The regulatory framework
for banks and the
emergence of FinTech in
Europe, the United States
and China
Author:
Annelou Engwegen
Supervisor:
Cenkhan Sahin
Faculty of Economics and Business
Statement of Originality
This document is written by Student Annelou Engwegen who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Abstract
This research explains the influences of the currently existing banking regulation tools on the FinTech sector, that emerged in 2008, in Europe, the United States and China. Two tools of central banks: the reserve requirements and Open Market Operations, with the con-sequence of a changing interest rate, are analysed and seem to have created room for FinTech companies to emerge. This research can be seen as a literature contribution to the problem of how to regulate the FinTech sector effectively in the long term, by explaining the influence of current banking regulations on the FinTech sector.
In order to create a complete view on how FinTech is affected by regulations, newly imple-mented FinTech-specific regulations in the United States, Europe and China are described. For example, the Payment Services Directives in Europe and the DFS Guideline in China. An event study is applied to one of these regulations: the proposal of the OCC to create a special purpose national bank charter for FinTech companies in the United States. There is not one general result observed and it shows that the returns of FinTech companies should be further analysed in order to create a reliable model, which would be able to estimate the effect of regulations on the FinTech sector.
1
Introduction
Since 2014 the Financial Technology (FinTech) sector got the attention of regulators, industry participants, consumers, and academics (Arner, Barberis & Buckley, 2016). Schueffel (2016) de-fines the FinTech sector as a new industry that applies technology to improve financial activities. This definition is rather broad. First of all the FinTech industry can indeed be considered as a new industry. However, Arner et al. (2016) state that it could also be traced back to the in-troduction of the telegraph in 1838 or the transatlantic cable in 1866 which contributed to the development of services in communication and technology. The internet became more relevant only since the last decades in the development of products and services. Since the emergence of the internet, where data can be exchanged very quickly, also firms, specialized in the development of internet services, arised. Together with the emergence of smartphones and the cooperation of telecommunication firms, a new form of financing has emerged: (mobile-centered) internet finance (Ping & Chuanwei, 2012). This is one way in which the FinTech sector develops technology to improve financial activities. Arner et al. (2016) describe other examples of financial activities in the FinTech industry (next to internet banking and mobile payments), such as crowdfunding, peer-to-peer lending, robo-advisory and online identification and they state that 2008 can be seen as the starting point for this kind of FinTech activities. Due to the broad range of FinTech ac-tivities, PWC (2016) states that the new industry of financial technology will have impact on all types of banks, asset and wealth managers, fund and payment providers, brokers and exchanges. According to Merler (2017), policy makers should also adapt to this new way of financing and even a whole new regulatory system, called RegTech, is developing all over the world.
Recent studies have concluded that different factors contributed to the emergence and growth of the FinTech industry. First of all, an important factor in the FinTech sector is the technology industry, so the performance of the technology sector during the financial crisis is relevant. Also the position of firms operating in new industries in the financial crisis is an important aspect. A third relevant factor for the FinTech sector is the demand for new technology and internet-based financ-ing activities. It is known that there is an increase in demand for alternative financfinanc-ing: Arner et al. (2016) even describe a shift from physically present depositors to technology. The main factor that has been analysed by researchers is the contribution of the development of technology to the growth of the FinTech industry. However, the regulatory framework in which the demand for Fin-Tech rose, should be analysed too in order to see where the demand comes from and how to adapt the regulatory framework in order to supervise FinTech companies as mentioned by Merler (2017).
even the regulatory framework of this system, in this research the impact of traditional banking regulations during the financial crisis on the emergence and growth of the new FinTech market is analysed. This will be done by analysing the regulatory framework for banks in the United States, Europe and China to see how FinTech emerged during the financial crisis, in different banking environments. China switched for example from a moderately tight monetary policy to an expansionary monetary policy in November 2008 (Zhang, 2009). The interest rates and bank reserve requirement ratios decreased (Zhang, 2009), but how did this banking regulations affect China’s FinTech sector? Also the United States and Europe used an expansionary monetary policy (Thornton, 2012; Trichet, 2011). It will therefore be analysed how changes in Reserve require-ments and interest rates, traditionally used to regulate banks, could impact the FinTech sector.
Although few is known about the influence of banking regulations on the FinTech industry, a whole new range of regulations specifically designed for FinTech companies is developing. In Eu-rope for example, the Payment Services Directive 2 is implemented in January, 2018. This new regulation states that each European bank is obligated to give (non)banking companies (and thus FinTech companies) acces to their information technology infrastructure, which contains customer account and payment information (European Commission, 2007). According to Ernst & Young (2017) innovative payment services companies are now able to compete with banks. The latter, since FinTech companies are able to build customer preferences based products and services with advanced technology. Also in the United States and in China regulations specifically for FinTech companies are being developed. In order to create a complete view on how regulations are affect-ing the FinTech industry, this research contains a case study of the influence of a new FinTech regulation on the performance of a FinTech company. The performance is measured by the stock price of the company and since the effect of the announcement of a new regulation is estimated, an event study, designed by MacKinlay (1997), will be used. He namely states that an event study is an application to measure the impact of a change in the regulatory environment.
In order to see how the FinTech market is affected by banking regulations and FinTech regu-lations, the determinants for the emergence of FinTech are explained first in section 2. In this section the findings of earlier research are stated, which are needed to understand the FinTech market. To see how traditional banking regulations contribute to the emergence of FinTech, the influences of policy responses during the financial crisis are described in section 3. Besides tradi-tional banking regulations, also regulations designed for FinTech companies are described, which is done in section 4. Section 5 provides a case study of one specific FinTech regulation and its influence on the performance of a FinTech company.
2
Literature review
As stated earlier, the technology industry, the position of firms operating in new industries and the demand for new technology and internet-based financing activities contribute to the emergence and growth of the FinTech industry. To understand how FinTech companies emerged, these three determinants are explained.
According to Haddad and Hornuf (2016) the main determinants in the field of technology for the growth of the FinTech sector are the availability of technology to the public and the number of mobile telephone subscriptions. They find a relationship in which one unit increase in the availability of the latest technology corresponds with an increase of 112% in FinTech start-up formations in the following year. From their empirical research it also follows that the number of telephone subscriptions are positively related with the amount of FinTech start-ups, with a high statistical significance.
Shim and Shin (2016) also describe how the development of technology is related to the emer-gence of the FinTech industry. According to them FinTech exists because of the converemer-gence of traditional financial services with mobile and social network services, big data and cloud technol-ogy. They state that mainly the rapid growing payment service market is a determinant for the emergence and growth of the FinTech industry.
Since FinTech companies started to emerge in 2008, at the beginning of the financial crisis, it is relevant to know how the technology sector performed during the financial crisis. Rojko (2011) concluded that the financial crisis affected the technology sector, but by doing research on different specific aspects of the information and communication technology (ICT) sector, he states that the financial crisis intensified the implementation of new and alternative technological solutions. This, since the latter stimulates cost effectiveness and productivity.
Next to the availability of technology, the position of firms operating in new industries during the financial crisis is an important aspect for the emergence of FinTech. Recent studies have shown that the most important funding source for FinTech start-ups is venture capital, mainly provided by investment banks. Block and Sandner (2009) state that the high risk a start-up faces, will make it difficult for banks to fund them. In order to finance activities, a start-up could also raise public equity, but Block and Sandner (2009) describe that the sales are at such a low level in a start-up, that public interest will also be low. Therefore they conclude that the main funding source for innovative start-ups is venture capital. In order to see whether FinTech start-ups were able to enter the market during the financial crisis, it is relevant to know how the financial crisis affected the venture capital market. From the empirical research of Block and Sandner (2009)
it is concluded that the amount of venture capital was negatively affected by the financial crisis, but mainly due to a lower valuation of start-ups by investment banks. According to them, this decrease in venture capital affects the venture capital investments in later stages the most, but start-ups that seek for initial funding are less affected.
A third important factor for the FinTech sector is the demand for new technology and internet-based financing activities. It is known that there is an increase in demand for alternative financing: Arner et al. (2016) even describe a shift from physically present depositors to technology. Fur-thermore, the global investment in FinTech companies has tripled between 2008 and 2013 (Shim & Shin, 2016). The main factor that has been analysed by researchers is the contribution of the development of technology to the growth of the FinTech industry. However, the regulatory framework in which the demand for FinTech rose, should be analysed too in order to see where the demand comes from.
3
Emergence of FinTech during the financial crisis: an
in-crease in demand for new technology- and internet-based
financing activities
The traditional view of banking regulation at the start of the financial crisis is based mainly on the Basel I and Basel II accords, which followed from the research of Kashyap, Rajan and Stein (2008). They state that one important part of the traditional view is that a depositor should be protected from losses due to bank failures: a bank should hold a sufficient amount of capital. Furthermore, they state that regulation has to monitor banking management in order to ensure banks do not engage in projects of which the returns are too volatile. They also describe the functioning of the risk-based capital system, in which riskier assets are priced higher. The com-bination of these factors describe the view on banking regulation at the start of the financial crisis.
At the start of the financial crisis, which was mainly caused by the non-transparent risk man-agement of banks, investors became reluctant to extend funding for banks (Ackermann, 2008). Ackermann states that the main problem was the uncertainty about the risk that a bank is exposed to and therefore banks had an incentive to enhance their transparency. Although the incentive was there, countries in Europe could not be supervised on a European level, since they had quite some freedom of action at the beginning of the financial crisis according to Trichet (2011). He stated that it was necessary to reform the global financial system. It is described below how two monetary policy tools of the central bank, the reserve requirements and an expansionary monetary
policy, influence the emergence of the FinTech sector.
3.1
Reserve requirements
In the United States the liquidity problems of banks increased at the beginning of the financial crisis, where large financial firms got government injections to protect them from financial de-faults, according to Tarullo (2016). He states that in 2009 stress tests started with the objective to measure the amount of capital needed by financial firms. The outcome of these tests became in 2009 the minimum capital level for firms and the Federal Reserve obliged firms to raise private capital to replace government capital according to Tarullo (2016). Together with injections of lending facilities provided by the Federal Reserve, the Treasury and the Federal Deposit Insurance Corporation (FDIC), he describes the stabilizing effect on the financial system at the end of 2009. At this time the debate about regulatory consequences started, which resulted in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The Dodd-Frank Act con-tains, among other things, higher capital requirements for large banks (Tarullo, 2016). 2009 was also the year in which the Financial Stability Board (FSB) was established and is described by Claessens and Kodres (2014). According to them the FSB had the objective to coordinate the work of national financial authorities at an international level. They describe the Basel III Accord and the Liquidity Coverage Ratio (LCR) as key reforms implemented by the FSB. Due to these reforms, capital requirements were implemented internationally and new liquidity standards were reached (Claessens & Kodres, 2014). Furthermore, they state that the incentives for risk-taking were reduced.
In what way did higher capital requirements and liquidity standards for banks and the controlled risk management of banks affect the FinTech sector? According to Arner et al. (2016) these reg-ulatory responses to the financial crisis diverted capital form Small and Medium sized Enterprises (SMEs) and private individuals: banks did no longer fulfill their need for credit. For example: in the report of the first half of 2009 the European Central Bank reports that a significant fraction of SMEs experienced a lower willingness of banks to provide loans. One way in which individuals and SMEs are trying to fulfill their need for credit is according to Bruton, Khavul, Siegel and Wright (2014) with crowdfunding and peer-to-peer lending. Instead of banks, internet platforms serve as intermediaries (Bruton et al., 2014) where capital is supplied directly by individuals. At this time (2008-2009) the first shift of customers from banks to FinTech companies is visible. Philippon (2015) states that the an advantage of the new FinTech sector is that FinTech companies are not affected by existing regulatory systems and they are funded with much more equity than existing firms. They are also able to use technology in providing low-leverage solutions (Philippon, 2015)
which is a more complex process in banks.
Moreover, not only the need for credit became more and more fulfilled by the introduction of FinTech, but also the effectiveness of financial intermediation improved. According to Philippon (2015) the unit cost of financial intermediation in the U.S. and Europe has been around 2% for the past 130 years, but as Arner et al. (2016) describe: technology removed the need for these financial intermediaries and thus reduced the transaction costs.
3.2
Low interest rates
Although it is showed that banks became less risk-taking and safer during the financial crisis, this was not the case at the start of the financial crisis. One of the first responses of the Federal Reserve to the financial crisis had according to Thornton (2012) a lowering effect on the interest rate. He states that from the second half of 2008 to the first half of 2009 the interest rate decreased in the United States.
Also the European Central Bank (ECB) did respond directly to the financial crisis. After the crisis started in 2008, the ECB cut the interest rate from 4.25% in October 2008 to 1% in May 2009 (Trichet, 2011). According to Gerlach and Lewis (2010) central banks cut their interest rates to support growth and to ensure inflation will be around the desired level. They state that the cuts in 2008-2009 were made to reduce inflationary pressures and in total, the interest rate was reduced by 325 basis points. Also the overnight interest rate decreased, which was according to Gerlach and Lewis (2010) caused by the behaviour of banks, which took advantage of the low interest rates by borrowing more than they needed.
By increasing the money supply and lowering the interest rate, central banks used a monetary expansionary policy. One of the consequences of such a policy is according to Bernoth, Gebauer and Sch¨afer (2017) the increased capacity of the financial system to bear risk and therefore the lending activity will be increased. This is the opposite effect of the earlier stated effect of capital requirement regulations.
The International Monetary Fund (IMF, 2016) lists consequences for the bank and nonbank sector of the monetary expensionary policy of central banks. For the nonbank sector the IMF (2016) concludes that a lower short-term interest rate will increase profits and therefore also their capac-ity to bear risk. This effect is stronger for nonbanks than for banks, according to the IMF (2016), since the nonbank sector depends for a larger extent on short-term funding. Lowering the interest rate will thus increase the risk-taking of nonbanks, including FinTech companies, more compared to the banking sector. Therefore, at the start of the financial crisis, FinTech companies were able to invest in riskier projects with higher returns. The timing of the financial crisis with the
consequence of lower interest rates, created perfect conditions for FinTech companies to emerge and grow. Moreover, they were not affected by reserve requirements, and therefore did not change the risk-taking behaviour of the nonbank sector.
3.3
China’s approach to financial inclusion using FinTech solutions
China’s banking system differs from the United States and Europe as described by Shim and Shin (2016). They describe that until 1983, the Peoples Bank of China was a commercial bank owned by the state and served as a central bank. From 1995 four state-owned banks were commercial-ized, although they remained under government control according to Shim and Shin (2016). The banking system now consisted of a central bank, the “Big Four”, second-tier commercial banks and city commercial banks and in 2003 the China Banking Regulatory Commission (CBRC) got the full authority to regulate the banking sector in China (Shim & Shin, 2016).
Before 2000, China was faced with problems regarding payment systems, financial institutions, credit systems and had a low availability of information technology as follows from the analysis of Shim and Shin (2016). They describe that because of the government control on the banking system and e-commerce, it took a lot of authorization processes to estabilish online businesses. However, in the late 1990s Chinas e-commerce emerged according to Shim and Shin (2016). The main problem that these online business experienced after their establishment, was the payment system which was only allowed to be handled offline through two banks of the “Big Four”. Only the bank UnionPay was permitted to make electronic payments which was commercialized in 2002.
While online businesses emerged in the late 1990s, SMEs were largerly underserved as Mittal and Lloyd (2016) describe. Just like in Europe and the United States, they were underserved due to the risk they face, which was not accepted by banks. According to Mittal and Lloyd (2016), these unfulfilled needs of SMEs were a driving factor for SMEs to seek for alternative financial solutions.
Next to the high demand for alternative finance, China has one of the highest mobile telephone penetration in the world (Arner et al., 2016), which is stimulated by the Chinese government (Jang, 2017). In this time of high demand for alternative finance, and high mobile telephone penetration, it was perfect for the Chinese government to tackle the problem that part of Chinas population was unbanked (Ngai et al., 2016). The main problem was according to Ngai, et al. (2016) the limited provision of financial services for the part of the population that could not meet the minimum investment requirement of banks. Since the first decade of the 21st century the Chinese government reformed the financial system with the objective to achieve full financial inclusion via digital finance (Jang, 2017). Arner et al. (2016) describe that the combination of an
underdeveloped physical banking system and a fast growing digital infrastructure will lead to a fast developing digital banking system, which is visible in China. Also the full financial inclusion is visible: according to Mittal and Lloyd (2016) the payment method Alipay is roughly used by the same percentage of third-tier cities (small and medium cities in China) as first-tier cities (big cities, for example Beijing and Shanghai).
As mentioned, the financial inclusion policy of the Peoples Bank of China was implemented by the transformation to the use of digital finance. By zooming in more into this policy, Ngai et al. (2016) state that the Peoples Bank of China launched its online payment interbank clearing sytem in Au-gust 2010. Xinhua (2010) describes that in this new system, online banking systems were linked to commercial banks. According to him, this made online banking easier and created faster transfers.
Besides the fact that FinTech emerged in China via the financial inclusion policy, China’s policy during the financial crisis regarding reserve requirement and interest rates is analysed too. Zhang (2009) states that China had to deal with two external shocks during the financial crisis: the fall of international demand and the collapse of the commodity markets, both in 2008. China responded on this shocks with macroeconomic and industrial policies, according to Zhang (2009). He describes that in November 2008 China switched to an expansionary monetary policy. Zhang (2009) also states that China cut down the interest rates, and lowered the bank reserve require-ment ratios.
As stated, the IMF (2016) describes that if the interest rates are low the nonbank sector, including FinTech companies, is able to invest in riskier projects with higher returns. According to the IMF (2016), this effect is stronger for nonbanks than for banks. In combination with the good position of FinTech companies, which follows from the low interest rates, the financial inclusion policy led to a FinTech-friendly environment in China.
4
Regulation of FinTech after its emergence
According to Bernoth et al. (2017) there is a rising gap between regulations for banks and non-banks (including the FinTech sector). From their research it follows that the nonnon-banks, which are not constrained by capital requirements, could increase their credit relatively to that of banks. This effect can cause an attenuation of the monetary policy effects, if bank credit can be substi-tuted by nonbank lending (Bernoth et al. 2017). The latter is possible as stated earlier since for example peer-to-peer lending platforms and crowdfunding are developed by FinTech companies. According to Bernoth et al. (2017) there exists a regulatory arbitrage opportunity for banks if bank credit can be substituted by nonbank lending: commercial banks can circumnavigate
capi-tal requirements by using nonbank intermediaries. In order to stabilize the financial system and protect the effectiveness of the monetary policy mechanism, the regulation of financial technology has become an important subject for policy makers.
At the start of the financial crisis in 2008, implementation of banking regulations took place at a national level. According to Hertlein (2015) this caused an increasingly fragmentated banking market in the European Union. Next to the fact that the market was fragmentated, supervisors from different banks did not cooperate or exchange information as described in the Larosire re-port (group of experts that did research for the European Commission). Because of this problem, the Larosire report states that there should be created an E.U. level agency to establish Euro-pean banking regulation and to implement supervisory rules. Therefore the EuroEuro-pean System of Financial Supervision (ESFS) and the European Banking Authority (EBA) were estabilished in 2011 (Hertlein, 2015). From now on, the EBA could propose regulations for the E.U. banking sector, which were usually approved by the European Commission (Hertlein, 2015) and banking regulation became more regulated by Europe instead of regulated at national level. Before the establishment of the EBA, European regulators were already in debate about the introduction of regulations concerning financial technology as described by Egner (2017). He states that the objective was to introduce a regulatory framework for payment account access which should en-courage FinTech companies to enter the payment market and banks to revise and expand payment services. According to Egner (2017), two Payment Services Directives (PSDs) should provide this framework for payments. According to the European Commission, the first PSD had to be imple-mented in the national law of E.U. countries by November 1, 2009. The first PSD was established to provide a set of rules on payments across the European Economic Area covering all types of electronic and non-cash payments, as described by the European Commission. It was followed by the PSD2, which has to be implemented in January 2018. According to the European Commis-sion, it should make internet payment services easier and safer, protect consumers better against fraud, promote innovative mobile and internet payment services, strengthen the consumer rights and it should also strengthen the role of the EBA to coordinate supervisory authorities. With the implementation of PSD2, European banks are obliged to give banking and nonbanking companies (FinTech companies) access to the payment accounts of their customers.
Also the Peoples Bank of China also implemented rules for payment services since 2010 (Wei-huan, Arner & Buckley, 2015). The Payment Rule has the objective to regulate the provision of payment services offered by nonbanks. It aims to protect the interests of consumers and it states that payment services may only be provided if the non-financial institution holds a Payment Ser-vices License (PSL), which is only obtained under strict requirements, according to Weihuan et al.
(2015). They state that more regulations were intended but the regulatory framework was frag-mentated and inadequate. However, in 2015 the Digital Financial Services (DFS) Guideline was implemented which Weihuan et al. (2015) describe as a significant achievement in the regulatory process. They state that the DFS Guideline provides a list of encouraged digital finance services and it supports the cooperation between FinTech companies and banks. According to Weihuan et al. (2015) the guideline also encourages the creation of DFS funds, in order to improve the envi-ronment for financing FinTech companies. Furthermore, the DFS Guideline provides tax benefits for FinTech start-ups and establishes a supportive infrastructure for further development of these start-ups. The fast growing peer-to-peer lending business also becomes more regulated with the DFS Guideline. Weihuan et al. state that peer-to-peer lending services are limited to small value transactions. Also subjects containing consumer protection and risk and fund management are part of the DFS Guideline.
According to a report of International Comparative Legal Guides (ICLG, 2017) there does not exist a FinTech-specific regulations in the United States. However, a FinTech company can be subject to state licensing or registration requirements and is also subject to laws and regulations at federal and state level (ICLG, 2017). There are on the other hand also specific FinTech regulations proposed according to Deloitte (2017). They describe that the Office of Comptroller of the Cur-rency (OCC) proposed to create a special purpose national bank charter for FinTech companies on December 2, 2016. According to the OCC (2016) this ensures that FinTech companies operate in a safe manner, and can effectively serve the financial needs. The proposed charter also promotes consistency in the application of law and regulations (OCC, 2016). Moreover, the OCC (2016) describes that the federal banking system would become stronger. If FinTech companies are able to serve financial needs better under a national bank charter, this effect would be reflected in the stock price of a FinTech company by the efficient market hypothesis (Fama, 1970). Therefore an event study is performed to measure whether the announcement of the OCC indeed influences the stock prices of a FinTech company. Since the OCC states that FinTech companies are better able to serve financial needs, FinTech activities are expected to rise and therefore the effect of the proposal is expected to positively affect the stock prices of a FinTech company.
The effect of the proposal is measured for three different American FinTech companies in the payment services sector. Since FinTech is relatively new, many FinTech companies are start-ups, in early funding stages, or in any case not listed which follows from the website crunchbase.com that provides information about innovative companies. Large firms like Amazon and Apple also engage in FinTech activities: they respectively launched payment services under Amazon Pay and Apple Pay. However, they are engaged in many more other activities which could disrupt the
event study that is only interested in the effect of the proposal on the FinTech part. Therefore the three existing listed FinTech companies found in the United States’ payment services sector: Square, VeriFone and First Data, are used in this case study to estimate the effect of the proposal.
5
Case study: how did FinTech companies respond to the
proposal of the OCC?
To estimate the impact of the proposal of the OCC to create a special purpose national bank charter for FinTech companies on the stock prices of Square, VeriFone and First Data, MacKin-lays (1997) methodology of an event study is used. The daily stock prices of the three firms are collected from Yahoo Finance.
First of all the event date, i.e. the date at which the OCC announced its proposal, is December 2, 2016. The estimation period contains 244 trading days and goes from December 1, 2015 to November 16, 2016. From November 17, 2016 to December 16, 2016 the event window is set. Hereafter, the event date is referred to as t = 0, and the event window will contain the dates t = −10 to t = 10. Since it is being tested whether the returns on the stock prices of each Fin-Tech company are significantly different after the proposal of OCC, MacKinlays (1997) formula for abnormal returns, given by ARiτ = Riτ− E(Riτχτ) is used. The difference between the actual
return of the stock prices and the normal return is denoted the abnormal return of the stock price. The abnormal returns will then be ARiτ = Riτ− ˆαi− ˆβiRmτ.1
The methodology tests whether the abnormal returns are significantly different from zero. If so, the proposal of the OCC has impacted the returns of the specific FinTech company and by analysing the sign of the abnormal returns it can be concluded in what way it impacts the stock prices of the three FinTech companies. The abnormal returns and cumulative abnormal returns (CARs) are given in Table 1.
To see how the cumulative abnormal returns responded to the event, the graphs of the CARs are given in Figure 1. At first sight, the behaviour of the cumulative abnormal returns of the three companies differ a lot. For the firm Square, none of the abnormal returns is different from zero if the significance level is 10% or lower, only if the nullhypothesis would be one-sided, the abnormal return on t = 3 would be significant at a level of 10%. First Data seems to be very volatile around zero in Figure 1. This is indeed approved by the t-values of the abnormal returns for this firm.
1The abnormal return is the error term of the market model, facing a zero mean with variance: AR iτ = σ2+L1 1(1 + (Rmτ− ˆµm)2 ˆ σ2
m ). The second term in the variance is due to the sampling residual and L1 is the length of the estimation period. If L1 → ∞, the second term of the variance will be nearly zero. In MacKinlays model the second term of the variance in the abnormal returns is therefore assumed to be zero.
Under the null hypothesis, which states that there is no impact of the proposal of the OCC on the returns of each FinTech company, the distribution of the abnormal returns in the event window will be ARiτ∼ N (0, σ2(ARiτ).
Table 1: Results abnormal returns and cumulative abnormal returns
Square First Data VeriFone
Date AR CAR AR CAR AR CAR
-10 0.010 2 0.010 2 0.011 0*** 0.011 0 0.004 6* 0.004 6 -9 −0.002 9 0.007 3 0.010 4*** 0.021 4 0.014 2*** 0.018 8 -8 −0.003 7 0.003 5 −0.028 6*** −0.007 2 −0.008 1*** 0.010 6 -7 0.016 1 0.019 6 −0.018 7*** −0.025 9 0.000 2 0.010 8 -6 −0.004 8 0.014 8 0.026 3*** 0.000 4 0.005 6** 0.016 4 -5 0.020 9 0.035 7 0.002 1 0.002 6 −0.003 0 0.013 3 -4 −0.011 7 0.024 1 −0.019 4*** −0.016 8 −0.014 4*** −0.001 1 -3 −0.007 3 0.016 7 −0.014 7*** −0.031 5 −0.009 8*** −0.010 8 -2 0.035 7 0.052 4 −0.021 3*** −0.052 8 −0.015 8*** −0.026 6 -1 −0.017 8 0.034 6 −0.021 3*** −0.074 1 −0.034 6*** −0.061 3 0 0.025 7 0.060 4 0.011 1*** −0.063 0 −0.044 9*** −0.106 2 1 0.003 1 0.063 4 −0.024 7*** −0.087 7 0.049 7*** −0.056 5 2 −0.001 2 0.062 3 −0.020 2*** −0.107 9 0.014 0*** −0.042 5 3 0.049 9 0.112 2 0.000 2 −0.107 7 −0.023 1*** −0.065 6 4 −0.016 9 0.095 3 0.013 7*** −0.094 0 0.000 2 −0.065 4 5 −0.008 3 0.087 0 −0.002 0 −0.096 0 −0.010 7*** −0.076 1 6 −0.002 5 0.084 5 −0.012 3*** −0.108 4 0.002 0 −0.074 1 7 0.009 6 0.094 1 0.007 3*** −0.101 1 0.081 0*** 0.006 9 8 −0.005 5 0.088 6 −0.007 6*** −0.108 7 0.046 6*** 0.053 5 9 0.017 8 0.106 4 −0.001 4 −0.110 0 −0.015 6*** 0.038 0 10 0.017 4 0.123 8 0.012 8*** −0.097 2 0.018 3*** 0.056 3 H0: ARiτ = 0 and * indicates a significance level of 10%, ** 5% and *** 1%.
On the event date, t = 0, the abnormal returns rose and are significantly different from zero. However directly after this increase, the abnormal returns are decreasing significantly. VeriFones abnormal returns were affected positively by the proposal of the OCC. Directly after the proposal the abnormal returns increased and were significantly different from zero with a significance level of less than 1%. Unless the decreasing behaviour in t = 3, t = 5 and t = 9, VeriFone was positively affected by the proposal of the OCC.
This case study does not provide one impact of regulatory changes on FinTech companies. The OCC proposed to give FinTech a special purpose national bank charter in December 2016. Ac-cording to Merler (2017), the FinTech market was disrupted in 2016 by events like the Brexit in Europe and the presidential elections in the United States. She states that the total investments in FinTech companies declined significantly.
Furthermore, some more research on the proposal of the OCC shows that directly after the pro-posal lots of comments were made. Rutkowski (2016) stated on December 2, 2016 that a national charter for FinTech firms could severely undermine state oversight and state consumer protec-tion laws. The uncertainty around regulaprotec-tions for FinTech companies and the fast changes in regulations are one of the reasons why in this case not one effect on the performance of FinTech
Figure 1: Cumulative abnormal returns
companies is measured.
Moreover the fit of the models, measured by the R2, is very low: for Square the R2 equals 0.0841
and for First Data and VeriFone respectively 0.2571 and 0.1676. Therefore, returns of FinTech companies have to be analysed further first, in order to make better estimates of the expected returns. In combination with more listed FinTech companies and a well developed regulatory framework for the FinTech market, this kind of case studies will give a good insight in how Fin-Tech companies in different FinFin-Tech industries are affected by specific regulations.
6
Conclusion
In this research the emergence of FinTech is analysed in three regions: the United States, Europe and China. The findings of earlier research on the determinants for the emergence of FinTech are described and have mainly showed how the technology sector and the venture capital market affects the performance of FinTech companies during the financial crisis. The latter, since FinTech companies started to emerge in 2008. In this research the emergence of FinTech is analysed from a regulatory perspective. The influence of traditional banking regulations during the financial crisis on the emergence of FinTech is described for the three regions.
In Europe and the United States, the reserve requirements for banks were already supervised before the financial crisis and strengthened during the financial crisis. As a consequence, banks could less fulfill the need for credit of SMEs. Private individuals and SMEs are therefore switching
to crowdfunding and peer-to-peer lending platforms, where capital is supplied directly by individ-uals. The latter also causes a reduction of the transaction costs, compared to the transaction costs for banks.
The reaction of central banks of Europe and the United States resulted in reduced interest rates. The financial system is as a consequene able to bear more risk and the lending activity should increase. Low interest rates also influences the profits of nonbanks, including FinTech companies, positively since the effect of the ability to bear more risk is stronger for nonbanks. The timing of the financial crisis, with the consequence of lower interest rates and higher reserve requirements for banks, thus created perfect conditions for FinTech companies to emerge.
Before 2000, SMEs were largely underserved in China too. Due to problems regarding payment systems, financial institutions, credit systems and a low availability of information technology it was difficult to start an online business in the 1990s. In Chinas payment system businesses were only allowed to handle transactions offline through two specific Chinese banks. Since also a sig-nificant part of the Chinese population was unbanked, China reformed financially by using digital finance services to improve financial inclusion. In this way Chinas FinTech sector emerged. At the beginning of the financial crisis in 2008, China lowered the reserve requirements after expe-riencing external shocks. China tried to reduce the need for credit and by lowering the interest rate nonbanks are able to bear more risk and therefore could engage in projects with higher returns. Since this effect is stronger for nonbanks, this created room for FinTech companies to emerge.
Already after the emergence of FinTech companies at the beginning of the financial crisis, the debate about FinTech-specific regulations started. In Europe this resulted in the Payment Ser-vices Directives, which should make internet paymet serSer-vices easier and safer, protect consumers better, promote innovative mobile and internet payment services and which should strengthen the role of the EBA to coordinate supervisory authorities. FinTech companies are with the PSD2 able to provide better services on the one hand and they are more able to compete with banks on the other hand.
China implemented the DFS Guideline in 2015 in which DFS funds are created to improve financ-ing for FinTech companies. Furthermore, FinTech start-ups receive tax benefits and support in their emergence and also regulations concerning consumer protection and risk and fund manage-ment are stated in the guideline. China now has a large FinTech market and it seems that the Chinese population switched from cash to eWallets instead of first to payment services by cards. The United States does not have a FinTech-specific regulatory framework. Although, FinTech companies are undermined to state licensing and registration requirements. The OCC proposed in December 2016 to create a special purpose national bank charter for FinTech companies. By
using an event study, the effect of this proposal is measured on the performance of three different FinTech companies in the American payment services industry: Square, First Data and VeriFone. As a measure for the performance, the daily stock prices are used.
Only the stock prices of First Data were positively influenced on the date of the proposal with a significance level of 1%. The stock prices of VeriFone were significantly negative affected on this date, however in the days after the announcement nearly all days show a positive effect on the stock price returns. Squares stock prices did not show any effect of the proposal of the OCC. Since in 2016 the FinTech market was disrupted by the Brexit and the presidential elections in the United States, the model for the expected returns could be less reliable. There were also many critics on the proposal of the OCC, which could influence the strength of the event and therefore the results. Moreover, the fit of the models was low. Thus, in order to estimate how a specific FinTech regulation influences the performance of a FinTech company, the returns of FinTech companies should be analysed further.
From this research it can be concluded that banking regulations during the financial crisis created in Europe and the United States an opportunity for the FinTech sector to emerge. This is also the case in China, however China already used alternative financing solutions for financial inclusion. In order to improve the effectiveness of regulations concerning the FinTech sector in the long term, this research shows how currently existing regulatory tools for banks affect FinTech companies.
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