In response to the changing risk landscape, the Depository Trust & Clearing Corporation (DTCC) published a whitepaper titled, “The Next Crisis will be Different: Opportunities to Continue Enhancing Financial Stability 10 Years after Lehman’s Insolvency.”
In the paper, the DTCC identifies FinTech as one of the most notable changes to the financial services industry and a potential new source of systemic risk.
On the Rise of FinTech
FinTech is playing an increasingly important role in the financial services industry. Investments in FinTech rose from $9 billion in 2009 to $25 billion in 2016. As of 2017, it is estimated that there are more than 10,000 FinTech start-ups worldwide. Moreover, analysts expect these trends to continue.
Estimates by Accenture suggest that up to 35% of the financial services market share may migrate to non-bank players in the next five years.[1] A McKinsey report suggests that 10 to 40% of banks’ revenues could be at risk by 2025 in consumer finance, mortgages, small-business lending, retail payments and wealth management.[2] Additionally, in a survey of financial services executives, 88% of respondents indicated that they are worried that part of their business is at risk to stand-alone FinTech companies in the next few years.[3]
On the Risks of FinTech
While FinTech has the potential to improve many aspects of financial service provision, including risk management, it also presents a new source of systemic risk. In its whitepaper, the DTCC recognizes the challenges associated with FinTech as an increasingly important source of systemic risk in the financial industry.
The paper states that while FinTech does not threaten financial stability currently, “there is also a growing consensus that the use of FinTech should be carefully monitored and thoughtfully supervised to balance the associated risks and rewards.” The growing popularity of cryptocurrencies and cloud-based computer services are specifically mentioned as FinTech applications warranting close supervision.
In the most recent Systemic Risk Barometer Survey, a semi-annual survey conducted by the DTCC, 15% of respondents identify FinTech risk as a significant source of risk. This is the first inclusion of FinTech risk in the survey.
While respondents acknowledge cyber security concerns and geopolitical risks as the primary threats to global financial security, the concern expressed by 15% of respondents is a healthy reminder of the risks associated with FinTech.
Assessing Credit Quality in the Digital Age
While the paper above highlights the risk of FinTech, the FDIC has published a fascinating study on the use of digital footprints in assessing credit quality. The paper entitled “On the Rise of the FinTechs—Credit Scoring using Digital Footprints” (the findings of which suggest near revolutionary implications) analyzes the use of consumer digital behavior in predicting default. The authors state that their findings suggest that the power of this information is on par with that of credit information typically used in bank underwriting. The authors state as follows:
Furthermore, the discriminatory power for unscorable customers is very similar to that of scorable customers. Our results have potentially wide implications for financial intermediaries’ business models, for access to credit for the unbanked, and for the behavior of consumers, firms, and regulators in the digital sphere.
Assuming these findings hold true, this can and would significantly impact the industry. Recall the credit bureaus recently suspended the use of tax lien filings from their credit reports due to an issue with accuracy. Although many lenders still use such information, but obtained from other sources, it at least suggests that there may be more easily accessible ways to evaluate credit risks. This of course would further streamline processes for consumers and could reduce costs and increase efficiency for lenders.
In a rapidly changing environment, it is difficult to forecast out to any significant time horizon. The financial sector is moving into that category and is becoming much less predictable.
[1] McIntyre, A. (2017, July 7). Banks Haven’t Gone the Way of Blockbuster — Yet.
[2] Dietz, M., Khanna, S., Olanrewaju, T., & Rajgopal, K. (2016). Cutting Through the Noise around Financial Technology.
[3] PwC. (2017). Redrawing the Lines: FinTech’s Growing Influence on Financial Services.
How to cite this blog post (APA Style):
Premier Insights. (2018, October 11). Financial Sector Risk in A Digitally-Dominant World [Blog post]. Retrieved from https://www.premierinsights.com/blog/financial-sector-risk-in-a-digitally-dominant-world.
