This second article in RBC Investor & Treasury Services' Fintech and Regulators series explores how technology-enabled innovations are redefining the relationship between central banks, regulatory bodies and financial services firms.
The rapid growth and expansion of fintech innovation is driving increased competition and continuous disruption. In response, regulators are broadening their scrutiny and oversight of these developments.
On June 27, 2017, the Financial Stability Board (FSB) published a report analyzing the potential implications of fintech on financial stability. The report summarizes outstanding supervisory and regulatory issues and establishes a framework for defining the scope of fintech activities.1 Determining the extent to which new technologies increase or reduce systemic risk is a key priority for the G20 supervisor as it looks to foster greater international collaboration and establish a robust regulatory framework for responsible innovation.
Key insights
- Fintech is reducing the barrier for market-entry and enabling growth in the number of third-party intermediaries
- Fintech is accelerating the rate at which financial data is processed, but the FSB is concerned by the heightened risk of “fire-sales" and “flash crashes"
- The rapid expansion of fintech products and services is adding to the complexity of drafting effective regulatory measures and mitigating systemic risk
“Regulators need to understand the impact that developments in fintech can have on financial stability, especially given the rapid rise of innovation in this space," said Carolyn Wilkins, senior deputy governor at the Bank of Canada and chair of the FSB's fintech issues group. She further noted that the report “sets out a clear picture of supervisory and regulatory issues, which the FSB will continue to monitor and discuss going forward."2
While the FSB's report finds no compelling or immediate financial stability risks arising from fintech, one of the three priority areas it identifies as requiring attention and international collaboration is managing operational risks from third-party service providers.
Managing risk
As the complexity of financial systems increase, so do the associated operational risks. Fintech is reducing costs, removing barriers to market entry and enabling third-party service providers to flourish. While this growth in intermediaries reduces over-reliance on centralized institutions, decentralization brings its own challenges.
As the complexity of financial systems increase, so do the associated operational risks
The FSB recommends that policymakers determine if current oversight frameworks for third-party service providers are appropriate. In particular, cloud computing, data services and increasingly stringent data protection regulation represent unique operational risks that must be carefully addressed. This will entail greater coordination globally across financial authorities, with non-traditional partners who will be responsible for the security of information technology systems used by market participants.
Financial stability through data efficiency
Fintech is enabling more data to be processed by financial service providers with ever greater efficiency, and this could strengthen market stability. However, the FSB report highlights some key concerns over the rapidly accelerating rate at which financial data is processed.
Big data mining techniques and machine learning processes mean that financial institutions are becoming inundated with data. There is a risk that the increased speed in analysis and execution could come at the expense of rigour in mitigating operational risks. The FSB warns that there is now a heightened risk of “fire-sales" and “flash crashes".3 Additionally, the greater efficiency of market participants might put pressure on the profitability of incumbents and lead to increased risk-taking.
Bringing legacy systems up to speed
Across financial institutions, legacy systems have been incrementally updated over decades to align with evolving demands. This patchwork development of key operational technologies may have resulted in an inconsistent application of security policies. In many instances, emerging fintech solutions can effectively reduce operational risk by modernizing and streamlining existing processes.
Emerging fintech solutions can effectively reduce operational risk by modernizing and streamlining existing processes
While fintech solutions are intended to reduce operational risk, the number of emerging new technologies adds to the complexity of crafting effective regulatory frameworks. The FSB report highlights concerns that many emerging financial technologies are vulnerable to cyber risk, and identifies this as another priority. To maintain confidence in fintech products and services, many of the legal uncertainties arising from the cross-boundary nature of these tools must be addressed.
In a statement released alongside the report, the FSB said, “The financial system is evolving, so the FSB will continue to scan the horizon to identify, assess and address new and emerging risks to financial stability."4
As financial services increasingly rely on technology-enabled innovations, asset managers and institutional investors must be prepared to implement appropriate measures to ensure the security of client assets. Regulators are beginning to establish the necessary frameworks to shape fintech innovation, but an effective regulatory environment will only be possible with greater international collaboration.
Sources
- Financial Stability Board (June 27, 2017) Financial Stability Implications from FinTech
- Reuters (June 29, 2017) G20 watchdog says fintech doesn't pose threat to financial stability
- Ibid. Financial Stability Implications from FinTech
- Business Insider UK (July 3, 2017) The body tasked with preventing the next financial crisis is turning its attention to fintech