Why should banking watchdogs worry about the consumer internet? The answer, as researchers have been warning for some time, lies in their “DNA loop,” shorthand for data, network, activity. It’s a powerful circuit, which regulators must be prepared to break if they want to stop the next financial crisis in time.
The original data about consumers may come from e-commerce, social media or online searches; nothing to do with money. But in an ever-expanding successful network, it becomes easy to mine disparate bits of information to map users’ repayment behavior, and set up lending operations to exploit that knowledge. User activity on payment and loan platforms generates yet more data.
As Bank for International Settlements’ economists have previously shown, Latin American online commerce platform MercadoLibre Inc.’s machine learning-based scoring model is superior to what credit bureaus can tell a conventional bank about borrowers’ creditworthiness in Argentina. All this does wonders for financial inclusion, especially for small businesses that don’t have tax documents and other formal markers of repayment capacity. But an expanding DNA loop means a built-in ability to thwart competition from players who lack similar technology platforms. Thanks to the 94% control of Alipay and WeChat Pay on mobile payments, Beijing saw the systemic risk first, and acted. Soon others may, too, have to follow suit.
From online gaming to ride-hailing and after-school tutoring, China has cracked down on so much of its successful private sector that it’s easy to lose sight of how it it all began: with November’s last-minute scuttling of Ant Group Co.’s $35 billion initial public offering, the biggest in history.
The restructuring of Jack Ma’s financial conglomerate that was subsequently ordered by China’s central bank included separating out Ant’s two money-spinning consumer lending businesses, Huabei and Jiebei, from its ubiquitous Alipay payments network. Folded into a consumer finance unit that regulators approved a couple of months ago, the company’s ability to lend on its own or together with banks is now strictly capped by capital.
The wisdom behind the move will eventually be recognized by other regulators, though currently many of them have it backwards. Open banking rules in the European Union are forcing banks to share payments data with the tech industry, but the general data protection law is obstructing traffic in the other direction. From the Federal Reserve to the European Central Bank, regulators will all have to treat consumer internet platforms as systemically important financial institutions, and insist — as China has — on a structure where the holding company is well-capitalized alongside the operating units.
For Beijing, reining in tech’s tentacles in finance goes beyond just the lending operations. Ant’s Yu'e Bao, once the world’s biggest money-market fund, shrank nearly 20% in the June quarter. Other central banks will have to tackle a very similar challenge from stablecoins, blockchain-based tokens that mimic the value of fiat money. If Facebook Inc.-backed Diem, formerly known as Libra, takes off, these privately issued currencies could go from being a fringe asset for the crypto community to a “too-big-to-fail” repository of consumer wealth.
Without proper regulation, stablecoin issuers will always have an incentive to boost profits by parking money in risky assets, which may be hard to liquidate in case of a run on the coin if users queue up to cash out. Depending on how mainstream they are by then, the tremors could lead to anything from a wobble in some asset markets to a full-blown financial earthquake.
The public-good nature of money could itself be at risk if stablecoins and other digital innovations lead to closed loops reinforced by network effects of social media or e-commerce data, BIS general manager Agustín Carstens and his colleagues noted this week in a paper, “Regulating big techs in finance.”
One way to ward off the threat is for central banks to compete with the private sector by issuing their own digital currencies. That’s a strong motivation behind Beijing’s e-CNY project. But regulating the tech industry has to be a concomitant second line of defense. It’s the overall DNA of the new kids on the block that regulators need to watch, not just their individual financial forays.
Bloomberg
