Buzz Update Fast-moving Fintech poses a challenge to regulators TOU

Buzz Update Fast-moving Fintech poses a challenge to regulators

 TOU

Fast-moving Fintech poses a challenge to regulators

Emerging companies are rapidly entering key financial services and often taking more risk than traditional banks.

Technology sometimes moves at confusing speeds. When it comes to innovation in economic activity, often referred to as fintech, the world is seeing big progress.

For banks, FinTech disrupts major financial services and pushes them to innovate to stay relevant. For consumers, this is potential Wide Access Good Services.

Such changes also increase the share of regulators and supervisors — although many private fintech firms are still small, they are able to scale much faster in both riskier clients and business segments than traditional lenders.

The combination of rapid growth and increasing importance of fintech financial services for the performance of financial intermediation may come with system-wide risks, which we will cover in our latest section Global Financial Stability Report.

Adding risk

Digital banks are increasing the systemic importance in their local markets. Also known as neobanks, they are more exposed to losses from consumer loans than their traditional rivals, which usually have fewer buffers against losses because it is more modest. Their exposure extends to higher risk-taking in their securities portfolio, as well as higher liquidity risks (in particular, the liquid assets held by Neobanks in relation to Neobanks’ deposits are lower than those held by traditional banks).

These factors also pose a challenge to regulators: the overall resilience of risk management systems and most neobanks will not be tested in a recession.

Not only are fintech companies taking greater risks, they are also putting pressure on long-established industry rivals. See for example in the United States, FinTech mortgage originators follow an aggressive growth strategy during times of expanding home loans, such as during the pandemic. Competitive pressure from fintech firms has significantly damaged the profitability of traditional banks and this trend will continue.

Another technological innovation that has grown rapidly over the past two years is decentralized finance, a crypto-based financial network without a central intermediary. Also known as DeFi, it offers the ability to provide more innovative, inclusive and transparent financial services, thanks to greater efficiency and accessibility.

However, DeFi also has the potential to increase leverage and is particularly vulnerable to market, liquidity and cyber risks. Cyber-attacks, which are serious for traditional banks, are often fatal to these platforms, stealing financial assets and undermining consumer confidence. The lack of deposit insurance in DeFi adds to the feeling that all deposits are at risk. Historically, large customer withdrawals often followed cybersecurity news on providers.

Chart showing deposit losses or withdrawals after cyber-attacks

DeFi operations mainly take place in crypto-asset markets, but the growing adoption by institutional investors has strengthened the links to traditional financial institutions. In some economies, DeFi helps accelerate cryptocurrency, in which residents adopt crypto assets instead of the local currency.

Step-up control

As more financial-service activities move from regulated banks to lesser or less oversight firms and platforms, the associated risks also increase. Although Fintech stepped in to challenge the traditional banks on their own ground, they brought more than competition. In fact, the two are often intertwined by providing liquidity and credit to fintechs through banks.

These pose challenges to financial authorities in the form of interoperability that requires oversight and regulatory measures, including regulatory arbitrage (relocation of companies or setting up operations in less-regulated sectors and regions) and better consumer and investor protection.

Both fintech companies and traditional banks need to be targeted on a pro rata basis. In this way, the opportunities offered by Fintech will grow, but the risks will remain. For Neobanks, this means that strong capital, liquidity and risk-management requirements are commensurate with their risks. For current banks and other established firms, prudent oversight may require less focus on the health of less technologically advanced banks, as their current business models may be less stable in the long run.

The lack of governing bodies means that DeFi is a challenge for effective control and oversight. Here, regulation should focus on entities that accelerate the rapid growth of DeFi, such as stablecoin issuers and centralized crypto exchanges. Supervisory authorities should also promote strict governance, including industry codes and self-regulatory bodies. These entities can provide an effective way to control monitoring.

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