Competition versus regulation in innovation

A couple of years ago, back in 2011, I put together a few slides about the key drivers in the European payments industry for something we were doing for one of our clients. I used the breakdown that came from my Centre for the Study of Financial Innovation (CSFI) research work — that was very kindly sponsored by Visa Europe — on innovation in payments. This looked at the drivers across three axes: the technology axis, the business axis and the social axis. This proved be quite helpful way of exploring issues and helping clients to clarify their thinking, so I'm always looking to refine and update the drivers across these axes to support our consulting work across sectors.

I remember seeing a similar breakdown last year, 2012, in the Barclays Equity research note about payments in June. They had come to a very similar breakdown and, I have to say, similar conclusions, which I naturally took to be something of a validation for our approach. On the technology axis they looked at the influence of technology players and forecast more convergence around mobile, on the business axis they predicted localisation rather than globalisation and on the social axis they saw regulatory factors as the most important drivers shaping overall strategy.

So where are we now? Do the assumptions of the last couple of years still hold and what are the mid-2013 drivers? I was thinking about doing some work on revising and checking the drivers when I read an article in the FT from the group chief executive of Standard Chartered bank. This reinforced the point about regulation as the most important driver. This is true in the US as well as in Europe: one of the most interesting projects that Consult Hyperion is currently working on in the US is helping a financial services organisation to integrate Durbin and EMV for its next generation debit products. Anyway, Peter Sands said that:

Regulation is an even more powerful impediment – and not only because “financial innovation” is a four-letter word in banking supervision circles. Technology-driven innovation that leads to big winners and big losers, that replaces established products with flexible service bundles, that overturns established business models and blurs the boundaries of banking, and that sometimes fails to deliver quite what was intended, does not fit well with today’s regulatory zeitgeist.

[From Banking is heading towards its Spotify moment – FT.com]

That's a nice way of putting it. He goes on to say "That is why accelerating technology-driven innovation is a top priority" at his bank. But what does "technology-driven innovation" mean to banking? I'm about to give a seminar on this topic to one of the leading Chinese banks and for that purpose I've been looking at how technology is causing different kinds of disruption to the different functions of retail banking. If we focus on the payment function then, in Europe, we see the regulatory issues channeling the innovation (as I, and indeed Barclays, predicted) so that payment innovators from outside of the banking system can develop new products and services. A good example of this effect is the recent announcement of EE's "Cash on Tap" mobile payments initiative that uses SIM-based NFC in three of their handsets on sale in the UK. The old version of the product was called "QuickTap" (I am a satisfied customer of such) and it centred on a bank-issued EMV application. The new version does away with the bank. The EMV application comes from Prepay Technologies. In the same way, the original Telefonica O2 Money card was issued by a bank. The new one isn't. And Telefonica obtained a Payment Institution licence a few months ago as well.

Stephanie Martin, associate general counsel for the Federal Reserve Board of Governors, warned members of the House Financial Services Subcommittee on Financial Institutions and Consumer Credit that in the broader regulatory scheme, many mobile systems may not be covered, especially those used by people or organizations that aren't banks.

[From Financial Officials: Regulations May Not Fully Protect Mobile Payments – Josh Smith – NationalJournal.com]

I don't understand this sort of thinking, however well-meaning. It is the payment instrument that should be regulated, not the particular means of executing a transactions. The legal protections afforded to me when buying using a credit card don't change depending on whether I'm buying from Amazon using my mobile phone or buying from the Amazon website on my Mac at home. It's the credit card that is regulated.

As I've said a few times recently, America could do worse than adopt something along the European lines. A regulatory framework that separated systemically risky operations such as banking from systemically unrisky operators such as low-value payments would benefit all concerned. We need competition in the payment space, and competing to provide additional layers on top of the existing retail payment schemes (ie, cards, essentially) probably isn't enough. Sean Park nailed this when he said that

Of course more regulations hurt the large financial institutions, but they hurt new entrants more. And competition is a whole lot scarier than regulation to incumbents.

[From The Park Paradigm – More competition beats more regulation]

So all of this boils down to saying that that the model developed for the CSFI, and the drivers that were predicted for each of the axes, turned out to be pretty much right. Of course – if they had turned out wrong, I wouldn't be writing this blog post!