We didn’t do anything wrong, but somehow we lost. That was the statement of Stephen Elop, CEO of Nokia, to end the press conference when he announced the Microsoft’s acquisition on his company. There was nothing wrong with Nokia when they dominated the sales of mobile phones in the world. However, they were late to learn and innovate, and Nokia was suddenly irrelevant.
In this era, innovation and changes occur quickly, accelerated with internet technology development and mobile devices. E-commerce is stated turning of the traditional retail store. GoJek challenges BlueBird’s stability as a leading transportation provider. The number of magazines and newspapers that stopped publishing the printed edition has already been uncounted because pressure by the online media.
The financial industry maybe more resilient than the other industries. Still, they face the same challenger as the other industries: the consumer wants a practical and fast service and if possible, cheaper. The financial service institution has to understand this and start innovate. Or they will be a dinosaur, irrelevant both by smaller startup or others financial service institutions.
During this competition, a supervisor institution concerns to ensure customer protection, financial system integrity (related to money laundering and terrorism funding), and economic stability. This regulatory and supervisory action has to be done while maintaining innovation room for financial service. This can be done by confirming the fair rules (same level playing field) and policy toward innovation between the existing financial institution and the fintech startup.
Level Playing Field
In the 2017 edition of Digital Economy Outlook September, BBVA said that the level playing field is interpreted differently and even in contrast between financial institutions and startups. In a side, the startup wants easy licensing to access the competition, while the financial institution asks for same obligation that is fulfilled by them also be implemented on startup.
It is not easy for banks to implement innovation because of many rules that they have to obey and maintaining risk. For example, there are a requirement to conduct an independent audit before they can publish an electronic channel product. This is increasing the costs and the times to deliver products of innovation.
This requirement does not apply to the startup. They can take advantage of the rule gap by playing in the sector that is not regulated yet. Startup can innovate faster. However, on the other side, startups experience difficulty by the strict requirement to gain a license. For instance, in order to get a peer-to-peer lending license, there are very detailed obligation to deliver inventory list and office equipment as the proves of operational readiness.
Based on BBVA, one of the solutions to apply a level playing field is by applied prudential regulation only in the main activity of the financial institution. The financial institution has an activity competing directly with a startup; they submit to specific rules in that activity. For example, mutual funds selling activity that is not related directly to the bank’s main activity can be regulated by the same specific rules regulating online mutual funds selling by e-commerce.
However, innovation often goes ahead of the rules. There are business areas that are not arranged yet in the current provision. Therefore, it needs a set framework that rules the new service from the financial institution or startup. The framework manages the supervisory steps if there is a new innovation that is not regulated yet. Roboadvisor, big data, and blockchain are some innovation that will appear in the financial sector. Using supervisory framework, innovation can be done without waiting for the specific regulations.
Frequently, there are innovation that beyond any current rules or in a grey area between may or may not be implemented. This kind of innovation still has to be noticed, if this innovation can benefit to the customers and financial stability. For this matter, the central bank of the Netherlands, De Nederlandsche Bank (DNB), with The Netherlands Authority for the financial markets, Authority for the Financial Market (AFM), already has a solution.
In December 2016, DNB and AFM launched an initiative that is called Innovation Hub. Innovation Hub basically is a regulatory sandbox in which a financial service institution or startup can “challenge” rules. This regulatory sandbox is created when there is innovation with a strong reason not to obey a policy, regulation, or rules. However, there are perquisite requirement, the innovation must positively contribute to financial stability, accelerate operational or helping service to customers and investors.
By using blockchain schemes from Bitcoin, for example, a bank can build a payment system faster and cheaper as well. However, this innovation can contrast with the rule that a bank can’t perform Bitcoin transactions. If this case happens, with the regulatory sandbox scheme, the supervisor will research reasons for non-compliance. The innovation might be doesn’t fulfill the regulation, but there are in the same pages as the regulation.
Innovation inside a sandbox is allowed to operate in a specific condition in a certain period that the supervisor determines. During that period, the supervisor will evaluate whether that innovation could continue further, requires adaptation, or must be stopped. This evaluation includes whether the regulation needs changes.
In addition to the sandbox, Dutch authorities offer three options of special licensing: partial authorization, authorization with requirements, and opt-in authorization. Those three kinds of licensing are not as heavy as the regular licensing but adapted to the activity that will be performed. By ease the licensing process, a startup can run operational and more freely to strengthen capital or recruit human resources while adjusting operational based on the provision step by step.
Those regulatory sandboxes and special licensing are just two of many solutions to give a room of innovation in the financial services supervision. However, the more important to be noted is a will from the supervisory agency in the Netherlands to interact actively with innovation both from financial institutions and startups. Active communication will make the supervisory institution understand the financial institution’s needs dealing with innovation. In this way, the supervisor able to determine the more appropriate control measures.
In the strict competition era, innovation has become a key to remain relevant. Nokia has shown that without doing something wrong, it still can leave behind. The only option for the financial institution and its supervisor is to keep moving and innovating.
Image Source: Planet Compliance.