Five years ago, if you mentioned the word ‘FinTech’ to somebody, they would probably shoot you a blank stare and not have any clue as to what you were talking about. Now, in 2016, it is perhaps one of the biggest buzzwords in finance – with many at the World Economic Forum in Davos, Switzerland this past January speaking of FinTech. The financial world’s de facto acronym for financial technology, FinTech, is a rising industry that applies technological innovations to financial processes, products and services.
However, the use of technology in finance is not new; rather, it is the novel application of technology and its speed of evolution that makes the current wave of innovation unlike any we have ever seen before. Although there are clear benefits FinTech affords, the financial sector needs to recognize the associated risks as well, working together with the public sector to mitigate these risks and ensuring the financial industry and its customers can benefit from what new technology has to offer.
This past January, economic advisors from all around the world and experts from the industry convened in Davos, Switzerland for the annual World Economic Forum (WEF). This year’s theme: “The Role of Financial Services in Society – Understanding the impact of technology enabled innovation on financial stability”. The aim of this meeting was to foster competition between traditional financial institutions and new entrants, while preserving system stability in the time of technological advancements.
The WEF’s report identified six big advantages to FinTech:
1. Increased competition
2. Increased collaboration
3. Diversification of risk
4. Improved risk management
5. Lower costs
6. Increased access to financial services through means such as smartphones.
But along with the advantages of technological innovations, come a new set of risks to the financial services industry. Activities such as risky peer to peer lending from inexperienced investors, the exploitation of trading algorithms (i.e. dark pools), the securitization of large stores of data, misconduct, and arbitrage could affect monetary policy worldwide, potentially far outweighing any positive contributions arising from technological innovations.
To combat these existential risks, members of the World Economic Forum set four key recommendations for stopping FinTech companies creating systematic risk. These are:
1. Debate on the ethical use of data
2. Set up a global public-private forum for discussion of technological innovation in finance
3. Create international standards for monitoring FinTech startups
4. Set up a private sector’s standards body that enforces good conduct at new players in the market.
The explosion of FinTech demands a joint effort on oversight and creates an urgent need for collaboration to spur competition while preserving stability. Influential executives from some of the world’s biggest banks should create public-private relationships to lead the way in developing regulations for the burgeoning financial technology industry.
Governments also need to do their part by creating bodies that would enable them to govern technologies that are transforming everything from the capital markets business to consumer payments. We have already seen some progress in governmental agencies studying and implementing practices on FinTech: in the US, agencies including the Treasury Department and Consumer Financial Protection Bureau have been studying ways to bring new systems under existing regulatory frameworks; in the UK, the Financial Conduct Authority is developing a system aimed at spurring innovation, including a model that allows companies to test new products with guidance from regulators themselves.
Within FinTech, tremendous potential still awaits. FinTech firms are developing their own industry, and while setting out to bypass banks and be more agile in meeting their customers’ demands, financial firms are increasingly banding together to develop their own technology-driven services. New technologies pose both competitive threats as well as opportunities to cut costs and bolster profitability – in the end, benefitting the customer.
There is a critical need to understand how the new industry works. When all players in the financial technology business manage risk and maximize potential, FinTech will garner the trust from society and be successful in the long run. FinTech companies entering the financial services market have the potential to digitally disrupt and shrink the role and relevance of today’s big banks. These large banking institutions have been overlooking financial technology and the digitalization of the business for many years. Now, FinTech has found a way to service those who were left out and fill a niche in servicing the once missing digital market.