Contents lists available at ScienceDirect Journal of Economics and Business journal homepage: Fintech and regtech: Impact on regulators and banks Ioannis Anagnostopoulos Kingston Business School, Department of Accounting, Finance and Informatics, Kingston Hill Campus, KT2 7LB, UK ARTICLEINFO Keywords: FinTech RegTech Business models Regulation Financial services Future research direction ABSTRACT The purpose of this paper is to develop an insight and review the e ect of FinTech development against the broader environment in nancial technology. We further aim to o er various per- spectives in order to aid the understanding of the disruptive potential of FinTech, and its im- plications for the wider nancial ecosystem. By drawing upon very recent and highly topical research on this area this study examines the implications for nancial institutions, and reg- ulation especially when technology poses a challenge to the global banking and regulatory system. It is driven by a wide-ranging overview of the development, the current state, and possiblefutureof ntech.Thispaperattemptstoconnectpractitioner-ledandacademicresearch. Whileitdrawsonacademicresearch,theperspectiveittakesisalsopractice-oriented.Itrelieson the current academic literature as well as insights from industry sources, action research and other publicly available commentaries. It also draws on professional practitioners roundtable discussions, and think-tanks in which the author has been an active participant. We attempt to interpret banking, and regulatory issues from a behavioural perspective. The last crisis exposed signi cant failures in regulation and supervision. It has made the Financial Market Law and Compliance a key topic on the current agenda. Disruptive technolo- gical change also seems to be important in investigating regulatory compliance followed by change.Wecontributetothecurrentliteraturereviewon nancialanddigitalinnovationbynew entrants wherethis has also practical implications. We also provide for an updated review of the current regulatory issues addressing the contextual root causes of disruption within the nancial services domain. The aim here is to assist market participants to improve e ectiveness and collaboration. The diculties arising from extensive regulation may suggest a more liberal and principled approach to nancial regulation. Disruptive innovation has the potential for welfare outcomes for consumers, regulatory, and supervisorygainsaswellasreputationalgainsforthe nancialservicesindustry.Itbecomeseven more important as the nancial services industry evolves. For example, the preparedness of the regulators to instil culture change and harmonise technological advancements with regulation could likely achieve many desired outcomes. Such results range from achieving an orderly market growth, further aiding systemic stability and restoring trust and con dence in the - nancial system. Ouraction-led researchresultshaveimplicationsforbothresearch andpractice.Theseshould be of interest to regulatory standard setters, investors, international organisations and other academicswhoareresearchingregulatoryandcompetitionissues,andtheirmanifestationwithin the nancial and social contexts. As a perspective on a social construct, this study appeals to regulators and law makers, entrepreneurs, and investors who participate in technology applied within the innovative nancial services domain. It is also of interest to bankers who might consider FinTech and strategic partnerships as a prospective, future strategic direction. 1 doi/10.1016/j.jeconbus.2018.07.003 Received 12 June 2017; Received in revised form 10 July 2018; Accepted 13 July 2018 1 Wethank twoanonymous refereesfortheirverythoughtful and constructing comments whotook akeeninterestin reviewing ourresearch and in this way contributed materially to the development of the paper. All other omissions and/or errors remain our own. Journal of Economics and Business 100 (2018) 725 Available online 21 July 2018 0148-6195/ 2018 Elsevier Inc. All rights reserved. T1. Introduction Sincethe nancialcrisisof2008,thelandscapeofthe nancialservicessectorhasbeengraduallychangingduetoanoverhaulin nancial regulation but also because of great advances in nancial technology innovation. Within the context of banking, the nature of nancial markets, services, and institutions is changing due to new entrants disruptive and innovating technological practices followingthelatest nancialcrisis(Gomber,Koch, it tripledduring 2014 alone to US$12.2bn and then nearly doubled in 2015 to $US22.3B. In 2017, theglobalfundingof ntechcompaniesstoodat$100.2billion,fourtimeslargerthaninvestmentsinventurecapital(IOSCO,2017a). Averyrecentstudy(Ernst the nancial technologyemployedwasesotericasanoperationalcapability.Itwasappliedexclusivelyonlybytraditionalbankswhichfollowedan established path to compliance. Accordingly, regulation - by its very nature - followed reactively the same, incumbent actors throughout. Yet, this current period is characterised by innovation not only in the nancial outputs delivered but largely by who distributes and how they convey such outputs. This has implications for banking and its regulation within the payments and fund transfers, insurance, lending, investment, and asset management domains (Schindler, 2017). It has also direct implications for the client base and as a result for incumbent nancial services rms. Fintech is rede ning the competitive setting, and is reshaping the Fig. 1. The Disruptive Innovation Model. Thisdiagramcontrastsproductperformancetrajectories(theredlinesshowinghowproductsorservicesimproveovertime)withcustomerdemand trajectories (the blue lines showing customerwillingness to pay for performance).As incumbent companies introduce higher-quality products or services (upper red line) to satisfy the high end of the market (where pro tability is highest),they overshoot the needs of low-end customers and many mainstream customers.This leaves an opening for entrants to nd footholds in the less-pro table segments that incumbents are neglecting.Entrants on a disruptive tracjectory (lower red line) improve the performance of their o erings and move upmarket (where pro tability is highest for them,too) and challenge the dominance of the incumbents. (For interpretation of the references to colour in the text, the reader is referred to the web version of this article.) I. Anagnostopoulos Journal of Economics and Business 100 (2018) 725 8lines that once characterised competitors in the banking industry. It causes disruption to the traditional value chain of nancial institutions. Kaal (2016)forexample, arguesit isthese disruptivetechnological innovations thatcreatean exponentialfacilitation in the value chain proposition for customers; a value chain once considered untouchable in the complex ecosystem of the nancial services industry. It is all about consumers and the channels through which they receive bene ts. The conventional methods of performing nancial services are lagging, and they are challenged by more modern, fresh, technology-empowered channels. Hence, the threat of ntech is also the impact it will have on customer expectations towards banking services. 1.1. Methodology and purpose statement Fintechs are a new, fast-growing part of the nancial services domain, and as such they are characterised by limited under- standing due to new phenomena emerging. Zavolokina, Dolata, and Schwabe, (2016) were one of the rst researchers to more systematically explore ntechs. The authors claim that ntech is a living body with a exible and changing nature rather than a stable notion that is transparent and clearly understood by both academia and the media (p 12). They further argue that the emergence of ntech is the result of three main factors simultaneously interacting and challenging the status quo at the same time. These are: organisations, people, and geographical locations (markets). Such phenomena have the potential to change business models, bring about structural changes, and/or change any other aspect of the system under investigation (Couphlan they are also enacted by enablers and other stakeholders. Furthermore, data availability is either scarce or non-existent in order to investigate ntechs deeper and understand further this observablephenomenon,whichisduetoitsnoveltyandexponentialdevelopmentpace(Dapp,Slomka, Coghlan Kaplan, 1998; Kemmis Ou Yang, Hsu, Sarker, (ii)to bridge the gap between rigour and relevance in our quest of understanding real issues in this domain while building scienti c knowledgeandcontributing totheory; and (iii)to highlightthe conditions underwhichinsightsfromre ectivedialogues andaction researchgiveresearchersauseful startingpointtothe eldand accordinglyestablishdialogue with ntech practitioners.Webelieve that such dialogue holds the promise of much fascinating research. Many banks have acknowledged being threatened by the growth of ntech companies. They have also formally voiced their concern about ntech competition and regulation held to exactly the same rigorous standards (Bunea, Kogan, they undercut costs, they o er a personalized, tailor-made service, better deals to the borrowers and lenders who con- gregate on such platforms, and they operate a fast-matching clientele outside normal business hours (KPMG, 2015). There is supply with enhanced accessibility and expediency. vi) Cyber safety: cybercrime-free transactions where there have been leaps and bounds of improvement and innovation in the nancial services protection over the last years (i.e. Apple Pay or the very recent disputes between Government and companies such as Google over tightly encrypted messaging). With this change new entrants have been compelled to create revolutionary digital products which a ord protection in addition to the features discussed above (PWC, 2015a, 2015b). vii) The nancialcrisisandregulation-enabledgrowth:Asarguedabovebetween2008and2013,investmentin nancialtechnology solutions grewfour-fold compared to venture capital. With the credit sector entirely stationary, mortgages became out of stock, smallbusinessloanswerefrozenandcreditcardlendingwaswithdrawn.Overthesameperiod,withbanksfeelingcompelledto spend great amounts on new regulation compliance in order to assure regulators they also became unable or unwilling to lend further and also invest on innovation (Stein, Goland, that is maturity mis- matching and leverage (Jaki they rather concentrate on the volume matching (and buy-side liquidity) by simply and transparently matching borrowers and savers directly. Thesenewplatforms donotdirectly raise nance withaviewto lending;acreditor pledgestheir funds aftertheyhave been matched and until the nal payment is due they bear all or any of the risk of default. They become the intermediary between banks and their customers. ix) Regulation as asource of disruption: The currentbanking regulation has also beenpartly responsible for the current climate and disruptive rise of technology. For example, the new liquidity regulation requirements in banking have made abundantly clear that to a large extent, deposits (accounts) as a source of funding are no longer considered an eminent source of nancing; they rather carry a penalty for over-reliance on such sources considered as less stable for the safeguarding of the nancial system. Hence, deposits experience scaled preference (further down in the pecking order of nancing) for the bank as a whole (Huertas, 2016). As a result, competition in the traditional deposits markets has shrunk; their importance as value-driven operations has declined along with its servicing qualities such as personalisation/tailor-made banking, accessibility, and convenience. As such, regulationinitselfcanalsobecharacterisedasdisruptiveandmany nancecompanyCEOshavethemselvescharacterisedregulation as a source of disruption (PWC, 2015a, 2015b). Another example is the Payment Services Directive (PSD2) in Europe. It has in- troduced the right to third parties to use bank accounts, the right to use APIs to connect the merchant and bank directly, and the abilitytoconsolidateaccountinformationinonesingleportal.ItwillinevitablydisruptthepaymentservicesinEurope.Ithasbeena signi cant prospect for ntech rms, and a certain problem for incumbent nancial institutions. The underlying consumer impact on the one hand is expected gains in overall consumer welfare due to the reduced costs of banking and investment, increased access and convenience, and personal banking o ered by the new contestants. Fintech has provided customers with a better banking experience as the technology ecosystem is capable of scrutinising huge data-driven con- sumer behaviour analytics and providing tailor-made solutions. On the other hand, it will compel slacking banks to alter their business models and their cost structures, reduce costs, and be forced to adopt and apply client-centered services amidst declining margins and declining pro tability, diminishing trust, and the threat of loss of market share. Yet, this disruption is also regulation- relatedand materiallyrelevant toprudentialregulators. Atthesametimeitisablessingandachallengetotheregulatorsobjectives for nancial stability and for safeguarding the protection of consumers. The di erence this time is that both the players and the processes are new; both are completely data-driven; and both move very quickly so that the pace of service and product novelty can make regulations pertaining to such product/services obsolete even before such regulations are agreed, nalised, and acted upon (Barefoot, 2015). The sections that follow examine the impact on banks and the impact on regulators. 3. Impact on banks and the nancial services sector The nancial services sector has a reputation of being ingrained in their traditional ways and being resistant to change. Banking has historically been one of the business sectors most resistant and suspicious to disruption by technology (Fichman, Dos Santos, they will have to self-re ect and choose whether - I. Anagnostopoulos Journal of Economics and Business 100 (2018) 725 11through utilising existing know-how and infrastructure - to co-lead, co-drive and reform the future of open banking. If not, they will be condensed to regulation-driven, deposit-taking suppliers of services, secondary to emerging, creative institutions (Carney, 2016). Averyinteresting,wide-rangingandin uentialstudypublishedbytheWorldEconomicForum(WEF,2015)reportstheimpactof ntech on the future outlook as envisioned by CEOs of major leading nancial institutions, academics, and start-ups. The report classi es the following implications for incumbent banks as safe bets (i.e. impact with a high degree of certainty regardless of whether the industry will consolidate or will operate as fragmented). More speci cally, the major disruptive e ect revolves around the channel of individual empowerment and loyalty. According to this research the fol