Platform-based finance — or financial services embedded in online marketplaces — can deepen financial inclusion by translating the scale and reach of a digital platform into low-cost financial services for the masses. But there is a catch. As big tech platforms increasingly enter the financial services space, there is a risk that they could undermine competition in ways that harm consumers and set back financial inclusion.
In many advanced economies, scrutiny of big tech platforms’ monopoly power and anti-competitive business practices has intensified in recent years. These issues regularly make the headlines and are the subject of investigations in the United States. The European Union and especially China have taken a more aggressive stance in regulating platforms and holding them to account for competitive abuses.
In emerging markets and developing economies (EMDEs), financial regulators can apply relevant lessons from the leading economies. On this basis, they may take steps to harness the potential of platforms while maintaining healthy competition in their financial services markets.
Tendency toward concentration
Growth and consolidation are central to the success of a platform business, whether in e-commerce, ride-hailing or some other sector. By adding more users, a platform can multiply its data points and generate network effects, generating increasing returns to scale. Integrating new business lines like financial services expands a platform’s scope and its data, connections and revenue. More is better.
As a result, platforms encourage “winner-takes-all” outcomes in which one or a small number of platforms come to dominate the market. To scale their core non-financial businesses, platforms often use below-cost pricing strategies in financial services to capture market share. Once they control the market, they may consolidate their positions by raising barriers to entry for competition, enabling them to increase prices and decrease product choices.
Platforms may engage in “gatekeeper” behavior, such as giving preference to their own products on their platforms. And they may buy out competitors or make it costlier for users to switch to other platforms. The global big techs, which are targeted in the European Union’s proposed Digital Markets Act, are the most obvious examples of companies that have engaged in such practices. However, the same tendency appears among local and regional platforms in EMDEs.
Platforms’ desire to control user data can drive exclusionary and predatory behavior. Platforms tap into many complementary sources of information to create databases that are not easily replicable. Dominant providers can assert control by limiting competitors’ timely access to key data, preventing others from sharing data, and inhibiting data portability.
Platform-based finance: a competitive threat to the banks?
Initially, platforms embedded digital financial services as a way to serve their core business. But increasingly, they are challenging the supremacy of incumbent banks holding the vast majority of customer data. They are doing this by leveraging their own user data to design financial products and make them easily accessible on their platforms. In some cases, banks still play a role by underwriting these services. In other cases, platforms can offer the services themselves without the need for a bank license, completely replacing banks. Either way, platforms pose a competitive threat by taking control of the customer relationship and the data that comes along with it.
Banks can respond to the platform threat by competing or cooperating. Competition may drive banks to take excessive risks, such as investing less effort in loan screening, to counter the downward pressure on profits. Alternatively, banks may partner with platforms via open APIs or by pivoting to a banking-as-a-service business model in which they offer white label financial services to non-banks. The banks gain from the sales and distribution capacities of the platforms. The platforms profit from synergies between finance and their core businesses, while avoiding the burden of applying for a financial license.
What's different in the EMDEs?
Banks tend to be more dominant and entrenched in the financial sectors of EMDEs than they are in advanced economies. They play a decisive role in monetary and payment systems, giving them a built-in gatekeeper advantage over challengers – one that is sanctioned and buttressed by regulation. Policy makers may view competition by challengers and disrupters as destabilizing.
Furthermore, banks often exploit their gatekeeper status by making it difficult or expensive for non-bank competitors to access to their payments systems. In Indonesia, for example, Go-Pay (owned by the ride-hailing platform GoJek) faces competition from the banks, but it depends on the banking system for key services. In 2018, two state-owned banks started charging Go-Pay users for topping-up their balances through the banks’ e-channels. Allowing platforms to enter the financial sector while subject to an appropriate regulatory framework can therefore encourage healthy competition, leading to better and cheaper services.
For now, platforms in EMDEs are mainly competing with each other and focused on their core, non-financial businesses; however, they are expanding into platform-based finance. Competition with traditional financial institutions may intensify as platforms win customers away from banks. Meanwhile, global big techs may translate their core market predominance into a leading position in financial services. In many markets, it remains to be seen whether platform-based finance will become a major strategic focus for platforms rather than merely a tactical move to gain advantage in the core business.
The regulatory agenda
EMDE regulators should monitor platforms with a view to harnessing their financial inclusion potential. The overall goal should be enabling platforms to introduce healthy competition into a bank-dominated financial sector while preventing them from creating new concentration risks. This is easier said than done. Risks may arise outside the financial sector, making it difficult for financial regulators to track them.
It is instructive to consider the experience of China, the largest market for platform-based finance. Early on, Chinese authorities let platform experiments play out while supporting outreach to the excluded. They adopted regulations in stages over time, learning from experience. As growth and disruption reached breakneck speed, the authorities took a harder line on risk — for example, designating as systemically important such platforms as Alibaba/Ant Group. A crackdown came in late 2020. Eventually, Alibaba was fined US$2.8 billion (4% of 2019 sales revenue) for abusing its dominant position. The company agreed to a “rectification plan” by which Ant would restructure as a financial holding company and reform its business practices. Other platforms also came under pressure for similar reasons.
The Chinese experience shows what forceful action can achieve, though the context is highly idiosyncratic. It would be difficult for most regulators, especially in EMDEs, to take such a stance and pursue it so aggressively. It would mean confronting foreign big techs enjoying large reserves of money and influence, without the kind of global bargaining power China brings to bear.
A more practical approach in the EMDEs might be to focus on two priorities.
The first is to clarify ex ante competition standards for platforms. These standards should promote interoperability with third parties (like India did with its Unified Payments Interface) and equal treatment for all business users on platforms.
The second is to combat gatekeeping by dominant platforms. Gatekeeping could be addressed through requirements for data sharing and portability, along with transparency in platform fees and switching costs.
All of this will require coordination between financial authorities and other key regulators — something we will discuss in the next and final blog in this series.
This is the third post a four-part blog series called "Platform-Based Finance: Regulatory Challenges and Solutions." The series explores the implications of platform-based finance for data protection, competition and regulatory coordination.