Sunday , November 29 2020
Home / Bank of International Settlement / Inside the regulatory sandbox: effects on fintech funding

Inside the regulatory sandbox: effects on fintech funding

Summary:
BIS Working Papers  |  No 901  |  09 November 2020 by  Giulio Cornelli, Sebastian Doerr, Leonardo Gambacorta and Ouarda Merrouche PDF full text (484kb)  |  42 pages Summary Focus The rise of fintechs promises to spur competition in the financial sector. This could lead to sizeable efficiency gains, more choice for consumers, and enhanced financial inclusion. However, the potentially disruptive growth of firms offering novel products and services poses new challenges for financial stability and consumer protection. In response, policymakers around the world are creating "regulatory sandboxes" to

Topics:
International Settlement considers the following as important:

This could be interesting, too:

International Settlement writes Capital flows, exchange rates and policy frameworks in emerging Asia

Amol Agrawal writes Fischer Black Prize 2021 awarded to Matteo Maggiori

Bank of Japan writes Monthly Schedule of Outright Purchases of Japanese Government Bonds (Competitive Auction Method) (December 2020)

Bank of Japan writes Schedules of Outright Purchases of CP and Corporate Bonds (December 2020-January 2021)

BIS Working Papers  |  No 901  | 
09 November 2020
PDF full text
 (484kb)
 |  42 pages

Summary

Focus

The rise of fintechs promises to spur competition in the financial sector. This could lead to sizeable efficiency gains, more choice for consumers, and enhanced financial inclusion. However, the potentially disruptive growth of firms offering novel products and services poses new challenges for financial stability and consumer protection. In response, policymakers around the world are creating "regulatory sandboxes" to foster innovation in the financial sector while keeping alert to emerging risks. One key objective of sandboxes is to facilitate start-ups' access to capital. The UK Financial Conduct Authority pioneered the world's first regulatory sandbox in 2015. To date, more than 50 countries have adopted sandboxes, but little evidence exists on whether they actually help innovative fintechs raise funding. And if so, why/how.

Contribution

This paper analyses how entering the United Kingdom's regulatory sandbox affects fintechs' ability to raise funding. We collect unique data on capital raised by UK fintechs between 2014 and 2019. Our sample covers fintechs that joined the sandbox, as well as a large group of comparable control firms that did not join the sandbox. Further, detailed data broken down by individual investor, as well as background information on firm characteristics, allow us to investigate different channels through which the entry in the sandbox could affect firms' access to capital. Our paper contributes to the current debate on public policies to foster innovation and competition in the financial sector. Sandboxes could provide regulators with an effective tool to gauge the various implications of innovations at an early stage of their development. An assessment of their effectiveness and an understanding of the channels through which sandboxes operate is hence indispensable.

Findings

Entry into the sandbox is associated with a higher probability of raising funding and an increase of about 15% in the average amount of funding raised. Our evidence suggests that regulatory sandboxes improve access to funding by reducing information asymmetries and regulatory costs for three reasons. First, the positive effect of sandbox entry on capital raised is particularly pronounced for smaller and younger firms, which are usually subject to more severe informational frictions. Second, sandbox entry is followed by an increase in first-time investors and in the share of investors that are based outside the United Kingdom. These investors are likely to face greater information asymmetries due to either geographical distance or a lack of previous relationships. Finally, we find that firms with a CEO who has a personal background in financial law benefit less from sandbox entry. This is in line with anecdotal evidence that CEOs without prior experience in financial regulation benefit more from the guidance provided by case officers during the process of obtaining authorisation.


Abstract

Policymakers around the world are adopting regulatory sandboxes as a tool for spurring innovation in the financial sector while keeping alert to emerging risks. Using unique data for the UK, this paper provides initial evidence on the effectiveness of the world's first sandbox in improving fintechs' access to finance. Firms entering the sandbox see a significant increase of 15% in capital raised post-entry, relative to firms that did not enter; and their probability of raising capital increases by 50%. Our results furthermore suggest that the sandbox facilitates access to capital through two channels: reduced asymmetric information and reduced regulatory costs or uncertainty. Our results are confirmed when we exploit the staggered introduction of the sandbox and compare firms in earlier to those in later sandbox cohorts, and when we compare participating firms to a matched set of firms that never enters the sandbox.

JEL classification: G32, G38, M13, O3

Keywords: fintech, regulatory sandbox, startups, venture capital.

International Settlement
The Bank for International Settlements (BIS) is an international company limited by shares owned by central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work through subcommittees, the secretariats it hosts and through an annual general meeting of all member banks. It also provides banking services, but only to central banks and other international organizations. It is based in Basel, Switzerland, with representative offices in Hong Kong and Mexico City.

Leave a Reply

Your email address will not be published. Required fields are marked *