Fintech could be risky if banks don't cooperate, says the Bank for International Settlements

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Banks are already beginning to use technology such as facial recognition (Source: Getty)

Banks will need to take measures over the coming years to mitigate the risks of financial technology (fintech), according to a new report from the Bank for International Settlements (BIS).

The central bankers' bank has set up a task force to “provide insight” into the new technology and “explore the implications” for current business models.

In its latest consultative report, it advised banks that they must cooperate with public authorities and each other to stay abreast of technological developments and minimise potential threats.

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“Banks will find it increasingly difficult to maintain their current operating models, given technological change and customer expectations,” the report stated. “The current position of incumbent banks will be challenged in almost every scenario.”

It noted that while research from McKinsey & Co in 2015 estimated that between 10 and 40 per cent of revenues and 20 and 60 per cent of retail banking profits could be put at risk by fintech over the next 10 years, other market observers saw the developments as more positive.

Banks should investigate and explore new technologies to improve their own efficiency, the report said, and avoid the risk of losing business to new market entrants.

But fintech could introduce or increase strategic, operational, cyber and compliance risk, the BIS found. It recommended that banks should have strong governance and risk management processes in place, without inhibiting innovation in the sector.

It also advised institutions to vet any outsourcers through a thorough due diligence process, saying that any risks and liabilities incurred during the operations would remain with the bank.

Since fintech developments are expected to raise issues which go beyond prudential supervision and into public policy areas such as data privacy and consumer protection, the BIS advised banks to foster a cooperative relationship with public authorities across borders.

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The BIS's fintech scenarios for the future

The better bank: Modernisation and digitisation of incumbent players

If banks were to modernise themselves through adopting technologies such as cloud computing, artificial intelligence and distributed ledger technology, they could get better at providing services, the BIS said.

The new bank: Replacement of incumbents by challenger banks

However, new players could prove just too agile in their ability to push the boundaries of technology, the report warned. In this scenario, new banks or tech companies with a banking branch could steal market share.

The distributed bank: Fragmentation of financial services among fintech firms and banks

Incumbent banks could carve out enough of a niche to survive, but other services could be provided by any fintech firm. Consumers would use multiple financial service providers, rather than just sticking with one bank for all their needs.

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The relegated bank: Incumbent banks become commoditised service providers and customer relationships are owned by new intermediaries

Fintech and other technology companies could use front-end customer platforms to offer a variety of financial services from a diverse group of providers. They would use incumbent banks for their banking licenses, to provide core commoditised banking services like lending and deposit-taking, and the relegated bank may or may not keep the balance sheet risk of these activities depending on the contractual relationship.

The disintermediated bank: Banks have become irrelevant as customers interact directly with individual financial services providers, for instance by using distributed ledger technology

In this case, incumbent banks would no longer be a significant player because there would be no need for a trusted third party or for balance sheet intermediation. Customers could have a more direct say in choosing the services and the provider. This futuristic scenario can be seen in its nascent form in peer-to-peer lending platforms and cryptocurrencies.

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Tags: FinTech