The (Unfulfilled) Fintech Potential

Consumers’ financial choices are often quite complex. For instance, choosing a new credit card entails assessing various features of each card, such as introductory and ongoing interest rates, annual fees, and cash-back rewards. These need to be calculated given the consumers’ specific expected behavior and where they shop, their income, and the likelihood of them forgetting to make a payment, as well as the chance that a card will be approved given their credit score. Such a complex decision is nearly impossible for the average consumer, but it’s trivial for an intelligent algorithm. Choosing and signing up to the optimal card, picking which card to use for every purchase (as well as where to make that purchase and which coupons to utilize), remembering to make a payment, or even making that payment while transferring funds from savings accounts to avoid an overdraft, are just a few of the functions modern technology could undertake for consumers quite seamlessly.

But it doesn’t. Despite the high expectations of technology to come to consumers’ aid, detailed by academics, technological experts, and government officials, the largest Fintech companies that address these issues have made only limited progress in resolving market failures that are derived from consumers’ bounded rationality, information, and attention. Although the relevant technologies and information are available, Fintech intermediaries simply don’t take on such roles, and in some cases, the design of these products even exacerbates existing market failures. Although technological innovations could change market dynamics and improve consumers’ decision making, such products aren’t coming into fruition.

My recent paper, The (Unfulfilled) Fintech Potential, offers several possible explanations for why such services, despite their potential benefits, aren’t appearing as significant participants in financial markets. First and foremost, just as bounded rationality distorts consumers’ demand for financial products, it also limits their ability to assess the benefits of products offered to resolve such failures. While consumers may be somewhat sophisticated with regard to their limited attention and costs of gathering information, their ability to demand products that highlight the costs of non-salient features is limited. Second, since consumers are sensitive to the upfront costs of such products, they prefer to receive free services, which often entail lowering the quality of the services they receive, while forcing companies to profit from back-end services, often to the detriment of consumers. Thus, since consumers don’t pay for comparison websites’ services, such sites often receive payments from credit card companies and banks, distorting the way information is presented to consumers and limiting such companies’ incentives to optimize consumers’ choices. Since consumers are highly sensitive to the price of the services they receive, companies often design their business model as a two-sided platform, in which they under-price the services offered to consumers, often providing them for free, while transferring such costs to other participants on the platform, such as retail businesses or credit card companies. These, in turn, transfer the costs back to consumers through the prices of the services they provide. Third, when financial service providers price their products with excessive margins, such platforms may try to capture these margins, instead of minimizing them. Finally, another factor influencing the design of such Fintech products may be the power and influence of existing incumbents, specifically banks and credit card networks. These incumbents can create barriers to entry through dependency on their approval for certain services, as well as strong financial incentives for Fintech companies to align their services in a way that preserves and enhances the networks’ profits.

Despite these challenges, there are several ways that markets can develop to fulfil the potential for enhanced products that resolve behavioral market failures. Policy interventions that look to antitrust and competition considerations, as well as the imposition of existing fiduciary duties or regulations promoting fairness and prohibiting misleading practices, can go a long way in driving out certain problematic practices. Additionally, market actors whose interests are aligned with those of consumers, such as employers and wealth managers, can help create the market demand needed to fund such services. But overall, it may be time to rethink previous notions of the role of Fintech intermediaries, as without a nudge, or even a strong push in the right direction, they are not likely to fulfil the potential ascribed to them. 

Aluma Zernik is SJD Candidate at Harvard Law School, Co-editor, Harvard Law School Forum on Corporate Governance and Financial Regulation and Terence M Considine Fellow in Law and Economics.