Fintech development and its implication for banks and its supervisors

The Basel Committee on Banking Supervision published a consulting document on the 30th August 2017 regarding the future development of the incumbent banks in light of the growing importance of fintech in the banking industry.

Fintech is the current Hype with which the digitalisation and technological innovation is now reaching the financial sector.  Investments, especially venture capital investments, have grown over the past few years, but it seems like they already reached their peak according to the Basel Committee. Parallel to other technological innovation, the investments are expected to decrease, following the “hype cycle”.

The market shares are still relatively low compared to the global banking services market, but there are regional examples where fintech companies start to dominate the financial market (Alipay in China, M-Pesa in Tanzania and Kenya).

It seems necessary for incumbent banks to adopt the technological changes and digitise as well as develop new innovative business models, structures and products, to keep up with the rapid developments in the economy as well as the society and in order to satisfy the growing demand for digital structures. Coherent with the banks adaptability is the need for modern and flexible supervisors and regulatory framework.

In general the Basel Committee recommends banks and its supervisors to be adaptive and open to the new innovations, while maintaining appropriate prudential standards.

Regarding that the Basel Committee made ten key observations about following problems and corresponding recommendations regarding how the banks and supervisors should react to the implications:

  1. The scope of banking risks changes and with that new risks, as well as opportunities, may arise Recommendation: find a balance to ensure safety and soundness and stability of financial sector without interfering with beneficial innovations

  2. Key risks include strategic risks, operational risks, cyber-risks as well as compliance risks Recommendation: Banks should ensure an effective governance structure and risk management, so the risks are detected early and dealt with accordingly

  3. Risks that are inherent with the use of new and advanced technology Recommendation: effective IT and risk management processes to detect and control the risks sufficient and effectively

  4. Implications for the bank when partnering with third parties and outsourcing key aspect of the financial services Recommendation: appropriate operational processes and legal structures to ensure due diligence and monitor outsourced operations and hold them to the same standards as its own operations

  5. Cross-sectoral issues and risks (data safety, IT security, customer protection) that occur due to fintech innovations Recommendation: cooperation with other authorities that are responsible for supervising other regulatory functions related to fintech

  6. Focus of fintech products and processes shifting form national to international level Recommendation: international cooperation between supervisors and coordinated supervision for cross-border fintech operations

  7. Changes due to fintech developments might require a reassessment of the current supervisory models and regulatory framework Recommendation: assessment of current staffing and training models regarding the effective oversight and supervision of the banks and fintech firms

  8. Fintech developments and technologies might also advance the supervisory operations effectiveness and efficiency Recommendation: supervisors should be open to adopt new technologies and should assess how innovative technologies and processes might advance the supervision, while sharing its insight among themselves

  9. Out-dated regulatory, supervisor and licensing framework may lead to gaps and makes activities outside the regulated environments possible Recommendation: current regulatory, supervisor and licensing framework should be reviewed regarding the new risks and developments fintech is implying and changed if necessary to ensure that the framework is sufficiently proportionate and adaptive

  10. Agencies already developed approaches regarding new innovative financial players and their innovative technologies and business models Recommendation: coordination and exchange between different supervisors and other agencies

In addition case studies focus on changes and implications that banks and supervisory might face due to three technology developments (big data, distributed ledger technology, and cloud computing) and due to three fintech business models (innovative payment services, lending platforms and neo-banks).

Furthermore the Basel Committee establishes five possible scenarios about how the structure of the financial marked might change due to the impact of fintech or bigtech companies. The Basel Committee predicts that market dominance is determined by who manages the customer relationship and interface and who offers the financial services and with that takes the risk.

Either the banks learn to adopt the technological changes and itself develop new business models, innovative products and processes and therefore retain the customer relationship and core banking services or (if they neglect to do so) new technology-driven and digitised banks will evolve that use advanced technologies to provide innovative banking services and own the customer relationship and with that replace incumbent banks.

Other than the two extremes there are three scenarios in which incumbent banks, bigtech and/or fintech companies share the financial market either side-by-side and each own the customer relationship and provide financial services or in cooperation and partnership and split the tasks so that one party is responsible for the customer relationship while the other provides the financial services.

Regarding to the Basel Committee it’s more realistic that both the incumbent banks as well as the technology-driven financial players will coexist on the financial market, which will lead to rapid changes in business models, products and operational structures, which might lead to new risks and supervisory and regulatory obstacles, but might also lead to new opportunities and advantages for both the customers and the banks and its stakeholders.