This series explores the implications of fintech developments for both banks and bank supervisors. In this first instalment RBC Investor & Treasury Services explores how technology-driven innovation in financial services may affect the banking industry and the activities of supervisors in the near- to medium-term.
As interest in fintech continues to grow, both banks and venture capital funds have made sizable investments. Due to the uncertain nature of how these investments may reshape global financial markets, the Basel Committee on Banking Supervision (BCBS) established a taskforce to monitor the implications of emerging financial technologies. In partnership with the Bank of International Settlements (BIS), the BCBS taskforce published a consultation paper in August 2017 to provide insight into fintech and its implications for banks and bank supervisors.
Key insights
- Emerging economies are adopting 'suptech,' the developing field of technologies that assist the operations of banking supervisors
- Technology firms are developing courses and workshops to assist banks and bank supervisors to train their teams on the latest fintech developments
- Banking incumbents have an opportunity to absorb fintech market entrants through acquisitions and by improving their own offerings
According to a Global Banking Annual Review by McKinsey & Co, between 10 to 40 percent of revenues and 20 to 60 percent of retail banking profits may be at risk of fintech disruption by 2025.1 However, the BCBS believes that incumbents in the banking sector may be able to avoid these potential losses if they are able to absorb new fintech market entrants through acquisitions and by improving their own efficiency and capabilities.2
The consultation paper sets out how technology-driven innovation in financial services may affect the banking industry and the activities of supervisors in the near- to medium-term. Various future potential scenarios are considered alongside their specific risks and opportunities.
Mitigating operational risk during rapid innovation
Banks, service providers and fintech firms are increasingly adopting and leveraging advanced technologies to deliver innovative financial products and services to clients. These enabling technologies, such as artificial intelligence (AI), advanced data analytics, distributed ledger technology (DLT), cloud computing and application programming interfaces (APIs), each represent opportunities but also pose inherent risks from outsourcing risk to operational risk.
In response, banks should adopt effective IT and other risk management processes that address the risks of the new technologies and implement effective control environments to properly support key innovations. The BCBS recommends the establishment of sound technology governance and infrastructure risk management programs.3
Managing third-party risk
Another area of attention for the BCBS is the growing reliance of banks on intermediary service providers. According to the 18th annual PwC Global CEO survey, more than 40 percent of banking CEOs see joint ventures, strategic alliances, and informal collaborations as an opportunity to strengthen innovation and gain access to new customers and new technologies.4 While these partnerships can reduce costs, increase operational flexibility and improve operational resilience, the associated risks and liabilities may largely remain with the banks.
Banks should ensure they have appropriate processes in place for due diligence, risk management and ongoing monitoring of any operation outsourced to a third party, including fintech firms. Contracts that clearly outline the responsibilities, expectations and liabilities of each party provide banks with the ability to maintain sufficient control over outsourced services and ensure adherence to the bank’s own operational standards of care.
Ensuring teams are adequately skilled
Fintech has enormous potential to disrupt the traditional banking business model. As the delivery of financial services becomes increasingly technology-driven, bank supervisors should reassess current supervision models in response to these changes. Adopting a more collaborative approach with fintech start-ups could help bank supervisors pre-empt developments in financial technologies and ensure continued effective oversight of the banking system.
Effective staffing and training models are also critical to ensuring that bank supervisors are adequately equipped to supervise new technologies and disruptive business models. Many technology firms, such as IBM, have been proactive in offering specialist-training courses in emerging fields such as DLT, machine learning and cryptocurrencies. Bank supervisors may find it necessary to leverage specialist training programs and consider recruiting staff with the required skills and knowledge to complement existing expertise.
The rise of 'suptech'
The same technologies that offer efficiencies and opportunities for fintech firms and banks may also improve supervisory efficiency and effectiveness. Similar to regtech, which aims to streamline corporate compliance, 'suptech' adopts emerging technologies to facilitate the operations of banking supervisors.
Similar to regtech, which aims to streamline corporate compliance, 'suptech' adopts emerging technologies to facilitate the operations of banking supervisors
Suptech, as a field, is still in its infancy but technology-enabled innovations that assist banking supervisors are beginning to be deployed in emerging markets. For example, in July 2017, the National Bank of Rwanda (NBR) developed an electronic data warehouse system to automate the reporting processes that facilitate supervision of its rapidly expanding microfinance sector.5 As suptech innovations mature they will help banking supervisors improve the quality, frequency, and scope of reported data in both developed and emerging economies.
While levels of fintech investment continue to rise and fall, the fundamental technologies driving financial innovation continue to progress. Fintech represents a massive opportunity to restructure existing business models for banks, and could also dramatically change the role and operations of banking supervisors. In order for these emerging technologies to be safely adopted, it is important that firms continue to monitor their appetite for risk.
In the second instalment of Basel's Fintech Review, RBC Investor & Treasury Services explores how fintech may create the risk of increased difficulties in meeting compliance requirements, particularly anti-money laundering and counter terrorist financing obligations.
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Sources
- McKinsey & Co (September2015) The fight for the customer: McKinsey global banking annual review 2015
- Basel Committee on Banking Supervision (August 2017) Sound Practices: Implications of Fintech developments for banks and bank supervisors
- Basel Committee on Banking Supervision (June 2011) Principles for the Sound Management of Operational Risk
- PwC (January 2014) 18th Annual Global CEO Survey
- The World Bank (August 6, 2017) Leveraging 'suptech' for financial inclusion in Rwanda