Financial technologies are very promising and create a lot of possibilities, however, they pose a challenge for constructing a proper regulatory framework. Adjustments have to be made quickly, which is not a feature of the regulatory framework of the EU. Regulations of the EU still follow old frameworks and unfortunately the process of change is very slow. As the number of risks involving new technologies is hard to assess by both regulators and consumers the regulatory enforcement stretches out in time. The former especially applies to the financial sector. While FinTech lending services show many opportunities, will the regulations follow?
FinTech Lending Services
As far as fintech lending services are concerned, they differ from traditional banks in certain ways. Fintech firms provide services without personal interaction, instead, they interact with customers in most cases completely online, using integrated digital platforms. What is as well characteristic, to process large amounts of customers’ information and assess their creditworthiness, fintech applies artificial intelligence, machine learning algorithms, and other innovative tools.
Downside Of FinTech Solutions
The downside to fintech solutions is that they cannot create money through lending, because they do not take deposits. Fintech firms in most countries are able to avoid supervision and reporting requirements, which nevertheless results in a lack of access to convenient funding sources. Fintech business models can be characterized by the following traits: high automation, low fixed assets, low capital requirements, low regulatory costs, younger customer base, most shares in funding, many IT specialists as employers. Although from reports of 2017, Europe’s share of global fintech lending was only at 3 percent. Fintech lending shares vary across countries. Nonetheless, the UK is a frontier in global fintech lending, accounting for about two-thirds of the share in Europe, followed by France and Germany.
Fintech Lending By Country
Considering the situation in per capita terms, the UK is still in the first place, placing in the second-place is Monaco, and in third place Estonia. Fintech companies started on a low base, but have extremely expanded from, reaching a 20 times higher transaction volume in 2017 in comparison to 2012. In 2017 in the UK fintech lending grew by 25 percent, at the same time in other European countries it even grew by 43 percent.
The Possibilities For FinTech In Europe
Furthermore, Europe’s infrastructure and innovative environment conditions could contribute to the further growth of fintech services. The 2020 Global Innovation Index is lead by several European countries among other Switzerland, the Netherlands, and the Nordic countries. Electricity and internet coverage on the highest level in Europe globally and a business environment supportive of innovations and technological environment shows promising prospects for fintech companies in Europe.
Regulating FinTech Lending
Fintech lending services are either regulated at the EU level or national level or can be not regulated, whereas the latter applies to most fintech firms. Unfortunately, there are no fintech-specific regulations in Europe. However, it is mandatory to have a general license to conduct certain financial activities, including banking services, payment clearings, settlement services, financial market services.
Due to the lack of deposit or other repayable funds taking activities by fintech firms, they do not fall under bank licensing requirements. Even though a full banking license is not required, lending activities performed by fintech companies are licensable and are subject to regulations. The former varies across countries depending on the design of platforms.
In Germany after exceeding a certain scale, lending and deposit businesses are obliged to obtain a license on a P2P platform. Furthermore, a platform operator may need to have a broker license or an investment firm license. Provision of investment advice or payment services requires a license. There may be a need to publish a prospectus in case of a public offering of investment products.
A third of European countries have developed fintech-specific regulations considering P2P lending and crowdfunding. In Belgium and in the UK activities of crowdfunding firms undergo authorization requirements and rules of conduct. By the power of these regulations, there are certain limits set on the number of investments on the crowdfunding platform or on the number of investments by an individual investor.
In other countries, which have no fintech-specific regulations, it comes down to separating analysis conducted by authorities. Then they consider general financial and company legislation.
EU Considers Creating A Unified Regulatory System For FinTech Lending
In light of creating a unified regulatory system in the EU considering crowdfunding and P2P lending, the European Parliament and the European Council have put into perspective one set of rules applicable to the European Crowdfunding Service Providers (ECSPs). The national competent authority (NCA) in the member state and the European Securities and Markets Authority (ESMA) and to some extent the European Bank Authority (EBA) would be supervising coordination between member states, data collection, and development of technical standards.
ECSPs will have to be authorized by the NCA of a country. Such a process would contribute to investor protection, increased transparency, and easier cross-border operations through ECSPs.
A so-called „regulatory sandbox” is aimed as a solution to the challenges in the financial sector posed by fintechs. The sandbox is a kind of safe playground to experiment with, it has been applied to different fields to check the impact of potential risks on the entire system without directly affecting it.
In the financial sector the sandbox is a controlled space for businesses to test innovative products, services and business models without the risk for consumers thanks to special safeguards and regulations. Most countries in Europe have innovation offices and some countries have additionally set up regulatory sandboxes for fintech firms to provide regulatory clarification of innovative financial products and services. Regulatory sandboxes were pioneered by the UK, but as well used in Austria, Denmark, Hungary, Lithuania, Netherlands, Poland, and Russia.
Money Laundering Challenges FinTechs
Money laundering (ML) is a serious problem worldwide, which also applies to fintech companies. First ML involved only cash, now the spectrum of ML possibilities is enlarged by the use of new technologies. Anti-money laundering directives (AMLDs) do not have fintech-specific regulations. Fintechs are obliged to directives, which involve the conducted by the services.
Fintechs AML obligations depend on the classifications and therefore are hard to clearly establish. To prevent money laundering across EU countries licenses are used. In the EU financial services are obliged to apply for a license in order to be registered as a services entity in a local Financial Service Authority (FSA). Fintechs are obliged to have the following licenses, depending on the services they provide: Electronic Money License (EMI), different Payment Institution (PI) license, Payment Service Provider license (PSP), banking or special banking license.
Each Country Plays By Its Rules?
In many EU jurisdictions fintech companies with EMI, PI or specialized banking licenses are liable to the same AML obligations as traditional banks. In Finland different payment services, payment institutions, electronic money issuance and electronic money institutions are regulated by the Act on Payment Institutions. The beforementioned service providers are administered the FSA of Finland Finanssivalvonta, as well as underlying the Act on Prevention of Money Laundering and Terrorist Financing.
Nevertheless, fintech start-ups are not completely certain, which license should they have due to the constant development of technology and products they provide. Local FSA is supervising the licensed entities, it may also analyze what measures are adequate for the given entity. Financial service providers registered to operate in the European Economic Area (EEA) through the passport mechanism can form international branches and provide cross-border services. A license from a local FSA in one EEA Member State allows the company to operate in the whole EEA.
Main AML Vulnerabilities Of Fintech
Fintechs main AML vulnerabilities are connected with customer identity verification. According to the Risk-Based Approach (RBA) fintech companies may only apply minimum requirements for customer identification. The fully digitalized process without the need to meet the customer in person allows creating an account within minutes. These conditions unfortunately increase the impersonation fraud risk.
The London FinTech FinCrime Exchange Survey 2019 proved the seriousness of this risk as fake identities were 26 percent of all financial crime risk typologies in virtual banking. Big amounts of service providers, lack of customer data cause difficulties in monitoring th movement of funds, making it easier to get away with criminal behavior. Fintechs show possibilities to risky customers that are not able through the service of a traditional bank. For example, in the EU fintech firms enable customers to transfer funds from the East to European markets, creating therefore an opportunity for money laundering.
Member States (MSs) of the EU are obliged by the EU AMLDs to supervise and regulate financial institutions. The EU does not provide strict instructions, this results in differences in supervision across countries. MSs use the following supervisory models: Financial Intelligence Unit (FIU), external, internal, or hybrid. As an example, Lithuania uses FIU model, Finland, Denmark, and Sweden use the internal-external model, and Estonia the hybrid model.
On the whole financial technologies are growing rapidly across European countries, encouraged by the favorable conditions of the innovation-friendly EU market. Further concentration on novel technologies in the banking sector will reshape the current regulatory conditions. Importantly a deeper understanding of fintech services and products is crucial to prevent criminal actions. As fintechs enable simple cross-border operations, a more unified regulatory approach in the EU would be more preferable.