The emerging interplay between big data and machine learning creates exciting opportunities for financial service providers. Fintech is harnessing techniques in this space to unbundle traditional banking services into discrete financial products and develop new advancements in algorithmic trading and automated market making. As these innovations become more influential in shaping global markets, it is important to acknowledge their potential effects on the stability of those markets.
Key insights
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Fintech developments may affect existing regulated financial services firms and the appropriate supervisory responses need to be put into place by regulators to protect against risk
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The Financial Stability Board has concluded that, at present, no immediate or compelling systemic risk has arisen due to fintech, but it remains an area to watch in the future
There is potential for financial technologies to introduce new risk to markets.1 Since many fintech providers operate within regulatory environments designed for traditional banks, it can be difficult to define whether fintech providers' operations constitute traditional banking activities. However, regulators are becoming more adept at handling fintech.
When peer-to-peer (P2P) lending platforms initially emerged in the US, for example, it was unclear whether they were subject to the same compliance obligations as banks offering similar services. Prosper, a P2P lending startup, operated for two years before the Securities and Exchange Commission ultimately issued it a cease-and-desist order after determining that its loans constituted investment products.2 More recently, on July 25, 2017, the Securities and Exchange Commission issued a ruling that specific Initial Coin Offerings, a blockchain-based investment structure, were securities and therefore subject to securities regulations.
When financial institutions engage with disruptive technologies, the combination of the immaturity of the technology combined with the pace of growth makes it more challenging to confidently assess operational risk. Firms must remain internally agile and receptive to changing guidelines from regulators, as new threats and precautionary measures in the fintech space are identified. As a corollary, regulatory bodies must also carefully consider the information that is made available to them, credit constraints and the pace of financial innovation before they can issue credible, prudential rules and recommendations on fintech.3
Defining where risk exists
Firms must remain internally agile and receptive to changing guidelines from regulators
Following the global financial crisis in 2008, the G20 economies established the Financial Stability Board (FSB) to monitor and issue recommendations on the global financial system. The FSB has identified, as one of its current priorities, the need for far-reaching discussions with national authorities to identify the supervisory and regulatory issues surrounding fintech as one of their top priorities.
The economists, ministers and central bankers that make up the FSB maintain they are Open-minded about the potential impact financial technologies may have on systemic risk. They acknowledge that the emergence of more decentralized and transparent financial services could bring greater stability to global trade and investment. However, the FSB has also indicated the need to open dialogue with regulatory bodies about establishing proportionate oversight for innovation facilitators, fintech-based credit intermediation, and the use of distributed ledger technology.4
On June 27, 2017, the FSB published a report* analyzing the potential financial stability implications of fintech, with a view to identifying supervisory issues that merit attention. Encouragingly, the report found that no immediate or compelling systemic risk has arisen due to fintech. However, the report did highlight several areas that may be of concern in future.5 In particular, the G20 watchdog cautions that further regulatory assessment is required in managing operational risks from third-party providers, mitigating cyber risks, and monitoring macro-financial risks.
Expanding the scope of supervision
Perhaps the greatest uncertainty over developments in fintech is the potential to change the dynamics of global markets. While early blockchain enthusiasts hypothesized that cryptocurrencies could displace traditional bank-based payment services altogether, the impact these technologies have had on the daily activities of consumers and investors has, so far, been negligible. As technological advancements progress, conventional measures for managing risk need to be reassessed.
Ultimately, regulatory frameworks must balance the fostering of competition between traditional financial players and disruptive new entrants, while preserving the stability of the system in the face of the rapid development of technology.
*Further insights on the FSB report will be published in an upcoming article
Sources
- US Office of the Comptroller of the Currency (Fall, 2016) Semiannual Risk Perspective From the National Risk Committee
- The Harvard Business Law Review (August 9, 2016) - Benjamin Lo It Ain't Broke: The Case For Continued Sec Regulation Of P2p Lending
- International Monetary Fund (July, 2012) - Javier Bianchi, Emine Boz, and Enrique G. Mendoza Macro-prudential Policy in a Fisherian Model of Financial Innovation
- Financial Stability Board (November 17, 2016) Financial Stability Board agrees 2017 workplan
- Financial Stability Board (June 27, 2017) Financial Stability Implications from FinTech