Fintech could materially change the risk landscape in the years to come in either positive or negative ways
As experimentation and development of new fintech applications continues to grow, The Depository Trust & Clearing Corporation (DTCC), the premier post-trade market infrastructure for the global financial services industry, today unveiled a new framework of nine key factors to assess when considering its impact on financial stability.
The framework is included in a new DTCC white paper, “Fintech and Financial Stability – Exploring How Technological Innovations Could Impact the Safety & Security of Global Markets,” which cautions that while fintech adoption benefits the financial services industry in areas such as improving client experience, strengthening critical infrastructure components, creating efficiencies and reducing costs, it could also pose or exacerbate certain risks, including cyber security concerns and other third-party risks.
While many fintech offerings are still in their early stages, which makes it difficult to assess their impact on financial stability, DTCC recommends that the rapid growth of fintech adoption requires close monitoring in order to identify emerging systemic risks on a timely basis. DTCC goes on to say that the impact analysis should be conducted on a case-by-case basis, given the wide range of underlying applications under consideration for fintech upgrades, each with their own characteristics and specific context. To guide this analysis, DTCC recommends that potential risks be assessed based on the following framework:
1. The provision of core banking functions by fintech firms
Fintech companies that provide core banking functions could enhance financial stability through diversification of credit and liquidity risk. However, given the short track record of these companies, they could also create systemic vulnerabilities.
2. The level of fintech-related fragmentation
The unbundling of financial services associated with the rise of fintech has the potential to fragment the creation and delivery of financial services across additional providers and platforms.
3. The impact of fintech on concentration risk
The rise of fintech could reduce concentration risk by allowing non-traditional service providers to compete with existing players. Conversely, it could also create new pockets of risk if a small cluster of fintech companies were to become dominant in any given area.
4. The substitutability of fintech services
Substitutability is a key concept in assessing systemic risk – financial services that are highly substitutable create less systemic risk than those that are not.
5. The effect of fintech on financial interconnectedness
The interconnectedness of financial service providers could have a significant impact on financial stability. It is important to analyze how fintech developments affect financial networks.
6. The degree of competition vs. cooperation between fintech firms and incumbents
Competitive pressures on banks could erode their profitability, and may encourage them to pursue riskier strategies. Outright competition between fintech companies and incumbents is less likely to promote financial stability than an environment where parties engage in cooperative arrangements.
7. The degree of reliance on automated decision-making processes
Overreliance on purely data-driven algorithms could lead to errors that may not have occurred in an environment that requires additional human judgement. In addition to the potential for errors, due to the inherent complexity of decision-making algorithms, their opaque nature could also hide biases that may be hard to identify.
8. The sustained growth and adoption of fintech services
The impact of fintech depends on the extent to which it becomes a mainstream part of the financial ecosystem and how it will ultimately be used for delivering critical financial services.
9. The evolution of the regulatory environment
Policy decisions and regulatory actions will determine to what extent fintech will penetrate and ultimately impact financial stability for years to come.
“We are at the earliest stages of a fintech revolution that could have significant implications for the financial services landscape,” said Andrew Gray, Managing Director and Group Chief Risk Officer at DTCC. “As a systemically important financial market infrastructure, we look forward to collaborating with industry stakeholders and regulators to assess and monitor potential risks as fintech innovations become more widely adopted. This will help us to gain a better understanding of fintech’s potential impact on financial stability.”
The whitepaper also notes that regulators around the world have also taken notice of fintech’s growing prominence. A global survey launched by the Financial Stability Board’s Fintech Issues Group this past February indicates that 20 out of 26 jurisdictions that were surveyed have already taken some measures to respond to fintech, with five additional jurisdictions planning to follow suit.
“The importance of the regulatory context in which fintech companies operate cannot be overstated,” said Andrew Gray. “Policy decisions and regulatory actions will determine to what extent fintech will impact financial stability for years to come.”