A blog on financial markets and their regulation
Uberization or not of finance
February 27, 2017Posted by on
Two years ago, Mike Carney (Chairman of the Financial Stability Board apart from being Governor of the Bank of England) warned financial regulators that they should:
not be in this position where we’re filling in with prudential regulation after the fact. In other words, facing an Uber-type situation in financial services, which many jurisdictions are struggling with.
(This discussion can be found around 59 minutes into the video from the World Economic Forum Annual Summit at Davos in 2015).
The Uberization of finance does appear to be a probable outcome, and many fintech startups are predicated on this possibility. But then I read the paper by Pollman and Barry on Regulatory Entrepreneurship which they define as:
pursuing a line of business in which changing the law is a significant part of the business plan
Uber and Airbnb are among the prominent examples of regulatory entrepreneurship that they discuss in their paper. Pollman and Barry enumerate several business-related factors, law-related factors and startup-related factors that facilitate regulatory entrepreneurship. Among these are two that appear to pour cold water on the Uberization of finance:
One important factor is the penalty that the law imposes on violators. For example, if the only penalty is a civil fine imposed on the corporation, pushing the boundaries of the law may be an attractive prospect. … On the other hand, if a law provides for the incarceration of the executives of a company that violates it, that may deter the guerrilla growth strategies that some modern regulatory entrepreneurs employ.
Relatedly, another key element is whether the law in question is determined at the local, state, or national level. Change at the state and local level is often possible more quickly than at the national level.
The authors refer to the shutting down of Napster to highlight the difficulties of regulatory entrepreneurship in the face of national level laws that carry significant criminal penalties. This lesson is clearly quite relevant to much of finance.
Another aspect that Pollman and Barry do not mention is that much of regulatory entrepreneurship has succeeded against incumbents who are not very technology savvy. The finance industry on the other hand is technologically quite sophisticated, and is quite capable of adopting and co-opting any successful innovations that the regulatory entrepreneurs may come up with. Examples of such behaviour include:
- Large investments that the big banks have made in blockchain technology in response to Bitcoin which was a highly anarchist innovation to begin with.
- Integration of peer lending institutions into mainstream finance – extensive use of securitization, reintermediation by hedge funds and other financiers, collaboration with large banks and so on.
A counterpoint to this is that historically some of the truly radical innovations in finance have come from criminal enterprises. Three centuries ago, central banking was created largely by criminals. Johan Palmstruch, the founder of the world’s oldest central bank, the Sveriges Riksbank of Sweden, was sentenced to death before a royal pardon reduced the death sentence to imprisonment. Another great pioneer of central banking was John Law, who escaped from the English prison where he was held on charges of murder, and went on to preside over the French experiment with central banking in the early eighteenth century. John Law was probably the greatest central banker of his generation, but he spent most of his life roaming across Europe as a fugitive from the law. The founder of the Bank of England, William Paterson was an exception in this regard (he was certainly of high integrity), but he was a reckless adventurer who would probably not be acceptable to any modern central bank. A lot of modern finance is actually re-purposed criminality – negotiable instruments (bills of exchange) were originally created to evade usury laws, fractional reserve banking is alleged to have evolved out of goldsmiths fraudulently lending out customer gold which was not theirs to lend (though this has been disputed), and so on. If there is money to be made in fintech, even the threat of a death penalty will not deter would-be entrepreneurs, and it is at this edge of criminality, that we must look for future radical innovations in finance.