The Regulatory Architecture of Fintech Credit Platforms
Global fintech credit platform transaction value exceeded €257 billion in 2020, with the European Union (excluding the UK) capturing 4.6% of it, shining a light on the importance of Fintech credit platforms in providing alternative sources of financing for start-ups, SME’s, and the underbanked. However, with little regulation investor, borrower, and the fintech platform relations are unsustainable, leading to the new regulation on crowdfunding (EU 2020/1503) being adopted recently, setting forth fintech platform transparency and borrower due diligence requirements to protect investors.
Janis Eismonts, CEO Sneekypeer
Here, Janis Eismonts, the CEO of data-driven analytics company Sneakypeer explains that a major distinction, however, has to be made between digital banks and Fintech platforms, per se.
Digital Banks are deposit-taking institutions like standard banks and are thus involved in risk transformation and are subject to deposit insurance schemes. Digital technology is exclusively used to provide services remotely through electronic channels. Digital banks engage in risk transformation like traditional banks, digital banks have a technology-enabled business model and provide their services remotely with limited or no branch infrastructure. Fintech platforms are not deposit-taking institutions but act as pure intermediaries between lenders and borrowers. Two broad categories have to be distinguished: fintech balance sheet lenders and crowdfunding platforms.
Fintech balance sheet lenders use their own balance sheet to intermediate between lenders and borrowers granting loans at their own risk. Meaning they are exposed to risks and have to fund their balance sheet through different kinds of assets. Whereas, crowdfunding platforms are exclusively matching borrowers with lenders without any involvement of risk transformation, as the intermediation is performed by a web-based platform that solicits funds for specific purposes from the public. Depending on the type of funding provided, we distinguish between loan crowdfunding and equity crowdfunding.
This emerging new financing architecture implies that regulatory frameworks will have to adapt and will likely differ for different kinds of credit institutions. The fundamental question will be what kinds of Fintech institutions fall under what kind of regulatory perimeter. A study by the Bank of International Settlements analyses the regulatory requirements for digital banking and Fintech platforms across 30 countries.
Digital banks as deposit-taking institutions typically fall under standard banking regulation, opposite of Fintech credit platforms. The situation is quite complicated, as those are not regulated as a banking institution. For example, crowdfunding platforms in itself could in principle be regulated by different regulators depending on the type of activity implemented. Crowdfunding platforms funding equity-related projects would typically fall under the supervision of securities regulators, whereas platforms funding loan-related projects would fall under the supervision of banking regulators. Most countries have no specific regulation for fintech credit platforms and regulatory requirements, thus considerably differ across countries, opening the door for potential regulatory arbitrage. Interestingly, in some jurisdictions, these platforms can even be used to broker multiple financial instruments.
As the potential degree of non-transparency of platforms implies major risks for investors, information disclosure and due diligence is of foremost importance. Some regulators let platforms decide on the information needed, while some are more prescriptive about the information to be provided. As many platforms do not invest their assets with risks covered by lenders, due diligence can be seen as the main function of those platforms. From an investor protection perspective, the risks substantially differ.
With the new EU regulation on crowdfunding in the process of being transposed aiming to create a common EU crowdfunding market, further analytics on risk management and due diligence is needed for the Fintech platforms to ensure their sustainability and growth. This is why the Sneakypeer Fintech expert group has developed an Integrated Risk Model framework together with a scoring and due diligence approach.