The modern financial services industry drastically differs from the one we had ten or even five years ago. As the pace of technological advancements accelerates, no industry can remain untouched. Banking is an industry especially touched and transformed by technology and emerged new types of players.
However, advancements of any kind always come with certain sacrifices. The efficiency of automation often lacks individuality and customization; also, the speed of underwriting often comes with significant risks of bad loans portfolio.
Both national and global governmental structures recognize rapid changes and pay close attention to them in order to anticipate possible risks and opportunities. Thus, in one of the most recent reports by the World Economic Forum (WEF) on the role of financial services in society, the organization recognized the six most important risks faced by the financial services industry.
Alternative sources of finance
As expected, WEF believes that the substitutes to capital available from traditional financial institutions (such as marketplace lending platforms) pose a certain threat to the stability of banks. While they certainly foster financial inclusion by enabling access to capital to those commonly rejected by banks, alternative sources also carry almost all the same financial risks that are associated with traditional credit products.
In addition to the potentially flawed risk management of the alternative financing sources, WEF suggests that in some cases, those businesses may shift the risk towards the customer with potentially significant losses carried by investors.
Companies like Robinhood, Wealthfront, Nutmeg and a range of other robo-advisors brought in a whole new way of trading assets. Not only have these companies significantly democratized trading, but have also engaged in passionate debates around the appropriate use of trading algorithms and the actual vs. perceived level of liquidity in global capital markets. Despite regulatory actions taken to ensure that capital markets incorporate factors of safety and testing, WEF believes this remains an area of intense scrutiny.
Security of data
Cybersecurity has always been and is expected to remain one of the most dangerous plagues of financial services industry. With the value of loss due to fraudulent activities in online banking expected to hit $7 billion by 2020, it is the number one priority to viability and sustainability of the whole industry. As businesses increase their reliance on technology and continue to amass larger stores of data, it becomes increasingly important (and difficult) to ensure resilient systems are in place to safeguard information, as WEF suggests.
It is important for industry participants to share the best practices and data on cyberattacks in order to improve existing security systems and adjust them to evolving risks.
Often lacking attention, the matter of professional misconduct is an important one. Misconduct is believed to be one of the largest sources of technology-driven risk as technology can significantly boost the potential of illicit actions that have evaded detection. In addition, because of the fact that technology often is far ahead of regulatory capabilities, deployed tech-powered innovation may lack control and bring potential compliance risks.
Some uncertainty also exists around the ownership of customer data and what is considered appropriate use of this information. The fight for maximally accurate underwriting will always encounter a data privacy issue, which is why there needs to be a distinguished line between enhanced risk analysis and use of data to refuse in credit to a particular customer.
Payments has been one of the hottest segments within the financial services industry. The highest number of FinTech disruptors supported by VCs are usually innovating payments. The face of industry has changed and now payments are not part of the banks or network providers exclusively. Services like PayPal and Alipay have drastically changed the perception of payments and customer expectations. Previously pure tech companies are now at the forefront of innovation in payments and dominate the market.
With tech-powered innovation, the risks, however, are still the same. Across the globe, countries are working to improve the resiliency of their payment rails and have also begun to develop new systems (EMV, blockchain-powered solutions, etc.) and stores of value which may actually impact the effectiveness of monetary policy and transmission mechanisms, as WEF reports.
We have already discussed the issue of regulating the technology-driven innovation, and WEF joins the part of the professional society to acknowledge the importance of clarifying the regulatory framework. Moreover, as WEF believes, the regulatory remit is often not consistently defined across countries and is based on a company’s legal entity designation vs. the financial activities that it engages in. It allows some businesses to fall through the supervisory cracks, reduces the portability of business models and stifles innovation.