Financial Innovation

Is the fear of regulation holding back innovation in the financial services sector?

‘Innovation’ has become a buzzword within the financial services industry in recent times. Often used as a slogan for success, it would appear that many consider the notion of innovation to be the be-all and end-all. And yet, it wasn’t too long ago that innovation and its associated risk (particularly in the mortgages and short-term debt sectors), paired with a lack of effective regulation, caused major economic problems right across the globe.

Fast-forward eight years and the UK seems to be in a much healthier position economically – standing as the world’s leading fintech centre, according to an independent report from Ernst and Young (EY) published in February. The UK is making efforts to learn from the mistakes of the past to benefit our growing digital economy. For instance, within the e-money market, the UK implemented the Electronic Money Regulations 2011 which has created clearer and more robust regulations and which may, in part, be responsible for the exponential growth of the UK’s fintech sector.

And yet, there is concern that regulations are stifling innovation within the industry. It has been argued that models and theories from the pre-digital age are still being applied to digital businesses, with potentially quite harmful consequences for the future of financial services innovation, as well as economic prosperity. So, with the UK government’s vision for the UK’s financial services to be the most competitive and innovative in the world, we have to ask – will the fear of regulation hold back innovation?

Do regulations act as a barrier to innovation? Following the global economic crash of 2008, the financial sector scrambled to bring in tighter regulations as to avoid a second recession. However, rather than just a dial that can be adjusted up or down, regulation is a multi-faceted, complex issue. This is no more apparent than in the increasingly globalised financial industry, where billions are transferred every day across the world in an infinite number of transactions.

There are arguments which suggest that regulations designed to promote competition, such as those on pricing, can incentivise companies to invest in innovation. Such regulations are argued to boost inclusion by driving more companies to become involved. At the same time, regulations that increase pressure on business models by adding barriers to market entry are more likely to hinder the opportunity to innovate. The complexity of regulations is further amplified by the threats of both criminal and terrorist elements carrying out fraudulent activities, such as money laundering, as a means to fund said activities. By regulators introducing measures to tackle these, companies often find it difficult to keep up with a constantly evolving regulatory framework and environment where compliancy requirements and sanctions are changing at a rapid pace. This is something we see time and time again at Neopay as a compliancy consultancy.

In an increasingly complex global regulatory environment, the burden of compliancy is also more widespread. This means that the failure to comply with regulatory compliancy effects more than the company – it causes a ripple effect. The bank which backs a new and innovative fintech company that fails to meet compliancy standards could face fines, which could then deter it from backing any future fintech companies. This then limits investment, lessens the opportunity for fundraising, and ultimately hinders innovation. What are the government and regulators doing to foster innovation? The UK government has made no secret of its ambition to grow UK financial services to be both the most competitive and innovative in the world. This is in the hope it will create better value for consumers by delivering greater choice.

In fact, our most recent research report looked into our changing relationships with traditional banks. It found that as many as 41% of those we surveyed believed there is room for improvements in customer experience. Offering fairer / lower fees and charges, and up-to-date banking information, such as real-time transactions, will go some way to achieving this – something which should be seen as an opportunity for further innovation within the UK’s financial services sector.

With fostering innovation in mind, in April this year the UK government published its innovation plan which sought to address three key issues. The plan looks at how technology is helping to shape financial services, how financial services regulators are adapting to new technologies, and how disruptive business models can be used to encourage growth. The plan also examines how regulators, given that their role does also go beyond competition and innovation, could use new technologies (so-called RegTech) in order to create efficiency savings, and thus reduce burdens on business.

Even before this plan, the government has been working to reduce barriers within the financial services industry, particularly when it comes to the entry of new, innovative firms to the market. The UK government has made concerted efforts to improve the Current Account Switch Service (CASS). This will make it easier for consumers to compare personal current accounts, identify the best deals and then switch in a simple, quick and secure way. The government has also been working to create the right regulatory environment so that innovative firms can compete in a healthy way and thus grow. Through the main regulators’ objectives and remits, HM Treasury has embedded competition and innovation objectives into the regulatory landscape.

In addition, the FCA launched its Project Innovate in October 2014 to help foster innovation within financial services, as well as introducing broader changes. These broader changes include the FCA assisting the government with its plans to introduce anti-money laundering regulation for digital currency exchanges. This initiative aims to create a more supportive environment for legitimate digital currency businesses and users whilst simultaneously creating a hostile one for illicit parties. So, is the fear of regulation holding back innovation? The UK’s financial services industry continues to grow at a rapid pace and is considered the hub of fintech – with a large majority of the e-money and payment firms operating in Europe basing themselves within the UK. Innovation within this sector in the UK seems to be thriving.

At Neopay, we work with some of the most innovative and cutting-edge fintech companies, helping them obtain e-money licences by reaching full compliancy with regulators, such as the FCA, so we know the landscape as well as the regulatory changes, as and when they’re delivered. We truly believe that through improved efforts to embrace and encourage innovation, the FCA and other regulators are reaping benefits, including closer customer relations and improved customer satisfaction.

This is something our research report found could suffer as consumer frustrations with traditional banking system begin to grow, particularly when it comes to charges and fees structures and branch closures. Creating a regulatory policy that creates the right conditions for innovation whilst still exerting some control is important. Regulations need to be strident enough to mitigate the capacity of innovation to create risk when improperly implemented – as we failed to do in 2008 – whilst also being flexible enough to accommodate its potential for positive change. When this balance is achieved not only does it help grow customer confidence and trust, it also brings the UK even closer to becoming the most innovative and competitive financial services industry in the world.