RBI’s biannual report on financial stability, released last week, flagged the potential big impact of big technology firms entering the financial sector in a big way. Technology firms, whose competitive advantage comes from creating platforms for e-commerce or search engines, have been a part of the financial ecosystem mainly through support services such as payment processors. However, it’s the next stage when they will have a bigger footprint in lending that poses challenges for incumbents like banks, and for regulators too.
A defining feature of big tech firms is the economies of scope built into their business models. As technology platforms gain users, their ever-increasing data trail increases the scope of the products that platforms offer. Tech firms are uniquely placed in financial services. A bank has limited information on a customer. That influences not just the products that can be offered but also the perception of risks in offering loans. In contrast, technology platforms have large data on users, providing an advantage over traditional lenders. As RBI points out this can further the cause of financial inclusion by reducing the information asymmetry between lenders and small borrowers. China and other parts of Asia, including South Korea and Singapore, have seen significant penetration of technology firms in all aspects of the financial ecosystem.
But these potential benefits come with regulatory challenges. Monetising data presents unique privacy challenges. It’s therefore essential that big tech firms function within a data protection law. India needs one soon. The overarching characteristic of the financial sector is its interconnectedness. When financial activity happens in a regulatory grey zone, systemic risks are concealed. Most financial crises originate from concealment of risks. Given this context, RBI needs to be cautious about the conditions under which technology firms expand in the financial ecosystem. The primary requirement is that financial intermediaries, physical or digital, conform to a uniform regulatory standard. There are examples from East Asia where digital banks are allowed to accept deposits but within boundaries set by the regulator. To safely harness technology’s benefits, a smart regulatory framework is needed.
This piece appeared as an editorial opinion in the print edition of The Times of India.
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