FINTECHs: Further innovation requires regulation

The large traditional banks have been monopolising the banking industry for as long as we have known - not just in South Africa but globally. We have trusted banks as intermediaries with our money and paid their fees - not because we were happy about it but more because there was no alternative.

Over the last decade, banking customers have switched towards the digital environment in their personal and business capacities – also demanding their suppliers follow suit. This has compelled merchants to digitalise the way they do business to better meet demand, or see customers take their business elsewhere.

At the same time, Financial Technology (FinTech) companies have been at the forefront of disrupting various industries, strategically positioning themselves in the market to better analyse their customer needs, service their customers better, faster and more effectively at a much lower cost. This has been done particularly well in the banking industry.

Demand for online shopping increased globally and in South Africa in the wake of Covid-19. As the shopping experience digitalised, so did payment methods. Merchants shifted from using clearing houses to rather use alternative payment methods allowing for instant payments through the likes of digital wallets, cryptocurrencies, peer-to-peer transfers, mobile money, payments with central bank digital currencies (CBDCs) and stablecoins to name a few. This has de-cashed our economy and its historical dependence on card payments.

In a world characterised by instant gratification and reward, consumers no longer want to wait for payments to clear via a third party. FinTechs have seized this opportunity to service new customers, often clearing payments within seconds. All this helps the customer reconsider the value of the existing business model of traditional banks and prompted the pop up of digital banks such as Tyme Bank, Bank Zero and Discovery Bank, even though these are still based on traditional banking principles.

Digital banks tend to have lower fees compared to traditional brick-and-mortar banks and are a step in the right direction, as customers become ever more digitally inclined. Whether they are digital banks or not, they are still a financial intermediary taking their piece of the fee pie. FinTechs are challenging this entire business model and the relevance of financial intermediaries in the digital age we live in.

Consequently, there is a significant need for regulation of FinTechs in South Africa’s open banking sector, which remains unregulated. Examples abroad show that regulating open banking has a positive impact on the economy by driving further innovation. In Europe, legislation called the Payment Services Directory (PSD2) became effective in 2018. It allowed for a more integrated payments industry and better collaboration between FinTechs and traditional banks. Each group of players uses quite different business models in the same space.

Post PSD2, traditional banks in Europe were forced to share their data with certain accredited FinTechs through Application Programming Interfaces (APIs). Historically, banks kept all client transaction data confidential, sharing it only among themselves (for their own advantage) - making it difficult for any other player to enter the banking sector. This also had the effect of halting innovation. However, FinTechs had the technological means to process data more effectively than banks.

The PSD2 legislation resulted in many benefits for the European economy:

  • Consumer protection through regulation
  • Greater transparency in the industry, allowing for a more level playing field and audit trail
  • Existing fee models were challenged, forcing banks to either relook their existing pricing models or to collaborate with FinTechs to remain relevant or gain a competitive advantage. This lowered costs across the industry by including more customers at more attractive fees allowing for greater financial inclusion in the banking ecosystem
  • Modernising the current banking sector through technology
  • Allowing for cross-border payments to be faster, less admin intensive and cheaper
  • Enhancing the security of online payments which resulted in a lower fraud risk

Would such regulation have the same positive impact in South Africa as in Europe? I believe so, with some additional benefits:

  • Social and economic growth
  • As a developing country with a large unbanked and underserved population it would allow for greater financial inclusion, aligning with our national transformation objectives
  • Currently the open banking sector remains unregulated. With regulation, investors would be better protected from fraudsters

South Africa needs to find the ‘right’ regulations for the banking industry – regulation that will facilitate innovation and collaboration in the banking industry rather than halter it.

This can be achieved by building on existing regulations and what is working in other countries. Regulators should work with the industry to find the right regulations to protect investors and promote innovation. Mazars’ view is that regulators should engage with industry players and allow them to provide input into draft regulations prior to implementing them.

It is not clear when we can expect to see regulation in South Africa relating to open banking. There exists a concrete effort by both government and the banking sector to partner with industry players. This effort is implementing pilot projects behind the scenes and is a welcome step in the right direction.

These efforts are an acknowledgement of the importance of modernising the South African banking industry and the important role FinTechs play in assisting the banking sector adapt and move through technology to remain relevant and competitive.

Mia Pieterse, Partner and FinTech Specialist