Emerging firms are quickly making inroads into critical financial services, and often taking on more risk than traditional banks.
Technology sometimes moves at a dizzying pace. When it comes to
innovation in financial activities, often referred to as FinTech, the
world is seeing major advances.
For banks, FinTech disrupts core financial services and pushes them
to innovate to remain relevant. For consumers, it means potentially wider access to better services.
Such changes also raise the stakes for regulators and
supervisors—while most individual FinTech firms are still small, they
can scale up very rapidly across both riskier clients and business
segments than traditional lenders.
This combination of fast growth and increasing importance of FinTech
financial services for the functioning of financial intermediation can
come with system-wide risks, which we cover in our latest Global Financial Stability Report.
Adding risk
Digital banks are growing in systemic importance in their local
markets. Also known as neobanks, they are more exposed than their
traditional counterparts to risks from consumer lending, which usually
has fewer buffers against losses because it tends to be more
uncollateralized. Their exposure also extends to higher risk-taking in
their securities portfolio, as well as higher liquidity risks
(specifically, liquid assets held by neobanks relative to their deposits
tend to be lower than what would be held by traditional banks).
These factors also create a challenge for regulators: the risk
management systems and overall resilience of most neobanks remain
untested in an economic downturn.
Not only do FinTech firms take on more risks themselves, they also
exert pressure on long-established industry rivals. Look for instance at
the United States, where FinTech mortgage originators follow an
aggressive growth strategy in periods when home lending is expanding,
such as during the pandemic. Competitive pressure from FinTech firms
significantly hurt profitability of traditional banks, and this trend is
set to continue.
Another technological innovation, which has grown rapidly in the
past two years, is decentralized finance, a crypto-based financial
network without a central intermediary. Also known as DeFi, it offers
the potential of delivering more innovative, inclusive, and transparent
financial services thanks to greater efficiency and accessibility.
However, DeFi also involves the buildup of leverage, and is
particularly vulnerable to market, liquidity, and cyber risks.
Cyberattacks, which can be severe for traditional banks, are often
lethal for these platforms, stealing financial assets and undermining
user trust. The lack of deposit insurance in DeFi adds to the perception
of all deposits being at risk. Historically, large customer withdrawals
often follow news of cyberattacks on providers.
DeFi activities mainly occur in crypto-asset markets, but growing
adoption by institutional investors has strengthened the links to
traditional financial institutions. In some economies, DeFi is helping
to accelerate cryptoization, in which residents embrace crypto assets instead of the local currency.
IMF
© International Monetary Fund
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