Finance: Research, Policy and Anecdotes

Today, the CEPR and the Korea Institute for Finance published a book, which I co-edited with Prof. Yung Chul Park, with the title Fostering Fintech for Financial Transformation. The motivation behind this book was an initiative by the KIF to draw on international expertise for specific policy lessons for Korean regulators.

The first four chapters draw on international experience and comparison, discussing the impact of financial digitalisation on the future structure of the financial system, providing a literature survey on the impact of financial digitalisation on the efficiency and stability of the financial system, focusing on innovations in money and payments, specifically the combination of new forms of digital assets with new forms of payment technology, and describing the regulation of cryptocurrencies across different jurisdictions.

The final chapter (which I want to talk a bit more about) focuses on Korea, taking stock of the current situation and drawing on international expertise for specific policy recommendation for Korean regulators. Fintech services have been regulated in Korea under a specific framework established in 2006, which has turned out too narrow.  At the initial stage of fintech development, Korea's financial regulatory authorities chose to embrace a market-led approach to fostering the fintech industry in line with a general move towards financial liberalization. A decade later, however, a series of market failures and inefficiencies of the laissez-faire approach has begun to take its toll, with P2P lending platforms losing their credibility and reliability as they were shrouded in widespread fraud and deception of investors and borrowers, the number of fintech startups ballooning, but few of them being efficient, and the fintech industry developing into an oligopoly controlled mostly by financial subsidiaries of big techs.

The financial regulatory authorities have reacted to these problems with a law restricting entry and lending in the P2P sector, which has effectively driven all platform operators out of business. The FSC also plans to establish a "fintech assistance center" as part of the program arranging policy loans, business consulting, and startup support for small fintech firms. In addition, there are current discussions underway to reform the broader legislative and regulatory framework for fintech.

How can the regulatory framework support financial innovation without undermining financial stability? Based on international experience, there are no easy answers, though some general principles. One first principle is that it is not desirable to regulate the FinTech sector through legislation alone, but rather use legislation to establish general principles and then set forth regulation for details. This allows a more flexible and swifter regulatory response to developments in the rapidly changing FinTech sector. A second principle is a risk-based approach, which focuses on prudential regulation of financial intermediaries and applies a less rigorous approach to other non-intermediating financial service providers. However, this principle might ignore the critical position that some non-intermediating financial service providers have in infrastructure services (e.g. cloud services, clearance services). So, both business and market linkages have to be taken into account when deciding on a FinTech’s regulatory regime.

A third principle is to recognise that regulation of financial services has two opposing objectives. One is to enable efficiency and competition. The other is to protect investors and savers and avoid the failure of non-intermediating institutions to prevent stability risk for other institutions and segments of the financial system. Given that these two objectives can clash, it is important to define whether two different regulatory institutions should be in charge of these objectives or whether the financial regulator should obtain a secondary objective as in the Bank of England with the competition.

These opposing objectives on the FinTech industry regulation also imply that, on the one hand, a light-touch approach is called for in the case of novel products and services (in the form of a regulatory sandbox) or as long as new providers are not directly involved in intermediation and have not taken on a systemically important role in the overall financial system. On the other hand, it requires frequent review of the supervisory status of FinTech companies to see whether they have grown to a relevant size or into a systemically important role that would require including them in the standard regulatory perimeter (in return, requiring a banking license).

Overview