Regulatory Uncertainty and FinTech Innovation

Abstract

Regulatory uncertainty is prominent in FinTech. Regulators lack experience in assessing the private and societal value of FinTech innovation, with instruments at their disposal being crude and underdeveloped. We advance a theory where FinTech innovators, incumbent firms, and regulators strategically respond to opportunities to innovate under uncertainty. In it, regulators acquire costly information about the value of innovation while FinTechs face regulatory uncertainty. We characterize how the rate of innovation in FinTech depends on the budget and skills of the regulator in assessing the gains and risks to innovation, the private rents that accrue to innovators, and the number of FinTechs with access to new technology. Multiple equilibria arise from the complementarity between regulatory preparedness/competence and investments into innovation, adding extrinsic risks to the regulation-innovation game. Among several policy implications, our theory shows that ample regulatory budgets prompt FinTechs to innovate more.

Keywords: Extrinsic Risk, Financial Innovation, Regulation, Incomplete Information