Financial intermediation: a transaction two.sided market model approach

In recent years, several players in the financial intermediation industry moved from a vertically integrated landscape, i.e. advising and selling their own products, to an open architecture one, i.e. intermediating a constantly increasing share of products provided by third parties. In parallel, and as a consequence, a raising attention has been placed from regulatory point of view on the relationships between intermediaries and product providers to protect the final clients from potential conflicts of interest and information asymmetry. While mentioned regulation focuses on one side at a time, to rule commercial agreements (or inducements) and to give full transparency of products and pricings to the investors, purpose of this research is to develop a more comprehensive interpretation of the vertical disintegration as a move towards a two-sided market. With this interpretation, the prices set by the platform on both sides, investors and product providers, are the legitimate consequence of the externalities between the two faced sets of agents and represent the platform’s strategy to remunerate its intermediation services. Since the early 2000s, two-sided markets have been of growing interest in academic literature as they differ from traditional market settings by having cross-side network effects and same-side network effects characterizing the transactions. Due to such externalities, pricing strategies can be based on subsidizing the participation of one side (i.e. considered key for the platform to attract the other side) while recovering the loss on the other side. While several applications of two-sided market framework are available in academic literature with regards to other products and industries (traditional examples are credit cards, shopping malls and newspapers), this research develops a new two-sided market framework to explain financial intermediation industry trends. It interprets the vertical disintegration as an exploitation of the market power coming from the distribution of financial products, thus a behavior change from merchant to platform, to show that prices are reflecting the cross side externalities between the two sides of the market faced by the financial intermediary rather than pure private negotiations between the single actors. To this extent, a model is developed to show how competitors behave when vertically integrated and how the peculiarities of a two-sided market – especially the market power of being a distribution network – act as an incentive to disintegrate. Additionally, it is shown that when all players act as a platform, the dynamics of a two-sided markets can allow at least a Nash equilibrium to exist, in which platform of different sizes enjoy positive profit while applying non-zero, legitimate fees to both sides in exchange of the distribution services offered. Finally, empirical evidences from Italian market are given to sustain – and to challenge – this interpretation.