovation with the risks FinTech companies bring. If all banking rules apply to the FinTech start-ups, but they do not get a banking licence, they will be forced to exit the market or demotivated to enter in the first place (Didenko, 2018). However, letting FinTech start-ups stay unregulated poses risks to the end-users and the financial system. To balance the pros and cons of the FinTech sector in the financial credit system, regulations dedicated to FinTech credits in the form of licenses were introduced in numerous countries in Europe, such as Switzerland, the UK, the Netherlands, France and Spain. These licences are much easier and cheaper to acquire than a banking licence so as not to stifle innovation. Yet, they put forward certain financial standards FinTech companies must meet to be allowed to lend money, like following anti-money laundering rules, insurance protections guaranteed standards, capital requirements and so on (FSB and BIS, 2017). Thus, the consumers are protected from scams, the market from failure and the FinTech start-ups are guided in the direction of responsible innovation.    

Another positive practice which could both promote innovation and allow for cooperation between the private and the public sector in the formation of the regulations are the so called regulatory sandboxes in the UK. The British sandboxes permit for FinTech innovators to test their programmes in a controlled environment for a limited time and number of users, reducing the time-to-market, the costs to entry and the risks and facilitating access to finance. These protect the consumers, too. According to the UK Financial Conduct Authority (FCA) 90% of the participants launched successful FinTech businesses (Zuckerman, 2018). Moreover, the Sandboxes permit the FCA to maintain contact with and an eye on the sector. This it can provide regulations needed to balance risk and innovation and embraced by both the traditional financial industry and the new companies. Regulation consultations are facilitated through the PPPs and incubator initiatives.

Finally, as already discussed FinTech start-ups face the challenge that local demand might not suffice for FinTech companies to build efficient and sustainable businesses (Didenko, 2018). Therefore, it is important for regulators to facilitate the international development of FinTech Start-ups. Apart from international standardisation of IP laws for FinTech start-ups, mire international cooperation on the topic in general is essential. Similarly, governments should make sure to increase the local demand for the technology. For instance, the UK FCA unveiled its plans to promote the sandbox practice on a global level next, cooperating with other governments to allow for international diffusion of the FinTech innovation (Zuckerman, 2018). Moreover, the Sandbox approach heightens consumers’ trust in the platforms and, thus, attracts more users. A step in the right direction were also the G20’s recognition that FinTech regulation should be on the block’s agenda (Becker, 2017).


Public Policy and Competition

Furthermore, FinTech in the credit market, as well as overall FinTech companies, could lower the power concentration in the banking sector. Currently, the financial services industry is extremely concentrated. As seen in Figure 1, in 2012, the five largest Canadian and Australian banks held more than 90% of the assets. The numbers in the UK, US and Italy, although lower, are equally worrying (IMF, 2014). The existence of a monopoly/oligopoly entails lower competition in the market and lowers the incentive to innovate. In Finance, FinTech aids increased access and decentralisation of the financial system, serving the underbanked and unbanked, enhances market integrity and might be the source for some early warning signs of systemic financial problems (Herweijer et al., 2018). Therefore, policy-makers have the motive to decrease the barriers to entry for the FinTech entrepreneurs as those could re-introduce innovation in financial services. Also, lower concentration of the financial market has the potential to bring more stability.

 

 

Figure 1:  Bank Concentration in Selected OECD Countries (Assets of five largest banks as a share of assets of all commercial banks, 2012)

Still, the existence of those monopolies means that banks have a beneficial position compared to the new-comers. They already have all the clients and data, as well as the trust. Furthermore, through the already discussed collaborations and possible acquisitions of FinTech start-ups by the bigger players, the market competition could be stifled. Not to mention that big tech companies have already expressed interest in disrupting the financial sector themselves. They, too, have enormous knowledge of the consumers and might put smaller FinTech start-ups, as well as banks at an advantageous position. After all, due to network effects and economies of scale the tech sector is vulnerable to market power concentration. The fact that data is concentrated in the hands of a few could facilitate the formation of cartels and of price-fixing practices. Big financial or tech companies might, also, abuse their dominant positions and sabotage innovators. Considering the positive effects FinTech innovation could bring to the individual, society, business and society, governments have in their interest to protect the FinTech innovators (Van Der Beek, 2017, Hinton et al., 2017, FSB and BIS, 2017, Didenko, 2018). Hence, those dangers should be considered by national and international competition authorities when regulations for the FinTech sector are created and when acquisitions are allowed to protect consumers’ interests. Moreover, policy-makers should ensure FinTech entrepreneurs are protected when they enter into a collaborative agreement with bigger player.


Open Innovation

In breaking up the imbalance of power in the financial sector, policy-makers must also confirm that FinTech start-ups are given access to bank infrastructure. Importantly, FinTech start-ups are disadvantaged by the data disparity in the financial services market. Usually, the banking leaders hold exclusively financial and user data collected on consumers for years. As newcomers, they lack access to the data necessitated for R&D, testing and compliance, which is the fuel of the technological innovation. Since openness and international interoperability between systems increase to scale FinTech businesses, it should be incentivised through open innovation policies (Didenko, 2018). When banks are reluctant or uninterested to share their information, regulators should implement rules on open data to eradicate barriers to innovation. A step in this direction is the Revisited Directive on Payment Services (PSD2) in the EU, the New Payments Platform (NPP) in Australia and the Open Banking Standard in the UK. The EU’s policy asks of banks to open access to consumers account via APIs. The British Open Banking Standard standardised the processes for use and setting-up of shared through APIs banking data accesses. Lastly, the NPP compels FinTech start-ups to collaborate with incumbents on “overlay services by limiting the open system access to authorized institutions (Hinton et al., 2017, Herweijer et al., 2018).

These Open Innovation practices, nonetheless, are accompanied by challenges and risks, as they ask of banks to part with their proprietary data. The perils circle around increased cybersecurity threats, privacy worries and probable negative outcomes of data misinterpretation. When data is opened one loses control over its use and reading. Moreover, bad news can diffuse through the system resulting in harmonised behaviour which threatens the financial systems’ stability. Last but not least, an increase in data permits algorithmic discrimination on factors which might appear legitimate, but in fact cause further economic divide. Consequently, these risks are important and should be well-understood and monitored by regulators.


Proactive or Reactive Law

The final problem with regulations which must be considered is whether those should be proactive or reactive. Traditionally, the law has worked mostly reactively, because of the difficulties to predict the future and the fact that people are uncomfortable with regulating something that does not already exist. At the same time this ‘wait and see tactic’ could fail to protect the market and the consumers from the risk of innovations or could result in a missed growth opportunity. Yet, badly designed proactive regulation could hurdle innovation. Moreover, the FinTech sector as all other technological industries are seeing breath-taking speeds of innovation which could make written law feel obsolete or irrelevant altogether very quickly.  

Creating a regulation sooner is a positive development to protect the users and avoid reputational risk or total loss of trust in the industry due to ‘a few bad apples’. Waiting to regulate the FinTech sector might incentivise heavily regulated entities to engage in harmful arbitrage, using FinTech as an excuse to avoid regulations in certain markers (Didenko, 2018). Thus, there are arguments for a reactive regulation to be created to ensure that the FinTech market continues developing.

Then again, FinTech innovation could benefit from reactive regulation, as well. Regulators should have a proactive approach, as usually FinTech companies are very small start-ups which lack the habit of engaging in dialogue with regulators and generally stay under the radar unless approached by policy-makers (Didenko, 2018). Once again, great examples of such proactive steps being taken are the regulatory sandboxes and PPP incubators. As already stated, these let governments regulate the market without risking stopping innovation or scaring off start-ups. Thus, it is important that the regulations created are not too strict and limiting to the development of financial technology. A priority for the regulators should be the technologies which pose higher risks to the financial system and the end-users.


Conclusion

What practices are important to ensure sustainable and efficient innovation in the financial sector through FinTech start-ups? Firstly, it is important that commercialisation is incentivised and facilitated. This could be done by promoting financial innovation in universities and amongst entrepreneurs, as well as by increasing the public’s trust in the newly formed sector. To do the latter, the customers interests should be considered and FinTech innovators should engage in responsible investments and social responsibility. Moreover, Public-Private and Private-Private Partnerships could promote innovation and enable commercialisation and scaling-up.

Public policy plays an important role in the financial services innovation, too. Since FinTech offers clear economic and societal benefits, policy-makers should support financially and through information and regulations its development. This should also be done through modernisation, simplification and clarification of the existing intellectual property laws. Nevertheless, since FinTech brings with itself certain risks and challenges, regulators must consider those when creating new regulations and must monitor FinTech start-ups activities continuously.

Lastly, governments must consider supporting FinTech innovators because they would allow for the breaking up of the concentrated financial market and more equal power balance. Thus, new FinTech policies should follow for anti-competitive practices by the power-holders. Furthermore, to allow for the innovation to continue growing at the current levels, regulators must guarantee FinTech start-up access to the financial infrastructure and data. To do this, policy-makers must force open innovation in the sector by introducing compulsory API data opening and by helping cooperation between stakeholders.

FinTech innovation is important for societies, businesses and individuals. As such, it should be supported by policy and law-makers. Yet, they should also continuously evaluate the risk FinTech start-ups could cause the financial system. Importantly, to prevent the stifling of innovations, regulations must bring a balance of promotion of innovating practices in the financial sector, ensuring fair competitive practices and protecting consumers. One way of doing this is through continuous consultations and a combination of reactive and proactive law practices.

Endnotes

[1] Hereafter called FinTech.


[2] The role of the length of the protection is debatable. On the one hand, longer period of IP right given to the inventor might give them bigger incentive to innovate. On the other hand, if the protection period is too long it might hurdle innovation in the sector as it prevents other players to utilise the innovation.


[3] More information about the incubator is available on their website: https://www.stoneandchalk.com.au/our-company/.


[4] For example, China allows local government to lower taxes for credit FinTech start-ups.


[5] RegTech is the usage of automated technology and big data to comply with a given regulation and hedge risks within the financial sector.

 

 

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