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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.
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.