FinTech in Latvia: Status Quo, Current Developments, and Challenges Ahead

Ramona Rupeika-Apoga; Stefan Wendt

doi:10.3390/risks9100181

Rupeika-Apoga, Ramona;Wendt, Stefan

2021-10-14 00:00:00

risks Article FinTech in Latvia: Status Quo, Current Developments, and Challenges Ahead 1 , 2 Ramona Rupeika-Apoga * and Stefan Wendt Faculty of Business, Management and Economics, University of Latvia, LV-1586 R¯ ıga, Latvia Bifröst University, 311 Bifröst, Iceland; stefanwendt@bifrost.is * Correspondence: rr@lu.lv Abstract: FinTech has been in the focus of discussion for quite some time. However, the market share of FinTech companies is still relatively small compared to that of more traditional ﬁnancial services. The purpose of this paper is to analyse the status quo, current developments, and challenges ahead for the Latvian FinTech sector. We combine three analyses: a political and legal, economic, social, and technological environment (PEST) analysis; a survey among FinTech companies; and an analysis of the size and ﬁnancial performance of FinTech companies during the last 10 years. We ﬁnd that the current status of regulation is one of the main obstacles to FinTech development, because it does not sufﬁciently consider FinTech-speciﬁc aspects. Problems in attracting a skilled workforce and an environment that is not very supportive of new developments in ﬁnance are further challenges and might explain at least part of the growth and ﬁnancial performance difﬁculties. A revision, modernization, and harmonization of regulation is essential to create a level playing ﬁeld for all market participants: FinTech companies, traditional ﬁnancial service providers, and those originally traditional players that are integrating FinTech solutions in their business model. Further efforts are also required to foster Latvia’s attractiveness for a skilled workforce. We hope that this study helps increase the visibility of Latvian FinTech and contributes to the development of the new Latvian Citation: Rupeika-Apoga, Ramona, FinTech strategy. and Stefan Wendt. 2021. FinTech in Latvia: Status Quo, Current Keywords: FinTech; ﬁnancial markets; PEST analysis; survey analysis Developments, and Challenges Ahead. Risks 9: 181. https:// doi.org/10.3390/risks9100181 1. Introduction Academic Editor: Mogens Steffensen FinTech has been in the focus of the discussion in the ﬁnancial industry, in politics Received: 30 July 2021 and regulation and in academic research for quite some time. However, even though Accepted: 9 October 2021 FinTech has often been labelled a disruption to the ﬁnancial industry (Gomber et al. 2018; Published: 14 October 2021 Laidroo et al. 2021a), the market share of FinTech companies is still relatively small in most areas compared to more traditional ﬁnancial services (IMF 2019). Deﬁnitions of FinTech Publisher’s Note: MDPI stays neutral cover both the application of new technologies to ﬁnancial services and corresponding with regard to jurisdictional claims in new business models, processes, and products. According to OECD (2018), “FinTech published maps and institutional afﬁl- involves not only the application of new digital technologies to ﬁnancial services but also iations. the development of business models and products which rely on these technologies and more generally on digital platforms and processes”. Similarly, the Financial Stability Financial Stability Board (2019) deﬁnes FinTech as “technology-enabled innovation in ﬁnancial services that could result in new business models, applications, processes or Copyright: © 2021 by the authors. products with an associated material effect on the provision of ﬁnancial services”. Licensee MDPI, Basel, Switzerland. For our study of FinTech companies in Latvia, we use the deﬁnition provided by the This article is an open access article Bank of Latvia in line with the deﬁnitions by the OECD and the Financial Stability Board: a distributed under the terms and FinTech company is “a company which develops and uses new and innovative technologies conditions of the Creative Commons in the area of ﬁnancial services. This leads to the development of new ﬁnancial products Attribution (CC BY) license (https:// and services or a signiﬁcant improvement of the existing ones” (Bank of Latvia 2020). This creativecommons.org/licenses/by/ deﬁnition also reﬂects the EU Parliament’s deﬁnition, according to which FinTech should 4.0/). Risks 2021, 9, 181. https://doi.org/10.3390/risks9100181 https://www.mdpi.com/journal/risks Risks 2021, 9, 181 2 of 23 be understood “as ﬁnance enabled by or provided via new technologies, covering the whole range of ﬁnancial services, products and infrastructure” (The European Parliament 2017). FinTech companies in Latvia provide services that are complementary to traditional ﬁnancial services, but also services that represent (potential) substitutes for services cov- ered by traditional ﬁnancial service providers. Therefore, the development of FinTech increases competition in markets for ﬁnancial services. It is worth mentioning, though, that FinTech development is not limited to pure FinTech companies. Traditional ﬁnancial service providers have also made increasing efforts to integrate FinTech solutions into their business models, which means that it is not fully possible to consider FinTech completely separately from more traditional ﬁnancial service providers. The success of FinTech development depends on, e.g., access to ﬁnance and human resources and the attitude of regulators, in particular with regard to openness to inno- vation and ﬂexibility (Rupeika-Apoga and Thalassinos 2020). Additionally, the risks for potential and actual clients (Horn et al. 2020) and trust in ﬁnancial services play important roles (Oehler and Wendt 2018). In Latvia, FinTech development meets well developed ﬁnancial market infrastructure as well as a highly skilled workforce with relatively high entrepreneurial ability. Additionally, Latvia is internationally highly ranked in the context of the information and communications technology (ICT) development, showing strong positions in Internet subscriptions, electricity access, and supply quality, and the percent- age of Internet users among the adult population (World Economic Forum 2019, 2020). Depending on their speciﬁc activities, FinTech companies are regulated and monitored by the Latvian Financial and Capital Market Commission (FCMC 2021a), the Consumer Protection Center (CRPC), or the State Revenue Service. FinTech-speciﬁc legislation is not existent in Latvia, though. Additionally, Latvia has a much more detailed and rigorous approach to customer due diligence than other countries (Saksonova and Koleda 2017), which affects FinTech companies as customers of Latvian banks, and in cases where FinTech companies want to obtain an FCMC license to provide their service. Despite the publication of some market factsheets, e.g., by the commercial bank Swedbank (Swedbank 2020) and Fintech News Baltic blogs (FinTech Baltic 2020), a compre- hensive understanding of the main drivers of the development of FinTech companies in Latvia has not yet been achieved. The purpose of this study is to add to this understanding, to shed light on the status quo, current developments, and challenges ahead for the Latvian FinTech sector, and to develop suggestions on how to foster FinTech development in Latvia. To achieve the purpose of this study, we combine three analyses: ﬁrst, we perform an analysis of the political and legal, economic, social, and technological environment (PEST analysis) that FinTech companies are facing in Latvia. Second, we analyse these companies’ responses to a survey with particular emphasis on their own assessment of current and potential future developments. Third, we analyse the size and ﬁnancial performance of FinTech companies in Latvia during the last 10 years. Our contribution to the academic literature and the public and political debate is four-fold. First, with its focus on the environment Latvian FinTech companies are facing, their own assessment of various drivers and obstacles of FinTech development, and their actual size and ﬁnancial performance, we substantially contribute to a comprehensive understanding of the complex topic of FinTech development in Latvia. Improving such an understanding will also help raise awareness for FinTech in Latvia. Second, based on the results of our analyses, we discuss suggestions on how to support FinTech development in Latvia. These suggestions might be of particular interest for FinTech companies, for traditional ﬁnancial service providers, and for policy makers and regulators. Third, the current research assists in the development of the new Latvian FinTech strategy by providing ﬁndings based on the results of the FinTech Survey. This paper helps policymakers to understand the main obstacles and challenges in the development of the FinTech market. The new policy is expected to be ﬁnalised by 31 October 2021. Risks 2021, 9, 181 3 of 23 Fourth, the ﬁndings of this study also provide implications beyond Latvia. Latvia is a small country with a small market, which might not necessarily appear of particular importance on a global scale or when it comes to international comparison in the con- text of FinTech. However, when it comes to FinTech, the small size of a country is not necessarily a disadvantage. As part of the Global Fintech Index City Rankings report 2020, Findexable (2019) ranks Latvia’s immediate neighbours Lithuania and Estonia fourth and tenth, respectively, in its global FinTech country rankings. According to the Fintech News Network, Latvia, Zimbabwe, and Israel have witnessed the highest surge in FinTech interest worldwide in 2021 (FinTech Baltic 2021). Hence, our ﬁndings for Latvia can also be relevant to other small countries, such as Lithuania, Estonia, Malta, Belarus, Gibraltar, and others. We ﬁnd that the current status of regulation is one of the main obstacles to FinTech development. This is reﬂected in both the PEST analysis and the responses to the survey. The regulation currently does not sufﬁciently consider FinTech-speciﬁc aspects. A revision, modernization, and harmonization of regulation in particular across different categories of ﬁnancial services, across different types of companies/institutions providing these services, irrespective of a higher or lower degree of involvement of new technologies, and internationally would truly provide a level playing ﬁeld for all market participants: FinTech companies, traditional ﬁnancial service providers, and those originally traditional players that are integrating FinTech solutions in their business model. Comprehensive regulation would also correspond to our ﬁnding that FinTech companies see themselves less in a disruptive role, but they emphasise partnership with traditional banks and that traditional ﬁnancial service providers will integrate new technology. The size and ﬁnancial performance of FinTech companies in Latvia during the last ten years indicates some difﬁculties when it comes to growth and when it comes to establishing and maintaining business models that are ﬁnancially sustainable. Problems in attracting a skilled workforce and an environment that is not very supportive of new developments in ﬁnance are further challenges and might explain at least part of the growth and ﬁnancial performance difﬁculties. Hence, further efforts are required to foster Latvia’s attractiveness for a skilled workforce. The structure of this paper is as follows. The next section, Section 2, focuses on the data and methodology. Section 3 uses a PEST analysis framework to investigate the environment that the Latvian FinTech companies are facing. Section 4 presents and discusses these companies’ responses to a survey with particular emphasis on their own assessment of current and potential future developments. Subsequently, Section 5 provides an overview of the ﬁnancial performance of a number of FinTech companies in Latvia during the last 10 years. Section 6 discusses the ﬁndings and concludes. 2. Data and Methodology The PEST analysis uses desk research methodology, also including the analysis of corresponding regulation. To identify potential survey participants and to be able to analyse size and ﬁnancial performance, we needed to identify FinTech companies that are registered in Latvia, because there is no ofﬁcial list of such companies. Neither the Latvian central bank, nor the FCMC, nor the Ministries of Finance and Economics provide a list of FinTech companies. The only available FinTech landscapes are provided by FinTech FinTech Baltic (2020) and Swedbank (2020). The Fintech Latvia Startup Map 2020 consists of 50 FinTech startups (FinTech Baltic 2020). According to the Latvian FinTech Report 2020 prepared by Swedbank in cooperation with Startin, however, the number of FinTech companies in 2019 was 75, and in 2020, it reached 91 (Swedbank 2020). Difﬁculties in classifying FinTech companies relate to the emergence of new business models, which make it difﬁcult to gather a comprehensive list. While we use the deﬁnition of FinTech provided by the Bank of Latvia, this deﬁnition also captures traditional ﬁnancial service providers using new and innovative technologies. To help identify FinTech compa- Risks 2021, 9, 181 4 of 23 nies, a company’s business model and operations must reﬂect the deﬁnition and fall into at least one of the following seven areas: Analytics—data mining, data (business) analytics, big data analysis, machine learn- ing, artiﬁcial intelligence used for automated advice, chatbots, customer relations management, and data handling. Banking infrastructure—user interface, processing enhancement, technology infras- tructure, various trading platforms, and software companies with a focus on the ﬁnancial sector. Deposit and Lending—crowd investing, crowdlending, invoice trading, and other lending forms such as payday loans. Distributed Ledger Technology—cryptocurrency and everything encompassing blockchain technology, even from companies that are payment or crowdfunding companies at the same time. Insurance—insurance-related products and services and InsurTech. Payments—mobile payments, online payments, money transfers, and anything related to payments. Investment management—online investment processes based on algorithms and models, robo-advisors, and social trading. This classiﬁcation is similar to the one used in the IFZ FinTech Study 2018 (Ankenbrand et al. 2019) and the FinTech Report Estonia 2019 (Tirmaste et al. 2019). To ﬁnd companies to be included in our analysis, we identiﬁed companies listed as FinTech companies in the Crunchbase, a platform for ﬁnding business information about private and public companies (Crunchbase 2020) and checked whether these companies fell under our deﬁnition. Then, we added FinTech companies found from other data sources: Key Capital for Latvia (Key Capital 2020), Alternative Financial Services Association of Latvia (The Alternative Financial Services Association of Latvia 2021), and Investment and Development Agency of Latvia (Investment and Development Agency of Latvia 2020). Additionally, the list of FinTech companies was cross-checked against the Register of Enterprises of the Republic of Latvia to ensure that only FinTech companies incorporated in Latvia are considered. This differs from the FinTech lists provided by FinTech Baltic and SwedBank, as they also include companies registered in other countries but operating in Latvia. In 2019, we identiﬁed 66 companies that meet our criteria. However, during the preparation of the paper, some companies were dissolved due to mergers or acquisitions, changed countries of registration, or were in the liquidation process. As a result, 56 compa- nies were selected for inclusion in the dataset. As the deﬁnition of FinTech is controversial, and as the FinTech sector is rapidly evolving, we understand that our dataset can never be complete. The survey questions were mainly based on the IFZ FinTech Study 2019 questionnaire (Ankenbrand et al. 2019) and the FinTech Report Estonia 2019 (Tirmaste et al. 2019) and were modiﬁed to assess the development of Latvian FinTech companies. The survey starts with general questions about the company, such as business model (B2B vs. B2C) and ﬁelds of activity, and questions on ﬁelds of activity, revenue model, and on some details of the operations. Then, the survey asks participants to rate a number of problem areas, such as competition, access to ﬁnance, and regulation, on how pressing they are on a scale from 1 (not pressing) to 10 (extremely pressing). The ﬁnal section of the survey includes questions on the current and expected future relationship between FinTech and traditional banking and between FinTech and the Latvian state, on the main triggers of FinTech development and the role of regulation. Most of the questions in this section of the survey were open-ended questions; for a few questions, some predeﬁned response items were included but were always accompanied by an open-ended response option. The results section will provide more details on the response items. The survey was conducted as an online survey in the summer of 2019. Links to the online questionnaire (on Google docs) were sent via email to the 56 companies identiﬁed as FinTech companies. Corresponding email addresses were determined based on data Risks 2021, 9, 181 5 of 23 presented in local business registries or companies’ webpages or found through personal contacts. If possible, the email was targeted directly to the company’s owners, board mem- bers, or executives (e.g., CEO, CFO). In the remaining cases, it was sent to the company’s general email address. The ﬁrst email was followed by two to three reminders. In some cases, follow-up phone calls and instant messaging through social media were also used to increase the response rate. Local institutions helped also by spreading the word about the survey, and news sites were used for the same purpose. We received a total of 21 responses, which corresponds to a response rate of 37.5 percent, but it also means that 62.5 percent did not respond. Even though the number of responses does not allow detailed statistical analysis, the response rate can be considered satisfactory for this type of survey (Hoque 2004; Olson and Slater 2002; Rikhardsson et al. 2020). In addition, and to examine the latest trends in the development of FinTech companies in Latvia, we collected size and ﬁnancial performance measures for the FinTech companies that responded to the survey from Bureau van Dijk’s Orbis database (Bureau van Dijk 2021) for the period from 2010 to 2019. As size measures, we include the number of employees, turnover, and total assets; as ﬁnancial performance measures, we include return on equity (RoE) and proﬁt margin. Given the low number of companies, we abstain from detailed statistical analysis but provide corresponding descriptive statistics instead. Even though using data for these companies instead of all FinTech companies in Latvia might bias our results to some degree, using the smaller sample of companies that responded to the survey allows us to discuss the size and ﬁnancial performance development and the responses to the survey jointly. Another challenge is the increasing number of FinTech companies over time. This means that we do not have data for all companies across the entire period from 2010 to 2019. Additionally, in very few cases, data points are missing. This means that results from comparing between years need to be interpreted with caution, in particular because new market entries are typically smaller than already established companies. 3. The Latvian FinTech Environment To provide a thorough overview of the Latvian FinTech environment, we analyse the political and legal, economic, social, and technological environment (PEST analysis) (Sammut-Bonnici and Galea 2015). This analysis of the environment FinTech companies are facing in Latvia is essential to be able to understand the status and development of FinTech in Latvia. The analysis of the political and legal environment is of importance due to increased competition between cities and, in particular, countries to become FinTech centres or hubs. Taking into account the experience of other countries, regulation can be an effective tool in stimulating innovation and economic development. Differences in the legal environment can lead to regulatory arbitrage between different jurisdictions (Rupeika-Apoga and Tha- lassinos 2020). Combining this thought with differences in political support or goodwill can even lead to regulatory/politically induced arbitrage within the same jurisdiction between cities or regions with different political situations (Ito et al. 2020). Eventually, this can trigger a race to the bottom between jurisdictions in deregulating the legal environ- ment and/or an escalation in political and potential ﬁnancial support to attract or keep FinTech companies. This becomes even more interesting when considering that relatively similar business models might be categorized quite differently depending on whether corresponding products and services are offered by traditional ﬁnancial intermediaries or by FinTech companies and even depending on different types of FinTech companies (Tirmaste et al. 2019). The economic environment refers to external economic factors that affect the economy, e.g., purchasing habits of consumers/customers and businesses, and therefore affect aspects such as actual and potential market size and development, entrepreneurial activity, and performance of FinTech companies. Customer purchasing power, taxes, unemployment, and many other economic factors can promote or hinder the development of FinTech Risks 2021, 9, 181 6 of 23 companies (Filimonova et al. 2020). The PEST analysis helps us assess how favourable the economic environment is in Latvia compared to neighbouring countries and Europe. FinTech companies, as with any other company, operate in a society, while each society constructs its own social environment. The main factors affecting the social environment, and hence, FinTech companies also include, e.g., the educational system and literacy level, attitudes towards innovative products, lifestyle, occupational distribution and consumer preferences, labour force expectations, consumption habits, and social inequality (Kluza et al. 2021). FinTech companies must be aware of the social preferences of society in relation to its needs and desires, and they must adapt to the social environment in which they operate in order to be competitive. The technological environment includes forces associated with scientiﬁc improvement and innovation that provide new ways of producing goods and services, as well as new methods and techniques for conducting business (Saksonova 2014). FinTech is inherently connected with technological development. In order to study the current situation and development of the Latvian FinTech sector, it is necessary to analyse aspects such as the pace of technological progress and institutional mechanisms for the development and application of new technologies, to name a few. 3.1. Political and Legal Environment 3.1.1. EU Regulatory Framework As Latvia has been a member of the European Union (EU) since 2004, EU regulation provides the main regulatory framework. In 2018, the European Commission adopted the FinTech action plan for the development of a more competitive and innovative ﬁnancial sector in Europe with the main purpose of increasing supervisory convergence toward technological innovation and to allow the EU ﬁnancial sector to beneﬁt from new technolo- gies (The European Commission 2018). Not only is the purpose to build a capital markets union but also a digital single market for consumer ﬁnancial services in order to allow innovative products and solutions to spread quickly across the EU. One of the purposes is to prevent regulatory arbitrage between the legal statuses, legislation, and supervision in the member states. EU regulation focuses on the application of the same rules to the same services and the same risks regardless of the type of legal entity concerned or its location in the Union, technology neutrality and a risk-based approach, taking into account the proportionality of legislative and supervisory actions to risks and materiality of risks (The European Parliament 2017). Latvia has implemented European regulation on a number of aspects that also relate to FinTech. Implemented directives include the Payment Services Directive (PSD2) (The European Parliament and of the Council 2015), the Directive on the prevention of the use of the ﬁnancial system for the purposes of a Money Laundering and Terrorist Financing (AMLD5) (The European Parliament and of the Council 2018), the Markets in Financial Instruments Directive (MiFID-2) (The European Parliament and of the Council 2014), Near- Field Communication (NFC) (European Union 2009), and the Investment Firms Directive ((EU) 2019/2034) (IFD)) and the Investment Firms Regulation ((EU) 2019/2033)) (IFR) (The European Parliament and of the Council 2019b); the new Prospectus Regulation (Commission Delegated Regulation (EU) 2019/980) regarding the format, content, scrutiny, and approval of prospectuses has been published in the Ofﬁcial Journal (The European Commission 2019). However, Latvia’s more detailed and rigorous approach to customer due diligence than other countries and higher compliance cost create challenges for FinTech companies as customers of Latvian banks and when obtaining an FCMC license. In addition, in November 2021, a new regulation on European providers of crowdfund- ing services for businesses will enter into force. This regulation is part of the Commission’s FinTech action plan with the aim of introducing a uniﬁed system across all EU mem- ber states to facilitate the provision of cross-border co-ﬁnancing services (The European Parliament and of the Council 2020). Risks 2021, 9, 181 7 of 23 3.1.2. Latvian Regulatory Framework As there is no speciﬁc legislative framework for FinTech companies in Latvia, they have to obtain licenses that match their business models if they require licensing, such as deposit-taking, investment management, capital raising, issue of ﬁnancial instruments, pro- vision of payment or electronic money services, insurance, or provision of consumer credit services. The FCMC or the CRPC regulate and supervise FinTech companies, depending on their ﬁnancial services. The main supervisor is FCMC, while CRPC is responsible for, e.g., consumer protection, market surveillance, and the safety of products and services. The main market participants are credit institutions, credit unions, investment man- agement companies, investment brokerage ﬁrms, alternative investment fund managers, insurance companies, payment institutions, private pension funds , and electronic money institutions. All institutions are subject to national laws and regulations, including the licensing process. There is a broad variety of rules and regulations, which means that ﬁnan- cial institutions are regulated very differently depending on the segment of the ﬁnancial sector they are active in. Hence, the following overview cannot provide a complete picture of corresponding regulations but is intended to provide a brief idea of the regulatory framework. Credit institutions and credit unions (ﬁnancial cooperatives) need to submit to the FCMC (The Financial and Capital Market Commission 2002) the corresponding application and documents to receive an operating licence (permit). The minimum initial capital for a credit institution is ﬁve million euros, while for credit unions, the minimum initial capital is 2500 euros, and the decision to issue a licence is adopted by the European Central Bank based on a draft proposal by FCMC. Regulation that applies to credit institutions includes, e.g., the Deposit Guarantee Law (The Parliament of the Republic of Latvia 2015a) and the Law on the Recovery and Resolution of Credit Institutions and Investment Firms (The Parliament of the Republic of Latvia 2017). Credit Unions are regulated by the Credit Union Law (The Parliament of the Republic of Latvia 2001a) and the Regulations on the State Fee for the Issue of a Special Permit (Licence) for Individual Types of Entrepreneurial Activity (Cabinet of Ministers 2011). FinTech companies that are only interested in offering consumer lending services are regulated by the Consumer Protection Act (The Parliament of the Republic of Latvia 1999) and monitored by the CRPC. These companies do not need a licence as a credit institution but should obtain a license from the CRPC, and their initial capital must be at least EUR 425,000. Investment-related services are provided by investment management companies, in- vestment brokerage ﬁrms (investment ﬁrms), and by alternative investment fund managers. Corresponding regulation includes, for investment management companies, e.g., the Law on the Investment Management Companies (The Parliament of the Republic of Latvia 1997), the Commercial Law (The Parliament of the Republic of Latvia 2000), and the Investor Protection Law (The Parliament of the Republic of Latvia 2001b). For investment ﬁrms, which provide investment and ancillary (non-core) services, such as brokerage, investment advice, portfolio management, and custody services, regulation includes, e.g., the Law on the Financial Instruments Market (The Parliament of the Republic of Latvia 2003) and the regulatory enactments of the FCMC, and potentially, regulation by the Latvian Central Depository. For alternative investment fund managers, the Law on Alternative Investment Funds and their Managers (The Parliament of the Republic of Latvia 2013), the FCMC normative acts, EU Regulations, the Commercial Law, and other regulatory enactments apply. An alternative investment fund manager can commence its activities after its regis- tration with the FCMC (registered manager) or after the receipt of the corresponding license (licensed manager). Additionally, investment management companies and investment ﬁrms must apply for a licence from the FCMC. The minimum initial capital shall be EUR 125,000 for investment management companies. On 26 June 2021, most investment ﬁrms became subject to a new prudential framework, composed of Regulation (EU) 2019/2033 (The European Parliament and of the Council 2019c) and Directive (EU) 2019/2034 (The European Parliament and of the Council 2019a). A permanent minimum capital require- Risks 2021, 9, 181 8 of 23 ment set in the regulation is EUR 75,000, EUR 150,000, or EUR 750,000, depending on the activities of the investment ﬁrm. Insurance companies are regulated under the Law on Insurance and Reinsurance (The Parliament of the Republic of Latvia 2015b), the Compulsory Civil Liability Insurance of Owners of Motor Vehicles Law (The Parliament of the Republic of Latvia 2004), the Insurance Contract Law (The Parliament of the Republic of Latvia 2018), the Insurance and Reinsurance Distribution Law (The Parliament of the Republic of Latvia 2019), and the Law on Insurance and Reinsurance. If they intend to offer particular insurance classes (motor vehicle third-party liability insurance, aircraft or ship ownership liability insurance, general liability insurance, credit insurance, suretyship insurance, or life assurance), a minimum initial capital of EUR 3.7 million applies, in other cases, a minimum initial capital of EUR 2.5 million applies. Institutions that offer payment services as speciﬁed in Article 1 (1) of the Law on Payment Services and Electronic Money (The Parliament of the Republic of Latvia 2010) need a licence from the FCMC. If a natural or legal person wishes to offer payment services but is not required to obtain a licence as a payment institution, it needs to be registered at the FCMC. The initial capital of a licensed payment institution must be at least EUR 20,000 if it provides only money remittance services, EUR 50,000 if it provides only the payment initiation services, and EUR 125,000 if it provides any of the payment services referred to in the above-mentioned Article 1 (1), Subparagraphs a, b, c, d, or e. No initial capital is required if it only provides an account information service. However, a payment institution that provides an account information service and/or a payment initiation service needs to have its professional civil liability insurance. Additionally, ﬁnancial allowances for persons intending to provide only an innovative payment service, which requires the authorisation of a payment institution or electronic money institution, are described in the Law on Payment Services and Electronic Money. Institutions that wish to issue electronic money need a licence from FCMC or—if they do not need a licence—need to be registered at the FCMC. These institutions are entitled to provide payment services in accordance with the Law on Payment Services and Electronic Money. The initial capital of a licensed electronic money institution shall be at least EUR 350,000, also in the case that it additionally offers payment services (The Parliament of the Republic of Latvia 2010). Even though some other services provided by FinTech companies might currently not need a licence from FCMC or CRPC, the regulatory framework for such innovative activities is evolving. Investment platforms, for example, need to obtain a licence from FCMC during the transition period. The State Revenue Service monitors cryptocurrency- related activities. Similar to regulators in other countries, the FCMC has launched a regulatory innovative sandbox and hub to allow testing of innovative ﬁnancial services, such as a new or substantially improved electronic payment or electronic money services. The intention behind such a testing opportunity is to reveal whether or not the innovative ﬁnancial service leads to one or more of the following improvements (FCMC 2021b): increased competition, i.e., is the innovative ﬁnancial service more advantageous, less costly and easier to use than traditional services; potential response from traditional market participants, either by improving their service or by adopting the innovative business model; access for consumers and non-professional customers to market segments that have traditionally not been available to them. 3.2. Economic Environment One of the preconditions for vibrant FinTech development is a well-developed eco- nomic environment. Since the general economic environment in a country, such as eco- nomic growth, economic policy, tax rates, ease of conducting business, and costs, affects FinTech businesses, FinTech companies—due to their high degree of international mobility— are typically located where the economic environment best meets their business needs. Risks 2021, 9, 181 9 of 23 Low tax rates and local monetary policy (currency stability, interest rates) are typically considered as the most important factors. According to a Global Financial Centres Index (GFCI) survey, the most important elements of a competitive environment for FinTech providers include the availability of skilled professionals and access to ﬁnance combined with big data analytics and cyber- security as most important applications (Yeandle and Mainelli 2015). With regard to the level of development of the ﬁnancial market infrastructure, there is a need for an efﬁcient trading system and a variety of tradable ﬁnancial instruments, such as stocks, bonds, and derivatives. Well-developed ﬁnancial markets allow ﬁnancing via traditional channels, such as stock exchanges or banks, or via alternative channels, such as crowdfunding, venture capital, or business angels. The efﬁciency of the payment system, its speed, and its security, also play important roles (Rupeika-Apoga and Nedovis 2016). The World Bank World Bank Group’s (2020) Doing Business Report ranks Latvia 19th among the 190 countries covered by the report (World Bank Group 2020). While that report draws a relatively positive picture for the overall business environment, the Global Financial Centres Index (GFCI) ranks the Latvian capital Riga in March 2020 only 70th out of 108 cities. While this rank is nearly the same as in 2016, when Riga ranked 71st, the city had climbed to rank 45 in the meantime and outperformed centres such as Stockholm (46th), Liechtenstein (48th), and Copenhagen (52nd) (Long Finance and Financial Centre Futures 2020; Solovjova et al. 2018). However, Riga could not maintain this position, mainly due to the major scandals related to the anti-money laundry (AML) processes, involving several Latvian banks. On the Global Entrepreneurship Index, which measures the quality and dynamics of entrepreneurship ecosystems, Latvia ranked 45th out of 137 countries in 2019, which is lower than Latvia’s neighbours Estonia (22nd) and Lithuania (37th). In the different subcate- gories, Latvia’s rank ranged from 38th for entrepreneurial ability to 51st for entrepreneurial aspiration (Ács et al. 2019) In the Findexable (2019) Global FinTech Index City Rankings 2020, Latvia ranks 49th out of 65 countries, with Riga ranking 34th among 50 leading European cities and 96th among 238 cities worldwide. Again, Latvia is outperformed by Lithuania (4th rank) and Estonia (10th rank) (Findexable 2019). 3.3. Social Environment One of the main sources of FinTech competitiveness and development is a skilled and educated workforce (Rupeika-Apoga and Saksonova 2018). This relates to the local professional workforce, representing the majority of the workforce, and to a smaller number of international professionals, who follow and develop their business moving from country to country, as well as to the relationship between these two groups. FinTech development requires a highly skilled international workforce with deep and extensive knowledge and experience in ﬁnancial and technology services. A large number of highly qualiﬁed potential local employees as result of, e.g., strong education policies combined with ﬂexible labour legislation would allow companies to recruit and expand according to business needs. Attracting international professionals requires open and ﬂexible immigration policies. The IMD World Talent Ranking (Institute for Management Development 2019), which evaluates the extent to which economies develop, attract, and retain highly skilled pro- fessionals, ranks Latvia 12th in investment and development, 48th in appeal and 41st in readiness, resulting in an overall rank of 34th out of 63 countries. Latvia ranks particularly well when it comes to female labour force (2nd), government expenditure on education per student (7th), and pupil–teacher ratio in secondary education (9th). However, brain drain (50th), remuneration in services professions (51st), and effective personal income tax rate (47th) represent main obstacles. In 2019, the Global Competitiveness Report (World Economic Forum 2019) ranked Latvia 22nd regarding skills, but only 100th out of 141 countries regarding ease of ﬁnding a Risks 2021, 9, 181 10 of 23 skilled workforce. Overall, Latvia ranks 28th regarding the labour market, with favourable conditions in wage ﬂexibility (10th) and workers’ rights (26th), but low scores in ease of hiring foreign labour (113th) and labour tax rate (114th). Further, the Europe 2020 Competitiveness Report (World Economic Forum 2020) ranks Latvia 5th in labour market and employment but only 22nd in education and training and 25th in social inclusion. 3.4. Technological Environment The World Economic World Economic Forum (2019) ranks Latvia 15th out of 141 coun- tries when it comes to information and communication technology (ICT) adoption, with a particularly strong position in mobile-broadband and ﬁbre internet subscriptions (12th), even though Latvia only ranks 32nd regarding Internet users within the adult population. Moreover, electricity access is excellent (2nd), while electricity supply quality (34th) and digital skills among the active population (39th) still need improvement (World Economic Forum 2019). However, out of 27 European countries, Latvia ranks only 20th in digital agenda and 24th in Innovative Europe index, signiﬁcantly lagging behind its neighbours Estonia (5th in digital agenda and 12th in Innovative Europe), and Lithuania (11th in digital agenda and 21st in Innovative Europe) according to the Europe 2020 Competitiveness Report (World Economic Forum 2020). 4. Survey Results This section presents the main ﬁndings of the survey. We start with a general portrait of the responding FinTech companies and then link the survey to the PEST factors (political and legal, economic, social and technological environment). 4.1. General Portrait of the Responding FinTech Companies Risks 2021, 9, x FOR PEER REVIEW 11 of 24 In total, 21 out of 56 FinTech companies responded to the survey. The distribution of the companies by their activity type is presented in Figure 1. 10% 9% 48% 14% 5% 14% Deposit & Lending Investment Management Analytics Payments Banking infrastructure Distributed Ledger Technology Figure 1. Breakdown of the responding FinTech companies by their field of activity. Figure 1. Breakdown of the responding FinTech companies by their ﬁeld of activity. TTen of the re en of the respondents spondents st stated ated their co their core ﬁeld re field o of activity f activity as dep as deposit and osit and lending, lend thring, ee stated payments, and three stated investment management or investment brokerage. Two three stated payments, and three stated investment management or investment broker- stated distributed ledger technology, one analytics, payments, transaction processing, and age. Two stated distributed ledger technology, one analytics, payments, transaction pro- public ﬁnance management, and two stated analytics and banking infrastructure. This cessing, and public finance management, and two stated analytics and banking infra- means that, even though deposit and lending represents the largest group, the group of structure. This means that, even though deposit and lending represents the largest respondents is quite diverse and includes representatives of most of the essential areas of group, the group of respondents is quite diverse and includes representatives of most of FinTech activity. The attractiveness of deposits and lending as a FinTech business model the essential areas of FinTech activity. The attractiveness of deposits and lending as a can be explained by the fact that Latvians typically borrow during periods when there is FinTech business model can be explained by the fact that Latvians typically borrow dur- an unforeseen need for additional ﬁnancial resources, and most of these borrowers are ing periods when there is an unforeseen need for additional financial resources, and young people (Rupeika-Apoga and Saksonova 2018). This group of customers might not most of these borrowers are young people (Rupeika-Apoga and Saksonova 2018). This group of customers might not be particularly appealing for traditional banks, which largely leave this part of the market to FinTech companies. Most of the respondents follow the B2C business model providing their services to individual clients (81%), focusing on both the Latvian market and international clients. About one-fourth of the FinTech companies work with both individual clients and other businesses. Even though the FinTech companies see the greatest business potential in the Baltic and Scandinavian markets, the geographical distribution of their activities in- cludes the EU countries, the Americas, as well as the countries of the Commonwealth of Independent States, Australia and New Zealand. So far, only a few companies are active in Asia. The connection between FinTech companies’ main activity and their revenue sources (Laivi Laidroo et al. 2021) is also obvious in our sample (see Figure 2). Since the main activity of the surveyed companies is deposits and lending, their main income comes from commission payments and interest income. Other revenue sources, such as license fees, centralized hosting of business applications, trading income, data, advertis- ing income, or other play a minor role or no role at all. Risks 2021, 9, 181 11 of 23 be particularly appealing for traditional banks, which largely leave this part of the market to FinTech companies. Most of the respondents follow the B2C business model providing their services to Risks 2021, 9, x FOR PEER REVIEW 12 of 24 individual clients (81%), focusing on both the Latvian market and international clients. About one-fourth of the FinTech companies work with both individual clients and other businesses. Even though the FinTech companies see the greatest business potential in the Baltic and Scandinavian markets, the geographical distribution of their activities includes Commission income (from services or the EU countries, the Americas, as well as the countries of the Commonwealth of Inde- 67% products you deliver) pendent States, Australia and New Zealand. So far, only a few companies are active in Asia. Interest income 62% The connection between FinTech companies’ main activity and their revenue sources (Laidr Centralized oo et al. hosting 2021a of bu ) issalso inessobvious application in s our sample (see Figure 2). Since the main activity of 10% (SaaS - software as a service) the surveyed companies is deposits and lending, their main income comes from commission payments and interest income. Other revenue sources, such as license fees, centralized Data (from gathering large amounts of data Risks 2021, 9, x FOR PEER REVIEW 5% 12 of 24 hosting of and/ business or selling an applications, alyzed data) trading income, data, advertising income, or other play a minor role or no role at all. License fee (from a product or software you 5% licence) 0% 10% 20% 30% 40% 50% 60% 70% Commission income (from services or 67% products you deliver) Figure 2. Revenue model (multiple responses allowed). Interest income 62% To finance their activities, FinTech companies primarily depend on their founders Centralized hosting of business applications (16 out of the 21 respondents), followed by crowdfunding (six), venture capital (five), is- 10% (SaaS - software as a service) suing securities (four), and business angels (three). Only two respondents indicate fund- Data (from gathering large amounts of data ing via retained earnings, and two indicate banks as source of funding (see Figure 3). 5% and/or selling analyzed data) License fee (from a product or software you 4.2. Assessment of Development Prospects for FinTech Companies 5% licence) In this section, we investigate the FinTech companies’ responses with regard to the impact of the political and legal, economic, social, and technological environment on 0% 10% 20% 30% 40% 50% 60% 70% their competitiveness and potential future development. This means that the results in Figure 2. this sect ion c Reveo nu mplement e model (m tu hle PE tipleST an response alysi s al s pres lowed) ent . ed in Section 3. Figure 2. Revenue model (multiple responses allowed). With regard to the economic environment, in particular the competitive environ- To ﬁnance their activities, FinTech companies primarily depend on their founders To finance their activities, FinTech companies primarily depend on their founders ment, FinTech companies were asked to name their main competitors. Mostly, they men- (16 out of the 21 respondents), followed by crowdfunding (six), venture capital (ﬁve), (16 out of the 21 respondents), followed by crowdfunding (six), venture capital (five), is- tioned other FinTech companies providing services in the same field, as well as tradi- issuing securities (four), and business angels (three). Only two respondents indicate suing securities (four), and business angels (three). Only two respondents indicate fund- tional service providers such as banks and non-financial sector companies such as IT funding via retained earnings, and two indicate banks as source of funding (see Figure 3). ing via retained earnings, and two indicate banks as source of funding (see Figure 3). companies. 4.2. Assessment of Development Prospects for FinTech Companies Founders In this section, we investigate the FinTech companies’ responses with regard to the impact of the political and legal, economic, social, and technological environment on Crowdfunding their competitiveness and potential future development. This means that the results in Venture Capital this section complement the PEST analysis presented in Section 3. With regard to the economic environment, in particular the competitive environ- Securities ment, FinTech companies were asked to name their main competitors. Mostly, they men- Business Angels tioned other FinTech companies providing services in the same field, as well as tradi- tional service providers sBa uch nk as banks and non-financial sector companies such as IT companies. Retained revenue State-owned development finance… Founders 02468 10 12 14 16 18 Crowdfunding Figure 3. Sources of funding, number of FinTech (multiple responses allowed). Figure 3. Sources of funding, number of FinTech (multiple responses allowed). Venture Capital They were also aSecurities sked to evaluate their situation relative to their competitors based on profit margin, fixed costs to assets, ability to scale, innovativeness, ease of compli- Business Angels ance, and customer costs on a Likert scale from 1 to 7; the anchors of the seven-point Bank scale differ between the items and are further explained below. The responses with re- gard to ease of compliance provide indication of their assessment of the legal and regu- Retained revenue latory framework, profit margin, fixed costs to assets, and customer costs, representing State-owned development finance… 02468 10 12 14 16 18 Figure 3. Sources of funding, number of FinTech (multiple responses allowed). They were also asked to evaluate their situation relative to their competitors based on profit margin, fixed costs to assets, ability to scale, innovativeness, ease of compli- ance, and customer costs on a Likert scale from 1 to 7; the anchors of the seven-point scale differ between the items and are further explained below. The responses with re- gard to ease of compliance provide indication of their assessment of the legal and regu- latory framework, profit margin, fixed costs to assets, and customer costs, representing Risks 2021, 9, 181 12 of 23 4.2. Assessment of Development Prospects for FinTech Companies In this section, we investigate the FinTech companies’ responses with regard to the impact of the political and legal, economic, social, and technological environment on their competitiveness and potential future development. This means that the results in this section complement the PEST analysis presented in Section 3. With regard to the economic environment, in particular the competitive environment, FinTech companies were asked to name their main competitors. Mostly, they mentioned other FinTech companies providing services in the same ﬁeld, as well as traditional service providers such as banks and non-ﬁnancial sector companies such as IT companies. They were also asked to evaluate their situation relative to their competitors based on proﬁt margin, ﬁxed costs to assets, ability to scale, innovativeness, ease of compliance, and customer costs on a Likert scale from 1 to 7; the anchors of the seven-point scale differ Risks 2021, 9, x FOR PEER REVIEW 13 of 24 between the items and are further explained below. The responses with regard to ease of compliance provide indication of their assessment of the legal and regulatory framework, proﬁt margin, ﬁxed costs to assets, and customer costs, representing economic factors. Ability to scale describes the ability to respond to an increasing or expanding workload economic factors. Ability to scale describes the ability to respond to an increasing or ex- or volume, reﬂecting the social and economic factors. The question how innovative the panding workload or volume, reflecting the social and economic factors. The question respondents are reﬂects social and technical factors. Figure 4 presents the corresponding how innovative the respondents are reflects social and technical factors. Figure 4 pre- ﬁndings. sents the corresponding findings. Profit margin Customers costs Fixed costs to assets Ease of compliance (regulatory Ability to scale requirements) Innovative Figure 4. Responses to the request to evaluate the FinTech company against competitors; 1 = low, 7 Figure 4. Responses to the request to evaluate the FinTech company against competitors; 1 = low, = high (means). 7 = high (means). Ease of compliance with regulatory requirements is assessed on the scale from “1, not Ease of compliance with regulatory requirements is assessed on the scale from “1, not subject to high compliance regimes” to “7, subject to very high compliance regimes”. subject to high compliance regimes” to “7, subject to very high compliance regimes”. The rThe resp esponseson have ses han aveaverage an average value valu ofe o 5. f Even 5. Even t though hough we we did did no not t speciﬁcally specificallylabel label t the he middle middle o offthe thescale, scale, this m this meae nans the v s the value alue of of 4 repr 4 rep esents resen being ts being in ain a similar simsituation ilar situatas ion as the competitors; we interpret these responses as indication that the FinTech companies feel the competitors; we interpret these responses as indication that the FinTech companies themselves feel themseas lves being as being under un a stricter der a stricte compliance r compliance regime re than gime the than competitors. the competitors. Proﬁt mar Profit gin (on a scale from “1, very low” to “7, very high”) has an average response of 4.5, which is margin (on a scale from “1, very low” to “7, very high”) has an average response of 4.5, slightly above the middle of the scale. The companies might therefore see their business which is slightly above the middle of the scale. The companies might therefore see their as slightly more proﬁtable than their competitors. Fixed costs to assets and Customer costs, business as slightly more profitable than their competitors. Fixed costs to assets and Cus- each on a scale from “1, very low costs” to “7, very high costs”, receive average responses tomer costs, each on a scale from “1, very low costs” to “7, very high costs”, receive aver- of 3.5 and 3.7, respectively. This means that they assess their costs as similar or slightly age responses of 3.5 and 3.7, respectively. This means that they assess their costs as simi- below their competitors’ costs. Ability to scale (on a scale from “1, very scalable” to “7, lar or slightly below their competitors’ costs. Ability to scale (on a scale from “1, very not scalable”) has an average response value of 2.7, which indicates that the respondents scalable” to “7, not scalable”) has an average response value of 2.7, which indicates that consider their activities as being more scalable than the activities of their competitors. the respondents consider their activities as being more scalable than the activities of their competitors. On a scale from “1, very innovative” to “7, not innovative”, the re- spondents assess their innovativeness with an average value of 3.1, which would reflect higher innovativeness than the competitors. Even though FinTech is often considered disruptive of traditional financial services (Gomber et al. 2018), the survey responses to the questions of how FinTech companies will change traditional banks, as presented in Table 1, leave a different impression. Nineteen of the 21 respondents expect that FinTech companies will be partners of tradi- tional banks, and sixteen respondents expect that traditional banks will adopt new tech- nologies, modernize, and digitalize. Still, nine respondents also expect that customer ownership will be with FinTech companies, while traditional banks will become com- moditized service providers. Only three respondents assume that traditional banks will not survive, and one respondent expects that traditional banks will become irrelevant. Risks 2021, 9, 181 13 of 23 On a scale from “1, very innovative” to “7, not innovative”, the respondents assess their innovativeness with an average value of 3.1, which would reﬂect higher innovativeness than the competitors. Even though FinTech is often considered disruptive of traditional ﬁnancial services (Gomber et al. 2018), the survey responses to the questions of how FinTech companies will change traditional banks, as presented in Table 1, leave a different impression. Nineteen of the 21 respondents expect that FinTech companies will be partners of traditional banks, and sixteen respondents expect that traditional banks will adopt new technologies, modernize, and digitalize. Still, nine respondents also expect that customer ownership will be with FinTech companies, while traditional banks will become commoditized service providers. Only three respondents assume that traditional banks will not survive, and one respondent expects that traditional banks will become irrelevant. Table 1. Responses to the question how the FinTech companies will change traditional banks (multiple responses allowed). Response Items Number of Responses Pre-deﬁned items Traditional banks will adopt new technologies, modernize and digitalize. Traditional banks will not survive and will be replaced by new technology-driven banks. FinTech companies will be partners of traditional banks. 19 Traditional banks will become commoditized service providers, leaving customer ownership to FinTech 9 companies. Traditional banks will become irrelevant as customers interact directly with individual ﬁnancial services providers 1 (FinTech). Other responses Traditional banks will not save retail and SME business. 1 Situation will vary from market to market, thus so many scenarios are selected. Exploring further the potential cooperation between FinTech companies and tradi- tional banks, we speciﬁcally asked the open-ended question of how the respondent’s FinTech company has cooperated with traditional banks. The answers reﬂect the variety of FinTech business models among our respondents. The cooperation ranges from the use of banking services, such as bank account services, daily payments or transfers, and funding opportunities, to client/customer identiﬁcation and exchange, providing analytics and other services to banks, API access to banking infrastructure, credit card acquisition and payment innovations, and promotion of the ﬁnancial industries. We also asked in an open-ended question what the main triggers behind FinTech development are. Six respondents mentioned IT/technology development/digitalisation, changes in technological opportunities or innovation as main triggers. This underlines the importance of the technology factor, as explained in the PEST analysis. Additionally, strong customer focus is reﬂected in several responses that see customer mind-set and expectations, customer needs, and customer centric products as main triggers, reﬂecting the impact of social factors on the development of the FinTech industry. However, six respondents also see the regulatory framework as the main trigger. One respondent elaborates: Fintech embraces inclusiveness of ﬁnancial services within different areas and allows to create targeted solutions for customers to try out without changing their bank. Incum- Risks 2021, 9, 181 14 of 23 bents have failed in both innovation and communication, thus creating space for new players. As well—payment services directives are a signiﬁcant trigger for increase of competition. Further, respondents mentioned the economic and business environment, bank charges and outdated banks, qualiﬁed human resources and talents, access to capital, and start-up incubators as main triggers for FinTech development. When asked about how pressing speciﬁc predeﬁned problems are on a scale from 1 (not pressing) to 10 (extremely pressing), the respondents answered as shown in Table 2 and Figure 5. When considering the median values, regulation is the most pressing problem (median: 8), followed by availability of skilled staff or experienced managers (median: 7). Competition, ﬁnding customers, and access to ﬁnance rank third, with a median of 6 for each of these three categories. Cost of production or labour and expansion to international markets are relatively speaking less pressing (median: 5). When considering the distribution of the responses, however, it also becomes obvious that agreement among respondents about how pressing the given problems are is low, in particular with regard to access to ﬁnance and competition. A relatively low level of variation is apparent for, e.g., cost of production or labour. Table 2. Responses to the question how pressing speciﬁc problems are; 1 = not pressing, 10 = extremely pressing. Level of How Pressing 1 2 3 4 5 6 7 8 9 10 N Median Number of responses to predeﬁned items Competition 2 0 1 2 2 6 5 1 1 1 21 6 Finding customers 0 1 3 1 2 4 5 3 2 0 21 6 Access to ﬁnance 2 2 3 1 1 2 5 2 1 2 21 6 Cost of production or labour 0 0 6 2 4 4 2 2 1 0 21 5 Availability of skilled staff or experienced 0 0 5 1 2 2 4 6 1 0 21 7 managers Regulation 0 1 3 0 2 1 0 6 5 3 21 8 Expansion to international markets 0 1 3 4 3 2 3 3 0 1 20 5 Other 1 0 0 0 0 0 0 0 0 0 1 1 The responses to the question how the Latvian state could contribute to the FinTech sector development as presented in Table 3 conﬁrm the request for special regulation for FinTech companies (sixteen responses). Additionally, eleven respondents saw regulatory sandboxes as meaningful contributions, and seven respondents considered tax relief im- portant. Although the predeﬁned response items only focus on a limited range of potential government support, none of the respondents suggested further government support options. Table 3. Responses to the question how the Latvian state could contribute to the FinTech sector development (multiple responses allowed). Response Items Number of Responses Predeﬁned items Special regulations. 16 Regulatory sandboxes. 11 Tax relief. 7 Other responses Mostly none. 1 Risks 2021, 9, x FOR PEER REVIEW 15 of 24 Table 2. Responses to the question how pressing specific problems are; 1 = not pressing, 10 = extremely pressing. Level of How Pressing 1 2 3 4 5 6 7 8 9 10 N Median Number of responses to predefined items Competition 2 0 1 2 2 6 5 1 1 1 21 6 Finding customers 0 1 3 1 2 4 5 3 2 0 21 6 Access to finance 2 2 3 1 1 2 5 2 1 2 21 6 Cost of production or labour 0 0 6 2 4 4 2 2 1 0 21 5 Availability of skilled staff or experi- 0 0 5 1 2 2 4 6 1 0 21 7 enced managers Regulation 0 1 3 0 2 1 0 6 5 3 21 8 Expansion to international markets 0 1 3 4 3 2 3 3 0 1 20 5 Other 1 0 0 0 0 0 0 0 0 0 1 1 The responses to the question how the Latvian state could contribute to the FinTech sector development as presented in Table 3 confirm the request for special regulation for FinTech companies (sixteen responses). Additionally, eleven respondents saw regulato- ry sandboxes as meaningful contributions, and seven respondents considered tax relief important. Although the predefined response items only focus on a limited range of po- tential government support, none of the respondents suggested further government support options. Table 3. Responses to the question how the Latvian state could contribute to the FinTech sector development (multiple responses allowed). Response Items Number of Responses Predefined items Special regulations. 16 Regulatory sandboxes. 11 Tax relief. 7 Risks 2021, 9, 181 15 of 23 Other responses Mostly none. 1 Competition Expansion to international 6 Finding customers markets Regulation Access to finance Availability of skilled staff Costs of production or or experienced managers labour Figure 5. Responses to the question how pressing specific problems are; 1 = not pressing, 10 = extremely pressing (means). Figure 5. Responses to the question how pressing speciﬁc problems are; 1 = not pressing, 10 = extremely pressing (means). The request for special regulation for FinTech companies is also reﬂected in the responses to the open-ended question if participants feel that existing ﬁnancial service regulations are restricting their activities and—if yes—in what way. Only three of the sixteen responses indicate that ﬁnancial service regulations are not restricting their activities. Twelve respondents answer that ﬁnancial service regulations are restricting their activities. They elaborate on this by mentioning, e.g., There is no 100% relevant regulation for our speciﬁc business. or They try to box all new innovations in existing framework which mostly does not work. Several respondents also mention the loan price limit from 1 July 2019 on, which is, in their opinion, not in alignment with the cost of capital of non-bank lenders. However, FinTech companies who responded to our survey are in regular commu- nication with state organizations (see Table 4). Communication with the State Revenue Service and the FCMC are mentioned most frequently, with twelve and eleven responses, respectively. Even though not included in the predeﬁned response items, nine respondents mention, in the open-ended part of the question, the Consumer Rights Protection Center as an organization with which they regularly communicate. Only single respondents mention other organizations, such as the Bank of Latvia or the Ministry of Economics. Overall, regulation and availability of skilled staff and experienced managers are the most pressing issues for Latvian FinTechs companies. Due to the supervisory status granted by the Committee of Experts on the Evaluation of Anti-Money Laundering Measures and the Financing of Terrorism (MONEYVAL) in 2018, supervision of the ﬁnancial sector has become much more detailed and rigorous compared to other EU countries. To provide services, the FinTech company needs to have an account with a commercial bank. However, FinTech companies as risky start-ups with low turnover but with the potential to become future competitors do not represent an attractive group of clients for commercial banks. Moreover, there appear to be problems of communication between FinTech companies and the regulator. The expectations of the regulator need clariﬁcation, as there are currently many uncertainties that lead to additional legal costs and extended product development cycle. This conclusion is in line with our assessment of the legal environment in Section 3.1. FinTech companies must obtain licenses from various regulatory bodies, and the rules are not always sufﬁciently clear, in particular for innovative products and services. Even Risks 2021, 9, 181 16 of 23 though regulators offer some support and advice, FinTech companies see the current regulatory structure as a substantial obstacle. Table 4. Responses to the question of which state organizations they communicate with on a regular basis. Response Items Number of Responses Predeﬁned items State Revenue Service 12 Financial and Capital Market Commission 11 Bank of Latvia 1 Other responses PTAC/Consumer Rights Protection Center 9 VARAM (Ministry of Environmental Protection and Regional Development) Ministry of Economics 1 LIAA (Investment and Development Agency) 1 Municipalities 1 None 1 “We are trying to avoid communication with state authorities without necessity. Usually ofﬁcials in Latvia are very conservative and they are not ready to help young entrepreneurs” Companies also ﬁnd that there is a shortage of local, highly skilled employees, which can be alleviated by reorienting training towards an IT specialty. Such effort, however, will take time. Another solution would be to hire foreign specialists. Given the relatively low salary level in Latvia compared to the EU, potential specialists would need to come from outside the EU. However, due to the rather strict immigration policy, it will be difﬁcult to attract specialists from outside the EU. The FinTech companies’ situation regarding attrac- tiveness for skilled personnel is also reﬂected in our conclusions on the social environment as part of the PEST analysis. Latvia suffers from high brain drain, low wages in the service sector, and high effective personal income tax rate. 5. Size and Financial Performance of FinTech Companies In this section, we analyse the 21 FinTech companies that responded to the survey to determine the latest trends in ﬁnancial performance and size. Table 5 displays statistics for three size measures: number of employees (Panel A), turnover (Panel B), and total assets (Panel C). On average, the number of employees increases continuously between 2010 and 2017 and remains stable afterwards. Even though the average might be inﬂuenced by one relatively large company as reﬂected by the maximum number of employees in the sample, the median number of employees largely conﬁrms the steady increase until 2017 and stable ﬁgures in 2018 and 2019. Moreover, from 2017 on, the number of companies in the sample is quite stable. Risks 2021, 9, 181 17 of 23 Table 5. Size of FinTech companies. 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Panel A: Number of employees Mean 6 14 18 32 33 39 43 46 47 46 St. Dev. 6 17 25 57 67 70 80 74 70 64 Median 5 8 9 14 11 14 20 24 24 26 Min 1 0 1 1 1 3 3 1 3 2 Max 18 56 86 200 243 260 322 311 295 266 N 6 8 9 10 11 12 14 15 15 16 Panel B: Turnover in thousand USD Mean 528 3953 7710 12,571 9773 9623 8306 8852 10,589 9213 St. Dev. 266 6978 15,712 28,498 22,360 22,037 11,798 11,417 13,233 10,733 Median 703 787 926 2698 1822 3078 1910 2586 5121 4069 Min 105 103 82 89 247 3 1 8 32 101 Max 761 20,920 48,959 92,909 76,504 85,168 39,230 36,770 42,509 30,354 N 5 7 8 9 10 13 16 17 17 18 Panel C: Total assets in thousand USD Mean 776 4622 16,548 30,970 27,527 21,734 21,029 24,150 21,153 19,252 St. Dev. 605 8122 40,316 76,071 78,379 51,725 42,655 46,834 36,511 30,893 Median 585 1736 2141 2980 1675 3201 3450 4093 2549 3677 Min 181 270 374 861 55 162 43 141 368 595 Max 2050 25,912 130,451 245,895 297,402 204,791 176,417 195,143 149,172 124,631 N 6 8 9 9 13 14 16 17 18 19 Interestingly, however, the development of turnover and total assets is not completely in line with the increase in the number of employees. Turnover and total assets increase quite strongly between 2010 and 2013. Subsequently, turnover ﬂuctuates around the 2013 level both in terms of mean and median values and only increases substantially again in 2018. Total assets ﬂuctuate around the 2013 level until the end of the observation period in terms of median values, whereas mean values drop quite signiﬁcantly between 2013 and 2015 and largely remain at the 2015 level until 2019. The latter effect seems to be driven by the largest company in the dataset as indicated by the development of the maximum value. The decline in turnover and total asset value can be attributed to several reasons. First, due to increased competition, borrowing interest rates have dropped signiﬁcantly. While in 2010, the rates of some lending companies reached 400% per annum, maximum rates were about 50% per annum in 2014. Second, due to changes in the legislation to protect clients, several restrictions are imposed on lending companies, including the maximum interest rate, the penalty rate, and the maximum repayment amount. Third, in 2015 and 2016, two large new players in crowdfunding joined the market, hence increasing competition for lending companies. Fourth, the Latvian market is small; therefore, several large players signiﬁcantly inﬂuence the overall statistics of the development of the FinTech industry. Table 6 presents ﬁnancial performance ﬁgures in terms of return on equity (RoE, Panel A) and proﬁt margin (Panel B). Most striking is the huge variation in ﬁnancial performance over time, as indicated by the development of mean and median values, and between companies, as indicated by standard deviation and minimum and maximum values. The relatively few FinTech companies that are included at the beginning of the observation period show quite high ﬁnancial performance in 2010 and 2011. Financial performance drops, though, in 2012 and ﬂuctuates around this level with quite substantial Risks 2021, 9, 181 18 of 23 swings in until 2016 or 2017, depending on the measure. Only towards the end of the observation period, ﬁnancial performance seems to improve, at least for some of the measures. Table 6. Financial performance of FinTech companies. 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Panel A: Return on Equity in percent Mean 77.8 51.9 2.1 20.0 2.8 11.2 20.2 2.2 9.9 26.6 St. Dev. 65.6 24.6 83.7 38.5 36.7 64.4 77.5 107.5 180.8 38.3 Median 77.8 58.7 15.6 14.3 13.5 4.9 3.7 38.7 26.6 25.5 Min 12.2 12.6 177.7 36.6 60.3 128.7 123.4 330.7 555.1 72.4 Max 143.4 81.7 107.8 74.8 48.6 100.0 199.0 93.8 410.5 99.4 N 2 5 8 8 11 11 11 12 15 14 Panel B: Proﬁt margin in percent Mean 2.7 36.1 15.4 2.1 3.8 11.3 9.4 4.4 19.9 8.5 St. Dev. 43.9 16.4 22.7 27.9 29.0 20.8 42.3 25.3 25.6 40.9 Median 22.6 42.0 12.4 2.1 9.3 5.5 2.1 0.8 15.2 13.2 Min 71.7 3.3 28.4 41.6 59.5 15.3 79.4 40.6 25.4 71.4 Max 37.2 56.2 53.1 45.9 38.5 44.4 93.1 50.2 91.5 95.4 N 4 7 7 9 8 10 12 13 14 16 As indicated above, we need to interpret these results with caution. However, the huge variation over time and across companies indicates that, overall, the FinTech sector does not appear to have found a basis for stable business development and ﬁnancial performance. Furthermore, the huge negative ﬁnancial performance by some of the companies, as partially reﬂected by the minimum values, might indicate that some of the business models might not (yet) be ﬁnancially sustainable. Reasons for this situation could be the strong dominance and competition between deposits and lending companies. The development of other activities, such as payment services, investment management, and insurance, has, though, the potential to open up new business opportunities. 6. Discussion and Conclusions The purpose of this paper was to analyse the status quo, current developments, and challenges ahead for the Latvian FinTech sector. Our analysis has been divided into three parts: a PEST analysis to investigate the environment that Latvian FinTech companies are facing, an analysis of survey responses with particular emphasis on FinTech companies’ own assessment of current and potential future developments, and an analysis of the ﬁnancial performance of FinTech companies in Latvia during the last 10 years. The results of the analysis of the political and legal, economic, social, and technological environment (PEST analysis) draws a mixed picture. The legal environment is largely predetermined by EU regulation, which also means that it is scattered across different types of ﬁnancial services. Depending on the provided ﬁnancial services, FinTech companies are regulated and monitored by the FCMC, the CRPC, or the State Revenue Service, since there is no legislation that comprehensively focuses on FinTech in Latvia. Instead, regulation that was established with focus on what nowadays are considered traditional ﬁnancial services also applies to FinTech companies or no regulation exists yet for some of the new services. The overall economic environment can be considered positive, but Latvia still falls behind, e.g., its neighbours Estonia and Lithuania in quality and dynamics of the entrepreneurship ecosystems. Additionally, in the speciﬁc ﬁnance-related economic environment, Latvia should improve its situation. The social environment is favourable in particular with Risks 2021, 9, 181 19 of 23 regard to level of skills and educational aspects as well as, e.g., labour market and female labour force. However, brain drain, remuneration in service professions, the labour tax rate, difﬁculties in hiring foreign labour, and, in general, difﬁculties in ﬁnding a skilled workforce raise substantial concerns. Even though Latvia does not reach top ranks when it comes to digital agenda and digital skills, its technological environment regarding, e.g., ICT adoption and electricity access is well developed. The survey responses support the conclusions from the PEST analysis. For Latvian FinTech companies, regulation is the most pressing problem. This, however, is not a purely Latvian issue. Studies in neighbouring countries conﬁrm that regulation represents a serious obstacle for FinTech development. In Poland, FinTech companies consider regulation ambiguous, imprecise, and requiring too much bureaucracy. They “[claim] that the rules are backward, neither follow the rapidly changing reality nor take the existence of the FinTechs into account” (Kliber et al. 2021). The same applies to Estonia, where the most critical problems are related to ﬁnding customers and to regulation (Laidroo et al. 2021b). Another result of the survey analysis is that the availability of a skilled staff or experienced managers is perceived as quite a pressing problem, which is, again, in line with the PEST analysis results. Further aspects, such as competition, ﬁnding customers, and access to ﬁnance, are perceived as pressing but to a lower degree than regulation and availability of skilled staff. A result that is quite interesting in the context of the general idea of FinTech as disruption to the (traditional) ﬁnance industry, which is typically purported in the literature and in the public debate, is the survey respondents’ view of integration of and collaboration between traditional banks and FinTech companies. FinTech is less perceived as disruptive but more as a driving force for innovation and modernization in the entire ﬁnance sector. The size and ﬁnancial performance of FinTech companies in Latvia during the last ten years indicates some difﬁculties when it comes to growth, and when it comes to establishing and maintaining business models that are ﬁnancially sustainable. This is, of course, in line with the general situation in areas with high levels and speed of innovation. Not all business ideas become successful; some business will disappear, while new business models take over. However, when jointly looking at the results of the PEST analysis and the size and ﬁnancial performance, the weaknesses that some of the aspects of the environment reveal seem to be signiﬁcant obstacles for FinTech development. In the context of our ﬁndings regarding regulation, it is no surprise that FinTech companies request speciﬁc FinTech regulation. The response to this request, however, requires some further considerations. On one hand, the absence of a legal framework that speciﬁcally focuses on FinTech might provide some additional comparative advantages to the FinTech market players compared to traditional ﬁnancial service providers, at least in initial stages of development. On the other hand, and, in particular, in subsequent stages, this absence slows down the development of the market and the creation of a level playing ﬁeld, both nationally and in the context of positioning Latvia as a FinTech hub internation- ally. More meaningful, however, both in the context of avoiding regulatory arbitrage of single market considerations and of increasing integration of FinTech solutions in more traditional ﬁnancial service providers, is a revision, modernization, and harmonization of regulation, in particular across different categories of ﬁnancial services, across different types of companies/institutions providing these services, irrespective of a higher or lower degree of involvement of new technologies, and internationally. Such a regulation would truly provide a level playing ﬁeld and would foster competition. In 2018, the Committee of Experts on the Evaluation of Anti-Money Laundering Measures and the Financing of Terrorism (MONEYVAL) granted Latvia supervisory status (Council of Europe 2019). As a result, supervision of the ﬁnancial sector has been sig- niﬁcantly strengthened, and Latvia has a much more detailed and rigorous approach to due diligence of clients than other countries, which creates a competitive disadvantage. Similarly, regulatory uncertainty is causing problems to FinTech companies looking to obtain an FCMC license to provide their service. Particular uncertainty exists regarding Risks 2021, 9, 181 20 of 23 activities related to cryptocurrencies and other crypto assets. Additional regulation is often seen as an obstacle to the development of the sector. However, the thoughts on regulation presented above would not necessarily result in more regulation. Instead, a revision, modernization and harmonization might lead to less, or at least less complex, regulation. It requires though that the regulation needs to cover all ﬁnancial services and should not leave blank spots for some of them. Currently, the FinTech industry needs to rely on the traditional banking industry, as, for example, all FinTech companies require a traditional bank account, as a result, making them dependent on banking policy. It is worth mentioning, though, that Latvia’s rigorous approach to strengthen its AML/CFT framework has proven fruitful and, according to the Financial Action Task Force Status (FATF), Latvia is not on the FATF List of Countries that have been identiﬁed as having strategic AML deﬁciencies (Financial Action Task Force 2021). This allows Latvia to think ahead and develop FinTech strategy, with an aim to identify and reduce any barriers to the growth of FinTech start-up companies. As the Latvian FinTech strategy is under development by a workgroup made up of the Ministry of Finance, the Financial and Capital Market Commission of Latvia, Fintech industry representatives, banks, the Investment and Development Agency of Latvia (LIAA), and various professional industry associations, our study provides contributions to the discussion and strategy development. Beyond regulation, the strategy development should particularly focus on further increasing the skill base and improving access to skilled employees, both nationally and internationally. Our study is not without limitations. First, even though the response rate to our survey can be considered satisfactory, the survey respondents still only cover part of FinTech in Latvia. For future research and for the debate in the context of Latvian FinTech strategy development, it would be beneﬁcial to include more FinTech companies. Second, we primarily focus on supply-side related drivers of FinTech development. To achieve a comprehensive understanding of drivers of FinTech development, the demand side also needs to be considered, regarding, e.g., consumers’ and other customers’ demand for FinTech solutions, their technology acceptance, ﬁnancial and IT literacy, and individual characteristics of (potential and actual) users of FinTech services (Oehler et al. 2021). Author Contributions: Conceptualization, R.R.-A. and S.W.; methodology, R.R.-A. and S.W.; formal analysis, R.R.-A. and S.W.; investigation, R.R.-A. and S.W.; data curation, R.R.-A.; writing—original draft preparation, R.R.-A. and S.W.; writing—review and editing, R.R.-A. and S.W.; visualization, R.R.-A. and S.W. All authors have read and agreed to the published version of the manuscript. Funding: This research was funded by LATVIAN COUNCIL OF SCIENCE, grant number LZP- 2020/2-0061, project DigiSMEs. Institutional Review Board Statement: Not applicable. Informed Consent Statement: Not applicable. Data Availability Statement: Data are available from authors upon reasonable request. Acknowledgments: The survey used in this study is part of a larger European study of FinTech in Eastern Europe and we especially want to thank Laivi Laidroo (TalTech School of Business and Gov- ernance Department of Economics and Finance) for her help in developing the questionnaire. We are also grateful to Inna Romanova (University of Latvia) for her support in the survey implementation. We would like to thank all the companies who took part in the survey. We also would like to thank the head of the Alternative Financial Services Association of Latvia Gints Aboltinš for promoting the survey. We are grateful to all of those who have spared their time to read the preliminary version of the paper and give us valuable comments. While the ﬁrst version of the paper was written, Stefan Wendt was at Reykjavik University, Iceland. Conﬂicts of Interest: The authors declare no conﬂict of interest. Risks 2021, 9, 181 21 of 23 Notes The survey additionally included some questions on the ﬁnancial situation of the companies and how they evaluate themselves vis à vis competitors. These questions were not considered for the further analysis though, because we decided to collect ﬁnancial information on survey participants separately for a longer observation period. Private pension funds are not further considered in the following descriptions due to relatively low relevance in the context of FinTech. Beyond the regulatory situation described in this section, all ﬁnancial service providers are subject to the Law on the Prevention of Money Laundering and Terrorism and Proliferation Financing (The Parliament of the Republic of Latvia 2008). The main institutions dedicated to combating money-laundering are the Financial Intelligence Unit of Latvia, FCMC, the State Revenue Service and CRPC. Combined with potential free FCMC expert advice in PSD2, crowdfunding and/or virtual assets. 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Keywords: FinTech; financial markets; PEST analysis; survey analysis

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FinTech in Latvia: Status Quo, Current Developments, and Challenges Ahead

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FinTech in Latvia: Status Quo, Current Developments, and Challenges Ahead

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