Does Fintech Contribute to Systemic Risk? Evidence from the US and Europe

ADBI Working Paper by Finance ’18 alumni Lavinia Franco, Ana Laura García, Vigor Husetović, and Jes Lassiter

A master project by four alumni of the Finance Program Class of 2018 is soon to be added to the working paper series of the Asian Development Bank Institute (ADBI).

Abstract

Fintech has increasingly become part of the global economy with the evolution of technology, increasing investments in fintech firms, and greater integration between traditional incumbent financial firms and fintech. Since the 2007–2009 financial crisis, research has also paid more attention to systemic risk and the impact of financial institutions on systemic risk. As fintech grows, so too should the concern about its possible impact on systemic risk. This paper analyzes two indices of public fintech firms (one for the United States and another for Europe) by computing the ∆CoVaR of the fintech firms against the financial system to measure their impact on systemic risk. Our results show that at this time fintech firms do not contribute greatly to systemic risk.

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Figure B.2: US Fintech: ∆CoVaR and Size
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Figure B.3: US Fintech: ∆CoVaR and Beta
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Figure B.4: European Fintech: ∆CoVaR and Size
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Figure B.5: European Fintech: ∆CoVaR and Beta

Conclusions and key results

Our results show that, for the US, the payment and remittances and the market and trading support categories contribute the most to the VaR of the fintech industry. Instead, in Europe, fintech firms that provide software solutions and information technologies seem to be contributing the most to the risk of the sector. The estimation that includes fintech firms and the representative sample of the financial sectors show that fintech firms are not systemically important. Within the US financial system, the fintech companies that do contribute to systemic risk increase it by around 0.03%, while, in Europe, fintech firms contribute very little to the systemic impact (close to 0%). The Spearman’s rank correlation between a fintech firm’s ∆CoVaR and its respective size and between a fintech firm’s ∆CoVaR and its beta strengthens the importance of our estimations for a better assessment of systemic risk rather than just relying on the size and the beta of the firms to determine their likely contribution to systemic risk.

Some limitations of our study include the scope of our analysis method (∆CoVaR), the representation of the fintech sector, and the analysis of only two markets. However, micro-level data analysis focusing on each individual fintech category and changing the focus on emerging markets could reveal the specific risks, highlighting key research lines. 


About the authors

All of the authors are alumni of the Barcelona GSE Master’s in Finance, Class of 2018.

Competition and the Hold-Up Problem – Guillem Roig ’08

Editor’s note: The following post was written by Barcelona GSE alumnus Guillem Roig (Competition and Market Regulation ’08). Guillem is currently a PhD student at the Toulouse School of Economics in France.


Competition and the Hold-Up Problem: a Setting with Non-exclusive Contracts

words-roig

The paper

Why some of us do not spend the desired time and resources to nurture and improve the relationship with our parents, friends or business partners? Because once the time and resources are spent, we are afraid of possible opportunistic behavior. Economists frame opportunistic behavior in simple trading relationships where a buyer and seller are able to undertake specific investment into the exchanged good. Fisher Body, a manufacturer of body cars, refused to locate their body plants adjacent to General Motors assembly plans, a move that was necessary for production efficiency.

To fight opportunistic behavior we cannot rely on “good faith” alone, but we need to establish institutions to reduce its occurrence. Many modern societies have written laws, neutral courts of justice and arranged reasonable rules to resolve disputes. Yet, what happens when a sound and solid institutional system does not exists? In this paper, I consider situations where investment contracts cannot be enforced and I explore how the introduction of competition among the sellers of an homogeneous good gives the right incentives to undertake profitable specific investment.

In these types of models, the equilibrium payoff of the sellers is a measure of their indispensability, which directly depends on the outside option available to the buyer. The trading partners invest efficiently only when the trading outcome is the most competitive. When competition is the most severe, investments do not effect the outside option of the buyer and each seller appropriates his marginal contribution of the trading surplus. Any other equilibrium gives the seller incentives to over-invest. Sellers’ investments not only generate larger trading surpluses but also reduce the outside option of the buyer. The asymmetric partition of the trading surplus generates investment inefficiencies.

In a related article, I study how the configuration of the market structure is affected by the way an endogenous number of suppliers compete in the market. With non-exclusive trade and a common buyer undertaking cooperative investment, I obtain a direct link between the level of competition and investment that affects the market structure of the supply side of the market. Trading outcomes that are more competitive are associated with a larger and more homogeneous distribution of investment among active suppliers, and an equilibrium with no investment might occur in trading outcomes that are less competitive. Buyer’s investment works as a mechanism to incentivize competition and this becomes more effective the more competitive the trading outcome is. The paper gives a theoretical insight for the coexistence of first with second tier suppliers and predicts situations where investment does not materialize.

Download the full working paper [pdf]

The process

I started this project in September 2012, after a short visit at the University of Arizona where I meet a group of law academics working on the design of trading contracts. I soon became interested in topics of contract theory and organization design and researched in the area of transaction cost economics.

The upturn of the project came in May 2013 when I benefited from an ENTER exchange program at the Universitat Autònoma de Barcelona. I presented my work in a series of seminars and the suggestions of Prof. Inés Macho and David Pérez Castrillo were invaluable at that stage of the project. I dismissed the design of complex trading contracts and I went back to basics. I concentrated on framing the problem of transaction costs without any established formal institution.

In my model, I never talk about investment contingent contracts or contract enforceability, I only allow for the interaction of economic agents in the market. In many situations, we might not need a complex and sophisticated institutional framework but we just must allow “the invisible hand” to function.

Toulouse School of Economics
Toulouse School of Economics

The working paper series of the Toulouse School of Economics are free and accessible online, so for further information please check out my articles here!