FinTech is a technologically enabled financial services innovation that may result in new business models, applications, and financial inclusion.
Fintech developments have the potential to significantly improve, transform, and/or disrupt many aspects of the financial services industry, including business models, applications, regulatory oversight, processes, and products.
Over the last few years, investment in fintech initiatives has grown exponentially across multiple sectors and could materially impact the financial ecosystem and financial stability either positively or negatively over the next five to ten years.
Fintech developments’ impact on financial stability must be assessed on a case-by-case basis, taking into account how each individual application may affect the various dimensions of systemic risk. It is too early in the fintech revolution to determine whether these innovations are beneficial or harmful to the system.
DTCC has developed an original framework to enable industry participants to analyze how specific fintech applications may impact financial stability. The framework covers a wide range of critical factors, including concentration and interconnectedness risk, fragmentation and substitutability of services, and automated decision-making processes.
Policymakers around the world are working on a variety of initiatives to better understand and manage the potential risks associated with fintech while also encouraging innovation and experimentation. These initiatives, however, must be closely coordinated across jurisdictions to avoid regulatory arbitrage and other undesirable outcomes, such as the emergence of a shadow infrastructure sector.
While the overall impact of fintech on the financial ecosystem remains limited at this time, potentially disruptive innovations will likely continue to unfold quickly and somewhat unpredictably. As a result, fintech developments must be closely monitored to help ensure that potential systemic risks or impacts are identified and addressed in a timely fashion.
Since the last global financial crisis, supervisory mechanisms and regulations have become more stringent, which has significantly improved the resilience of banks, thus positively affecting financial stability. Apart from traditional financial institutions, which have been supervised according to strict regulations and standards, technological development in financial services, commonly called FinTech, has introduced new trends, providing fast peer-to-peer lending, which directly matches lenders and borrowers, thus putting more pressure on policymakers and supervisors.
This paper presents the potential implications of FinTech developments on financial stability while explaining FinTech’s influence on market structure as well as the benefits and risks of technologically driven financial innovations to financial stability.
The paper stresses the importance of international cooperation of regulators in order to preserve financial stability in the recent world of technological changes and innovations. FinTech has changed consumers’ expectations and preferences while also increasing the number of users expecting fast and easily accessible services available on mobile phones and other electronic devices. The paper shows that new technology provides the space for expanding financial services, but it also poses additional risks to the financial system in terms of micro-financial and macro-financial risks.
FinTech’s rapid development has influenced financial markets and traditional financial institutions’ business models. In order to follow current trends and to compete with their fast growing competition, traditional financial institutions are adapting to changes in order to satisfy the needs of the market. Both supply and demand-side factors could act as drivers of financial innovations. Customers, especially new generations, are looking for fast, easy-to-approachable financial services that are accessible at any time and anywhere. In regards to that, they are more likely to use electronic payments, mobile banking, FinTech credits, or other DLT-based products and services instead of using traditional financial services methods.
FinTech credits, BigTechs, and third-party providers are considered the main channels through which FinTech could influence market structure and therefore impact financial stability. FinTech credit could jeopardize financial stability if it becomes too large. So far, the FinTech credit market is not that significant to have a potential to cause financial instability, but its rising trend has to be closely monitored. Increased entry of BigTech firms into the world of financial services could have significant consequences and potentially jeopardize the activities of traditional financial services providers. BigTechs are entering new markets relatively easily because of their strong technological developments and large data access.
FinTech brings opportunities and benefits to market players and customers, but at the same time, it also brings risks that have to be adequately assessed and managed. Technologically enabled financial innovations provide greater decentralization, wider diversification of products and services, and then faster, transparent, efficient, and broader access to financial services, thereby contributing to financial inclusion. Unlike that, FinTech could pose threats to financial stability in terms of micro and macroeconomic risks. In that regard, international and national bodies are taking FinTech into consideration when assessing potential risks and creating regulatory frameworks. International institutions such as the FSB, IMF, and WB are calling for international cooperation among national and international institutions with the aim of addressing and reducing regulatory gaps, preventing the occurrence of potential risks and mitigating the likelihood of those risks developing into systemic risks, which could further jeopardize financial stability on local levels and potentially spread to the global level.
Elements of a broad-based risk management approach Fintechs that have an interest in becoming a bank, expanding their portfolio of bank-like products and services, or partnering with more traditional financial services firms will be expected by regulators to have a risk and compliance framework that sufficiently addresses their inherent risks as generated by their book of business. In general, some of these risks would include but not be limited to anti–money laundering for marketplace firms, or the potential for misrepresentation in disclosures and marketing material for lending and wealth services firms. When risk and compliance programmes are implemented correctly by a fintech, they can be a revenue enabler and may put them in an advantageous position to collaborate with banks and other traditional financial service institutions who are required to have robust risk management practises in place. Fintechs can “get it right” and potentially save costs by taking advantage of synergies between and among risk domains and designing their capabilities to cut across them as outlined below.
Figure 1. Risk & Compliance program framework Regulatory interaction Data capture Issue management Awareness and training Governance and policy Risk assessment and regulatory change Monitoring and testing
The entrance of big and well-established technology firms, known as BigTechs, into the financial sector could influence market structure and easily expand their business into the world of financial technology innovations. BigTechs are nontraditional institutions that have developed networks and have accumulated big data, and some of them already have a foothold in financial services in some jurisdictions (FSB, 2019a). Therefore, these already big firms entering the financial market could put pressure on the market and be strong competitors to traditional financial service providers offering lower-cost or even free services (FSB, 2019a).
The services they provide are credit, insurance, and wealth management. According to the BIS (2019) annual report, FinTech firms are formed to primarily provide financial services, whereas BigTech firms provide financial services as part of a much broader set of activities. BigTechs such as Amazon, Alibaba, Facebook, and Google have grown rapidly in the last decade.
Although BigTech companies serve clients globally, the majority of their operations are located in Asia, the Pacific and North America (BIS, 2019). BigTechs’ expansion into financial services has been most rapid in China, but it has also been rapid in emerging economies (EMEs), particularly Southeast Asia, Latin America, and East Africa (BIS, 2019).
There are two types of BigTech payment platforms (BIS, 2019). The first one refers to overlay systems where users rely on third-party infrastructures such as credit cards and retail payment systems used to process and settle payments. Examples are Google Pay and PayPal. These overlay systems are used more in developed economies such as the United States, where credit cards were already in use when e-commerce such as Amazon and eBay came to the market.
In the second type of BigTech payment platform, users are able to make payments that are processed and settled on a system proprietary to BigTechs, such as AliPay and MPesa. These proprietary payment systems are more ubiquitous in countries where the penetration of credit cards and other cashless means of payments is low, as in China, where the volume of BigTech payments services accounts for 16% of GDP (BIS, 2019).
Entries by BigTech firms into the financial system introduce new risks. BigTech firms have the potential to emerge very quickly in payment systems as systemically important financial institutions, therefore becoming significant from the perspective of financial stability. Thus, their impact goes beyond the interests of their direct stakeholders having broader public interest (FSB, 2019a).
The first financial services that BigTechs offered were payments in order to increase trust between buyers and sellers in e-commerce. For example, Alipay or PayPal allow guaranteed settlement at delivery and/or reclaims by buyers and are fully integrated into e-commerce platforms (BIS, 2019). As stated in the BIS report (2019), even though the payment platforms of BigTechs compete with those of banks, they are still dependent on banks.
In that regard, users require bank accounts or credit or debit cards to transfer their money throughout the network. The BigTechs hold their money in regular bank accounts and they do not participate in regular interbank payment systems for the settlement of central bank money. However, financial innovations (FSB, 2019a) are developing very fast and technology firms are entering markets at a fast speed, which could be illustrated using an example of Alibaba’ subsidiary Ant Financial, established in 2014. Ant Financial expanded activities into wealth management on behalf of its e-commerce business and its payment platform Alipay, creating Yu’e Bao, which for five years has become the world’s largest money market fund with 170 million customers and whose asset volume amounted to $237 billion as of June 2018 (FSB, 2019a).
The rapid emergence of fintech applications is arguably one of the most promising and exciting developments in financial services today. Fintech’s exponential growth, the breadth of its scope across sectors and markets, and its worldwide reach combine to create a powerful force that could spur transformational change over the next several years. At the same time, these developments could also impact financial stability in both positive and negative ways.
While many of these technologies are at a nascent stage at this time, there is little doubt that fintech will likely alter the risk landscape in the future, produce unintended consequences and lead to new types of risks. It is too early to provide a definitive assessment of the associated systemic risks or benefits of fintech at this time, but we are confident that the most appropriate way to gain a better understanding of fintech’s potential impact on financial stability is to identify the most relevant questions that should be considered.
The framework we have developed includes nine key factors to consider when assessing the potential systemic impact of fintech applications on a case-by-case basis. While these factors build on insights related to interconnectedness, substitutability, and other systemic risk concepts, they also leverage DTCC’s expertise as a critical market infrastructure, our legacy of using technology to improve the post-trade process, and the work we have done recently to advance the use of fintech innovations.
We hope this paper helps contribute to a better understanding of fintech’s potential to strengthen or weaken financial stability. As we have done in the past, we intend to use it to engage with clients, regulators, and other stakeholders to discuss topics and questions that will likely remain a focus area for many years to come. We actively encourage you to share your thoughts and participate in the ongoing dialogue we are looking to foster.
Is fintech a threat to financial stability?
There is a lot of debate surrounding the role of fintech in the financial stability of the global economy. A majority thinks that fintech innovation can help improve the efficiency and transparency of the financial system by utilizing artificial intelligence, cloud technology, and data technology, which in turn could lead to more stable financial markets.
How does fintech help in promoting financial inclusion?
Fintech is assisting in making financial services more accessible to a larger number of people. Fintech aims to increase financial inclusion for vulnerable populations by enabling them to access, use, and manage financial products and services to meet their individual financial needs. It includes having a bank account, borrowing money, and being able to use financial products.
What are FinTech regulations?
FinTech regulations are the laws and rules that govern the activities of FinTech companies and their users. They can include requirements for companies to have licenses, registration, and other compliance measures. FinTech regulators’ main concerns have been investment fraud, cryptocurrency securities, systemic risk regulation, central bank functions, money laundering, and taxation.
What is big tech and FinTech?
Fintech credit appears to penetrate market segments not served by banks; thus, it serves as a complement, but only in emerging economies. Bigtech firms compete even more with banks, driving some banking products out of the market in both emerging and advanced economies.
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