An Overview of the European Legislations Governing the Financial Sector.
Author: Mr. Charalambos Papasavvas
Co – founder of Flywit Corporation Ltd
Founder of Neocourses Innovation Center
European Union Legal Framework
A number of EU legislations exist to regulate the banking sector, aiming to provide stronger prudential requirements for banks, enabling bank supervision and resolution, managing failing banks, and protecting depositors. Such measures are referred to as the single rulebook.
EU legislation for prudential bank requirements include:
- The Capital Requirements Directive IV (CRD IV): consists of prudential rules for banks and investment firms. CRD IV contains two components: the Capital Requirements Directive 2013/36/EU (CRD)and the Capital Requirements Regulation 575/2013 (CRR). CRD IV imposes requirements on the quality and quantity of capital, liquidity and leverage requirements, counterparty risk rules, standards for a countercyclical capital buffer, and capital buffers. Commission Delegated Regulation (EU) 2015/61: a supplement regulation to Regulation (EU) 575/2013 on the Liquidity Coverage Ratio (LCR).
- Regulation (EU) 2019/876 (CRR2): which is an amendment of Regulation (EU) 575/2013 of CRD IV with regards to the leverage ratio, the net stable funding ratio, counterparty risk, market risk, exposures to central counterparties, reporting and disclosure requirements.
- Basel III: developed by the Basel Committee on Banking Supervision, the Basel III agreement and its implementing act in Europe aim at enhancing the resilience of the banking sector. Basel III includes a set of regulating, supervising, and risk assessment measures to consolidate the banking sector ability to handle financial and economic shocks. The EU commitment to Basel III started in July 2017 by enforcing the CRD IV package.
Bank supervision and resolution is governed by the Single Supervisory Mechanism Regulation (SSMR) and the Single Resolution Mechanism Regulation (SRMR). The Bank Recovery and Resolution Directive (BRRD) sets the rules for managing failing banks. The Deposit Guarantee Schemes Directive (DGSD) provides insurance protection for depositors within the euro area.
The above regulations and directives are designed to govern the operations of traditional banking institutions. Their applicability and effectiveness in regulating FinTech companies in providing traditional banking services is a research question that will be considered as part of this work.
FinTech Solutions and Their Relation to Traditional Banking Services
FinTech is radically reshaping the financial sector through a variety of innovative solutions. The main characteristic of FinTech solutions is the heavy reliance on technology resulting in more financial processes efficient, low pricing, agility, and the appeal to new customer segments. The diffusion of FinTech in the financial sector falls under a number of solution categories which includes :
- Payment Solutions: a major growth factor of FinTech payment solutions is the exponential growth of Business-to-customer (B2C) e-commerce transactions. eWallet solutions such as Paypal dominate the Fintech payment category. Cryptocurrency transactions represent another important method for exchanging funds online. Such payment methods and transactions allow parties to quickly and cost-effectively send money to each other without the need to directly interact with banks. Payment solutions supporting Business-to-Business (B2B) are also emerging with the requirement for more specialized systems in return to higher profitability. A related service to B2B payment is e-invoicing that can quicken the payment process, reduces fraud, and supports smooth transactions in the supply chain.
- Crowdfunding platforms: are becoming increasingly popular in the finance sector. Crowdfunding is a type of financing that supports raising money over the Internet and can serve different purposes. This includes donation-based crowdfunding with the public donating money to a certain project. In equity-based crowdfunding (crowdinvesting), the financier receives shares and possible future profit from the financed projects. In lending-based crowdfunding (crowdlending), the financier is expecting a reimbursement of the amount funded.
- Equity financing: FinTech financial technology companies are making equity financing more accessible and easier for start-ups. In addition to the equity-based crowdfunding model, FinTech companies connect accredited investors with vetted start-ups. The whole equity financing process is done virtually online supporting quick and simplified funding transactions.
- Consumer Banking (Retail Banking): which are Fintech solutions that provide personal financial services to individual consumers over the Internet and mobile apps. This includes checking and saving accounts, personal loans, and credit cards. Fintech consumer banking represents an appealing alternative to traditional banks as consumers can avoid high fees. Fintech consumer banks usually target underbanked consumers who cannot get approved for credit cards. This includes providing customers prepaid cards.
- The capability of FinTech consumer banking to provide an online customer experience that can be tailored to the customer’s specific needs enhances the appeal of such solutions.
- Personal Finance Management: in the traditional bank setting, financial advisors provide customers advice on their personal finance, usually in face-to-face meetings. Customers tend to use software tools such as spreadsheets to keep track of their finance. However, there are currently many FinTech solutions that are trying to digitize the entire personal finance management for consumers. They offer personal financial advice and budgeting features in addition to goal-driven savings products. Such products can be well integrated with lending, insurance and investment services. The services can be customized to accommodate the specific financial goals of the consumer.
- Robo-Advisors: which are software programs that provide investment advice based on customer information. Robo-advisors usually utilise data analytics, artificial intelligence, and machine learning tools. They offer a much cheaper alternative to human wealth advisors and can avoid any conflict of interest negatively affecting the sector.
- International Money Transfer: the foreign exchange and international payment market have benefited greatly from FinTech solutions. Due to the lack of transparency in the market, traditional banks have been able to impose big profit margins on foreign exchange transactions. With the lack of regulatory obligations on banks to report charges, banks have been hiding such charges within exchange rates they impose on customers. FinTech companies have been adopting a more transparent, technology-based approach, with international transfer and foreign exchange provided at much lower prices.
- Insurance: FinTech companies have also been providing insurance solutions. Using technologies such as mobile apps, FinTech insurance companies target customers that are underserved by the more traditional insurance institutions. A variety of FinTech insurance business models is followed including peer-to-peer insurance, comparison sites, and short-term insurance schemes.
Time lead to the digitalization?
Digitization is seen as the way of the future by most traditional banks. FinTech solutions are heavily based on IT technologies and can be greatly beneficial for traditional corporate banks to ensure competitive advantage and embark on a more IT-based service delivery strategy. This includes the use of FinTech specialized services on specific parts of the value chain in payment processing and supply chain financing. Less regulated and easy to launch FinTech services such as automated electronic invoicing and payments can be adopted. Low cost is another characteristic of Fintech solutions that traditional banks can capitalize on. For example, FinTech international money transfer services are being offered 80% cheaper than traditional offerings. Eliminating the need for physical distribution channels leads to the cost advantage of FinTech settings. This enables passing on substantial cost reduction to customers in addition to reducing service time. Corporate banks are realizing that the end is coming to banking realized by physical distribution. They appreciate the importance to deliver services in a seamless, online, and customizable customer experience. FinTech physical distribution independent offerings can provide an opportunity for banks to differentiate their customers’ channel and product experiences. Partnerships with FinTech companies can allow banks to exploit flexible and state of the art IT architectures to support real-time operations, low service times and high service availability.
FinTech offerings could enable traditional banks to reach underserved customer segments. This includes customers with low credit scores who are usually denied access to traditional financial offerings. Flexible credit check models used by FinTech solutions enable the serving of customers whose financial records do not conform to traditional models. Other customer segments that find FinTech offerings appealing are millennials and small businesses. For example, millennials can favour automated software over human advisors. Corporate banks can benefit from FinTech partnerships to increase their market share with customer segments who are sensitive to cost, prefer remote delivery, and open to innovative financial offerings. Strong data analytics solutions offered by FinTech companies combined with the substantial amount of customer data corporate banks have could enable the offering of services that are more tailored to customer requirements and expectations in terms of pricing and providing individually-tailored services.
An important aspect of FinTech is data analytics and the innovative use of data. This allows financial institutions to experiment with new credit-scoring models that are based on, not only on financial records, but also on the customer’s personal profile and social media data. Advanced big data analytics offered by FinTech solutions can dynamically understand customer needs, predict best actions, and offers financial services on new distribution channels such as mobile phones and wearables. Data analytics can be also instrumental in customer acquisition, retention, and loyalty. With increasing competition, not only from other banks but also from non-traditional financial companies, banks can use the advanced data analytics of FinTech to enhance their marketing capabilities. Pursuing a digital marketing strategy and tools similar to e-commerce businesses is critical to the banking sector continuous success.
Our approach and Conclusion
FinTech innovations must be seen by traditional banks as an opportunity rather than a disruptive factor. The agility, the technological features, and the appeal to substantial customer segments must be considered by banks when shaping their future strategies.
