A pound of flesh for your Libra inclusion

The Bank for International Settlements (BIS) has just released its annual economic report and this year it features a special chapter on the entry of big tech into finance.

The chapter couldn't be more topical, says BIS economic adviser and head of research Hyun Song Shin.

“We chose the right week to launch our chapter,” Shin notes in reference to the launch of Facebook's Libra coin last week.

But while it would be tempting to linger on BIS views about Facebook's audacious plans to literally almost take over money, that would be to overlook some of the more nuanced but equally important views about fintechs in general.

The report's key point is that the entrance of big tech into finance promises all sorts of efficiency and financial inclusion gains — which is a good thing — but those gains mustn't come at the cost of other things like privacy, financial stability and market competition.

To wit, there's an implicit suggestion that the regulatory landscape needs to change to address these new multi-faceted issues. It comes by way of this regulatory compass which shows how three core regulatory issues intertwine in the presence of big tech in finance: 1) Financial regulation. 2) Competition regulation. 3) Privacy.

Individual regulators are not best suited to covering these factors when they're combined in one package in big tech.

Take competition as an example. In banking, there are two views on the subject. One: new entrants are good because they challenge incumbents, increase inclusion and lower costs. Two: new entrants undermine financial stability because they don't have the experience of capital buffers incumbents do.

But when the new entrants are big tech companies . . . this debate becomes moot. What new entrants bring to the table isn't necessarily more competition but less. And it's to do with how data analytics, network externalities and interwoven activities feature in big techs’ business models. This is something the BIS sums up as being in their DNA.

From the BIS (with our emphasis):

However, the relationship between entry and effective competition is far from obvious when the DNA feedback loop is taken into account. New entry may not increase market contestability — and competition — when big techs are envisaged as the new entrants. This is because big techs can establish and entrench their market power through their control of key digital platforms, eg e-commerce, search or social networking. On the one hand, such control may generate outright conflicts of interest and reduce competition when both big techs and their competitors (eg banks) rely on these platforms for their financial services. On the other hand, a big tech could be small in financial services and yet rapidly establish a dominant position by leveraging its vast network of users and associated network effects. In this way, the rule of thumb that encouraging new entry is conducive to greater competition can be turned on its head

In that context, the BIS continues, “the traditional focus of competition authorities on a single market, firm size, pricing and concentration as indicators of contestability is not well suited to the case of big techs in finance.”

But what's the real story here?

Ultimately, we would argue, it's about trade-offs.

An important point raised by the BIS is that big tech's approach to credit quality evaluation is possibly very robust. So far, the use of big data and social behaviour mapping is proving highly successful in terms of predicting who is risky and who is not. Yes, the system hasn't been tested in a down cycle. But that, to some degree, doesn't matter.

Let's assume the techniques big tech uses to achieve superior evaluation of credit quality are as good as implied. The question is: what's the cost? Banks for generations have assessed credit quality through a combination of relationship formation and continuous monitoring of projects lent to, with payments enforced through liens on collateral pledged. Even this has seemed, in some cases, overly oppressive and ethically dubious (like the mass eviction of people from their homes during the subprime crisis).

It's in this area of “enforcement” that big tech diverges massively from banking. And it's here, Alphaville would argue, where the dystopian stuff really sets in.

As the BIS notes (our emphasis, again):

Big techs can address these issues differently. When a borrower is closely integrated in an e-commerce platform, for example, it may be relatively easy for a big tech to deduct the (monthly) payments on a credit line from the borrower’s revenues that transit through its payment account. In contrast, banks may not be in the position to do so as the borrower can have accounts with other banks. Given network effects and high switching costs, big techs could also enforce loan repayments by the simple threat of a downgrade or an exclusion from their ecosystem if in default. Anecdotal evidence from Argentina and China suggests that the combination of massive amounts of data and network effects may allow big techs to mitigate information and incentive problems traditionally addressed through the posting of collateral. This could explain why, unlike banks, big tech's supply of corporate loans does not closely correlate with asset prices.

These are the sort of techniques that quickly bring us models which may see, for instance, Uber drivers being locked out of their cars electronically because they've been sick for a week and missed payments. Or worse, having their pay docked at source until what's owed to the lender is paid out of personal compensation.

Getting even more dystopian (moving along the Chinese social credit route) the tech companies could even threaten to lock users out of wider services (train travel, plane travel or even entertainment services) unless loans are repaid, or share sensitive private information with other (possibly even personal) third parties the consumer would rather not share it with.

What you end up with is a social system where one's work/labour is effectively enforced by a form of institutionalised ransomware. “Go to work and earn the money you owe us, or else we will share information about your bad behaviour with the train service, so you don't get to enjoy your weekend with your family as planned.”

That's an effective strategy for eking out payments. But whether it is ethical or desirable is another matter entirely.

The added ethical factor is the social bifurcation that is likely to follow. The rich and well off will always be able to opt out of such onerous terms. The poor, not so much.

Which leads to a tiering of society between those big tech can control because they're desperate, and those they can't.

Is that really how the unbanked issue should be solved? By turning half of society into an effective slave class that gets access to capital only on the condition that their compliance to community standards is guaranteed on all fronts? To the point that if they don't comply they're banished, embarrassed or blacklisted in the global market for services of all kinds?

Who dictates what those community standards are anyway? And whose politics are they set on?

There's a meme going round the internet that kind of spells out the dystopia perfectly (hat tip to Climateer Investing):

Big tech supporters might argue that the unbanked are effectively already frozen out of these systems, and thus any access opportunity is a way forward. That may be the case, but again the question becomes, whose politics are these access rights being based on and where was the democratic debate that established them?

As Shin told Alphaville (our emphasis):

We are facing issues that go well beyond the traditional financial stability domain of the financial regulators. We have the DNA loop, which has a market dominance /competition aspect and we need a joined-up approach where we have competition issues and financial regulation taken together. And ultimately it may even transcend the economic efficiency goal, we may feel that data privacy is such a basic goal that we shouldn't reduce those to economic objectives.

Which is another way of saying this stuff may lower costs and increase efficiency, but are the political implications potentially regressive?

In the words of Team America: Freedom isn't free.

Related links:
Float management isn’t easy — FT Alphaville
Mpesa: the costs of evolving an independent central bank
— FT Alphaville
Will fintechs sink or swim when floats are regulated?
— FT Alphaville
On the limits of a new AI-inspired Gosplan system — FT Alphaville
When tech companies become more powerful than governments
— FT Alphaville

Copyright The Financial Times Limited 2019. All rights reserved. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.

Read next:

Read next:

Lookout, there’s a dollar crunch!

FT Alpha Tweets