How do FinTechs Address the Issue of Information Asymmetry in Financial Markets?
Chapter One
Preamble of the Study
In any transaction in which one of the two parties involved has more information than the other and so has the potential to make a more informed decision, financial markets display asymmetric information.
According to economists, unequal information causes market failure. That is, the rule of supply and demand, which governs how products and services are priced, is distorted.
Chapter Two
Literature Review
Understanding Asymmetric Information
When either the buyer or the seller has more information about an investment’s past, present, or future performance, asymmetric information can arise in the financial markets. One party is capable of making an informed judgment, but the other is not.
It’s possible that either the buyer or the seller is aware that the asset is undervalued. In each situation, one side stands to gain financially from the deal at the expense of the other.
The Subprime Meltdown and Asymmetric Information
The subprime mortgage crisis of 2007-2008 could serve as a textbook example of the consequences of asymmetric knowledge. Mortgage-backed securities were the cause of the financial crisis. Consumers were given mortgages by banks, which were subsequently sold to third parties. These third parties bundled them together and sold them to investors in batches. The securities were evaluated as high-quality and sold accordingly.
However, many, if not all, of the individual mortgages involved in those products had been issued to borrowers purchasing homes at inflated prices that they couldn’t afford. The borrowers, as well as the secondary buyers of their mortgages, were stuck when prices halted.
The vendors have information that the end buyers did not have unless no one done their homework at any point during this lengthy process. That is, they were aware that high-risk mortgages were being misrepresented as high-quality financing. They were taking advantage of asymmetry in information.
Ignoring Risks
According to economists who research asymmetric information, such scenarios might create a moral hazard for one of the parties in a transaction. When a seller or buyer knows or reasonably guesses that the transaction involves a real but unreported risk, a moral hazard can arise.
Consider the selling of such mortgage-backed securities, for example. The vendors may have done their homework and realized they were offering sub-prime mortgages disguised as high-yielding investments. Or they may have detected early warning signs of a coming housing price crash.
Did the buyers have access to the same information as the sellers? If they did, they were most likely playing the same game of pass-the-trash and hoping to profit by reselling the securities before the finish.
Fintech
The term “financial technology” is referred to as FinTech. For many consumers, FinTech is a new concept with a nebulous definition. Financial literacy and education, stock investment, cybersecurity, blockchain technology, retail banking, and crypto-currencies like Bitcoin and Ripple are all examples of technological innovations that fall under this category.
FinTech has been a reemerging, fast-developing sector within the financial services industry for several years, spearheaded by those who are developing or innovating new technologies to change the way financial markets operate traditionally. When it comes to daily procedures, FinTech has essentially disrupted huge banks and traditional financial institutions. A handful of smartphone apps that enable stock trading without charging consumers any fees each trade is one easy illustration of this disruption.
Funding Circle, Ant Financial, Robinhood, Stripe, and Atom are among the companies that have pioneered these technologies. While start-ups and financial accelerators drive much of the FinTech sector, some of the world’s top banks, such as HSBC and Credit Suisse, have actively invested in establishing their own FinTech programs in addition to the more traditional financial services they provide.
Advantages of Fintech
- Improved accessibility. This leads to a rise in the number of people who are banked, as anyone with internet access may easily open an account and ask for a loan.
- Applicant response times for fintech companies range from 10 minutes to 48 hours on average.
- Time management. Because all processes are carried out over the Internet, it is not essential to visit a physical branch in the majority of circumstances.
- A wide range of services. Fintech has been able to segment services so that a wide range of services are available to meet the demands of both users and producers of financial services.
- Financial services for users include anything from creating a savings account to applying for a credit card, purchasing various types of insurance, and investing in a company seeking funding to expand, as well as international financial markets.
- Fintech options for financial service providers include assessing credit application profiles, storing data in the cloud, and streamlining payment procedures, among other things.
- Cost-cutting. Another key distinction of fintech, which most of them seek to use to compete with traditional financial institutions, is that the vast majority of fintech companies charge cheaper commissions than banks.
Chapter Three
Conclusion
To summarize, FinTech development is expected to continue at a rapid rate, aided by demand-side reasons. FinTech introduces new opportunities to the economy, but it also introduces new hazards. Regulators must handle these risks in order to reap the benefits of innovation without jeopardizing the financial sector’s stability.
The advantages of decentralization, accessibility, openness, and other features are especially enticing and innovative. However, macroeconomic and microeconomic variables must be taken into account. Although peer-to-peer lending is on the rise, it raises the issue of informational disparities.
References
- Claessens, S and L Laeven 2005 “Financial dependence, banking sector competition, and economic growth” Journal of the European Economic Association, 3(1), 179–207
- Claessens, S, J Frost, G Turner, and F Zhu 2018 “Fintech credit markets around the world: size, drivers and policy issues” BIS Quarterly Review, September
- Coase, R H 1960 “The problem of social cost” Journal of Law and Economics, 3 Coase, RH 1937 “The Nature of the Firm” in PJ Buckley and J Michie (eds) Firms, Organizations and Contracts, Oxford: Oxford University Press
- Cornelli, G, J Frost, L Gambacorta, R Rau, R Wardrop and T Ziegler 2020a “Fintech and big tech credit: a new database” BIS Working Papers, 887
- Cornelli, G, S Doerr, J Frost and L Gambacorta 2020b “Big techs vs G-SIBs: differences in market funding” mimeo Aghion, P, P Bolton 1997 “A theory of trickle-down growth and development” Review of Economic Studies, 64(2), 151–72
- Gambacorta, L, Y Huang, H Qiu, and J Wang 2019 “How do machine learning and non-traditional data affect credit scoring? New evidence from a Chinese fintech firm” BIS Working Papers, 834
- Gambacorta, L, Y Huang, Z Li, H Qiu, and S Chen 2020 “Data vs collateral” BIS Working Papers, 881, September
