DTCC assess fintech impact on stability

While financial technology startups and established players vie for attention on the exhibition floor at Sibos, the impact of fintech on financial stability is the subject of a new white paper from The Depository Trust & Clearing Corporation (DTCC).

Fintech and Financial Stability – Exploring How Technological Innovations Could Impact the Safety & Security of Global Markets, warns that while fintech adoption benefits the financial services industry in areas such as improving client experience, strengthening critical infrastructure components, creating efficiencies and reducing costs, it could also pose or exacerbate certain risks. These include exacerbating cyber security threats or amplifying third-party risks.

While many fintech offerings are still in their early stages, which makes it difficult to assess their impact on financial stability, DTCC recommends that the rapid growth of fintech adoption requires close monitoring to identify emerging systemic risks on a timely basis. It advises that any impact analysis should be conducted on a case by case basis, given the wide range of underlying applications under consideration for fintech upgrades, each with their own characteristics and specific context.

To guide this analysis, DTCC recommends that potential risks be assessed based on a framework that includes nine main factors for firms to assess when considering the impact of fintech on financial stability. These are:

• Fintechs that provide core banking functions could enhance financial stability through diversification of credit and liquidity risk. However, given the short track-record of these companies, they could also create systemic vulnerabilities.
• The unbundling of financial services associated with the rise of fintech has the potential to fragment the creation and delivery of financial services across additional providers and platforms.
• The rise of fintech could reduce concentration risk by allowing non-traditional service providers to compete with existing players. Conversely, it could also create new pockets of risk if a small cluster of fintech companies were to become dominant in any given area.
• “Substitutability” is a key concept in assessing systemic risk – financial services that are highly substitutable create less systemic risk than those that are not.
• The ‘interconnectedness’ of financial service providers could have a significant impact on financial stability. It is important to analyse how fintech developments affect financial networks.
• Competitive pressures on banks could erode their profitability and may encourage them to pursue riskier strategies. Outright competition between fintech companies and incumbents is less likely to promote financial stability than an environment where parties engage in cooperative arrangements.
• Over-reliance on purely data-driven algorithms could lead to errors that may not have occurred in an environment that requires additional human judgement. In addition to the potential for errors, due to the inherent complexity of decision-making algorithms, their opaque nature could also hide biases that may be hard to identify.
• The impact of fintech depends on the extent to which it becomes a mainstream part of the financial ecosystem and how it will ultimately be used for delivering critical financial services.
• The evolution of the regulatory environment. Policy decisions and regulatory actions will determine to what extent fintech will penetrate and ultimately impact financial stability for years to come.

“From its earliest days, financial services has successfully achieved higher levels of efficiency, speed and cost reduction, through the use of technology, but the current fintech revolution may deliver results that far surpass the benefits we’ve seen in the past,” says Andrew Gray, managing director and group chief risk officer at DTCC.

“Recent innovations, such as distributed ledgers, cloud computing, artificial intelligence and robotics, have the potential to transform the global marketplace and produce significant changes in everything from market structure to post-trade processing.”

As the functional and geographical breadth of fintech grows larger, the discussion needs to evolve to also focus on the potential systemic risks posed by these new technologies and their impact on financial stability – both positive and negative, he adds. “For all the investment in fintech and experimentation occurring today, we are still in the early days, making it the opportune time for the industry to thoughtfully consider this question.”

DTCC believes fintech is likely to have a greater systemic impact through key transformational mechanisms, such as the disintermediation of incumbents, disaggregation of financial services and decentralisation of networks.

These effects, along with fintech’s potential to fundamentally alter competitive forces, market dynamics, financial inclusion, consumer rights and many other areas, could strengthen or weaken overall financial stability. For DTCC, this is a subject of “great concern” given its role as a critical market infrastructure and its mission of protecting the stability and integrity of the global financial system.

The whitepaper also notes that regulators around the world have also taken notice of fintech’s growing prominence. A global survey launched by the Financial Stability Board’s Fintech Issues Group in February indicated that 20 out of 26 jurisdictions that were surveyed had taken some measures to respond to fintech, with five additional jurisdictions planning to follow suit.

“The importance of the regulatory context in which fintech companies operate cannot be overstated,” says Gray. “Policy decisions and regulatory actions will determine to what extent fintech will impact financial stability for years to come.”

Earlier at Sibos, Petra Hielkema, division director payments and market infrastructure at De Nederlansche Bank, said regulators are entering “new territory” with fintech. Dialogue between banks and fintechs will help them to navigate the issues.

“All of the new fintech companies and banks are ultimately dealing with the trust of consumers and with financial stability,” she said. “We think it is great to see all the innovations and we think they are good. What we strive for as a central bank is efficient, robust, safe and accessible payments. The focus for us as a regulator is safety and robustness. Fintechs coming in is great for technology, but they are dealing with other people’s money and that means safety is paramount.”

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