How FinTech is Changing the Game for Banks and Customers

Key Takeaways

• FinTech refers to the use of technology-enabled innovations in the financial sector, such as digital lending, digital capital raising, and online payments.
• FinTech and competition have a double-edged sword effect on the financial sector. They can bring benefits to customers and the economy, but they can also pose challenges to financial stability and regulation.
• FinTech and stability have a balancing act effect on the financial sector. They can improve the performance and resilience of the financial system, but they can also create new risks and challenges that require adequate regulation and supervision.
• FinTech and regulation have a catch-up game effect on the financial sector. They can foster a more inclusive, innovative, and competitive financial sector, but they can also require a more adaptive, proactive, and coordinated regulatory approach.
• FinTech is changing the game for banks and customers, as well as for stability and regulation. FinTech can bring many benefits and opportunities to the financial sector, but it can also pose many challenges and risks to the financial sector.

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Fintech Vs Banks

Have you ever wondered how technology is transforming the world of finance?

How new players are challenging the traditional banks and offering more choices, convenience, and efficiency to customers?

How these innovations are affecting the stability and resilience of the financial system?

If you are curious about these questions, you are not alone. FinTech, or financial technology, is a hot topic that has attracted the attention of policymakers, academics, and practitioners alike. FinTech refers to the use of technology-enabled innovations in the financial sector, such as digital lending, digital capital raising, and online payments. FinTech has experienced rapid growth in recent years, reaching over $25 billion in transaction volumes globally in 2020, excluding China.

But what does FinTech mean for you, as a customer, a borrower, an investor, or a saver?

How does FinTech affect the way you access and use financial services?

And what are the risks and opportunities that FinTech brings to the financial system?

In this blog post, we will try to answer these questions and more based on the publication by IMF titled "Does FinTech Increase Bank Risk Taking?" and authored by Selim Elekdag, Drilona Emrullahu, and Sami Ben Naceur.

So, let’s dive in!

FinTech and Competition: A Double-Edged Sword

One of the main effects of FinTech is that it increases competition in the financial sector.

FinTech firms offer new products and services that can be cheaper, faster, and more convenient than those of traditional financial institutions (FIs), such as banks and non-banks. For example, FinTech firms can use alternative data and algorithms to assess the creditworthiness of borrowers who may not have a formal credit history or collateral. This can expand access to finance for previously underserved segments of the population, such as small businesses, low-income households, and young people.

As a customer, you may benefit from FinTech competition in several ways.

• You may have more options to choose from, more transparency to compare prices and quality, and more convenience to access financial services anytime and anywhere.
• You may also enjoy lower fees, better interest rates, and faster processing times. For instance, imagine that you need a loan to start a new business, but you don’t have a good credit score or enough collateral to get a loan from a traditional bank.
• You may turn to a FinTech platform that offers balance sheet lending, which means that the platform manages the entire loan process, from collecting applications to servicing payments, and assumes the financial risk if loans go unpaid. The platform may use your online activity, social media connections, and other alternative data to evaluate your creditworthiness and offer you a loan with a competitive interest rate and flexible repayment terms. You may receive the loan within minutes or hours, instead of days or weeks, and start your business right away.

However, FinTech competition also has a downside.

It can put pressure on the profitability and stability of traditional FIs, which may respond by taking on more risks to maintain their market share and margins. For example, traditional FIs may lower their lending standards, increase their leverage, or invest in riskier assets, such as cryptocurrencies or derivatives. These actions may increase the likelihood of financial distress or failure, especially in times of economic downturn or market turmoil. For instance, imagine that you have a deposit account with a traditional bank that faces intense competition from FinTech firms. The bank may try to boost its profits by lending more money to risky borrowers or by investing in volatile assets. If some of these borrowers default on their loans or if the value of these assets drops sharply, the bank may suffer losses that exceed its capital buffer. The bank may then become insolvent and unable to repay your deposit unless it is bailed out by the government or another entity.

Therefore, FinTech and competition have a double-edged sword effect on the financial sector. They can bring benefits to customers and the economy, but they can also pose challenges to financial stability and regulation.

FinTech and Stability: A Balancing Act

Another important effect of FinTech is that it influences the stability and resilience of the financial system.

FinTech can enhance financial stability by improving efficiency, transparency, and diversification in financial services.

FinTech can also reduce financial stability by increasing complexity, interconnectedness, and cyber risks in the financial system.

As a customer, you may benefit from FinTech stability in several ways.

• You may have more efficient and transparent financial services that reduce information asymmetry, transaction costs, and agency problems.
• You may also have more diversified financial services that reduce concentration risk, systemic risk, and contagion effects. For example, imagine that you want to invest some of your savings in a new project that promises high returns, but you don’t have enough information or expertise to evaluate its feasibility and profitability. You may turn to a FinTech platform that offers peer-to-peer (P2P) lending, which means that the platform connects borrowers and investors directly, without intermediaries. The platform may provide you with detailed information and ratings about the project and the borrower, as well as the terms and conditions of the loan.
• The platform may also allow you to diversify your investment by lending small amounts to multiple borrowers across different sectors and regions. You may then enjoy higher returns, lower costs, and lower risks than if you invested in a traditional financial institution or a single project.

However, FinTech stability also has a downside.

• It can increase the complexity, interconnectedness, and cyber risks in the financial system, which may amplify shocks and vulnerabilities. For example, FinTech firms may use sophisticated technologies and algorithms that are difficult to understand, monitor, and regulate.
• FinTech firms may also create new linkages and dependencies among different types of financial actors, such as banks, non-banks, platforms, and customers.
• FinTech firms may also expose the financial system to new sources of cyberattacks, fraud, and data breaches, which may compromise the security and integrity of financial transactions and data. For instance, imagine that you have a payment account with a FinTech platform that offers online payments, which means that the platform enables you to make and receive payments electronically, without cash or cards. The platform may use advanced encryption and authentication methods to protect your account and transactions from unauthorized access and misuse. The platform may also connect you with other platforms and financial institutions that offer complementary services, such as e-commerce, remittances, and insurance. However, if the platform or any of its partners is hacked, malfunctioning, or mismanaged, you may lose access to your account and transactions, or your personal and financial data may be stolen or leaked. You may then suffer losses, damages, or identity theft, and you may have limited recourse or compensation.

Therefore, FinTech and stability have a balancing act effect on the financial sector. They can improve the performance and resilience of the financial system, but they can also create new risks and challenges that require adequate regulation and supervision.

FinTech and Regulation: A Catch-Up Game

A final effect of FinTech is that it challenges the existing regulation and supervision of the financial sector. FinTech can create regulatory gaps, arbitrage, and inconsistencies, as well as regulatory opportunities, innovations, and collaborations. FinTech can also affect the objectives, instruments, and institutions of financial regulation and supervision.

As a customer, you may benefit from FinTech regulation in several ways.

• You may have more regulatory opportunities and innovations that enhance consumer protection, market integrity, and financial inclusion.
• You may also have more regulatory collaborations and coordination that foster cross-border cooperation, harmonization, and standardization. For example, imagine that you want to send money to your family or friends abroad, but you face high fees, long delays, and cumbersome procedures from traditional money transfer services. You may turn to a FinTech platform that offers online remittances, which means that the platform allows you to send and receive money across borders quickly and cheaply. The platform may use blockchain technology and digital currencies to facilitate fast and secure cross-border payments, without intermediaries or intermediation fees.
• The platform may also comply with the relevant regulations and standards in the countries where it operates, such as anti-money laundering, counter-terrorism financing, and data protection rules. The platform may also cooperate with other platforms and regulators to ensure a smooth and safe transfer of funds and information.

However, FinTech regulation also has a downside.

• It can create regulatory gaps, arbitrage, and inconsistencies that undermine financial stability, competition, and innovation. For example, FinTech firms may operate outside or across the existing regulatory frameworks and jurisdictions, which may create loopholes, ambiguities, and conflicts.
• FinTech firms may also exploit the differences and discrepancies among different regulators and regulations, which may create unfair advantages, distortions, and spillovers.
• FinTech firms may also face regulatory uncertainty and complexity, which may hamper their growth, development, and innovation. For instance, imagine that you want to raise funds for a new venture, but you don’t have access to traditional sources of finance, such as banks or capital markets. You may turn to a FinTech platform that offers digital capital raising, which means that the platform enables you to issue and sell securities, such as equity or debt, to investors online. The platform may use crowdfunding or initial coin offering (ICO) models to attract a large number of investors with small amounts of money. The platform may also operate in a regulatory gray area, where the legal status and obligations of the platform, the issuer, and the investor are unclear or undefined. The platform may also face different and conflicting regulations and requirements in different countries, which may limit its scope and scale. The platform may also encounter regulatory changes and challenges, which may affect its viability and sustainability.

Therefore, FinTech and regulation have a catch-up game effect on the financial sector. They can foster a more inclusive, innovative, and competitive financial sector, but they can also require a more adaptive, proactive, and coordinated regulatory approach.

Conclusion: FinTech and the Future of Finance

FinTech is changing the game for banks and customers, as well as for stability and regulation. FinTech can bring many benefits and opportunities to the financial sector, such as lower costs, higher returns, greater access, and better quality. FinTech can also pose many challenges and risks to the financial sector, such as lower profits, higher volatility, greater complexity, and less clarity.

As a customer, you can take advantage of FinTech to improve your financial well-being and experience, but you also need to be aware of the potential pitfalls and trade-offs. You need to be informed, responsible, and vigilant when using FinTech services, and you need to protect your personal and financial data and interests.

As a regulator, you need to keep up with FinTech developments and innovations, and you need to balance the objectives of financial stability, consumer protection, market integrity, and financial inclusion. You need to be flexible, responsive, and collaborative when regulating FinTech services, and you need to adopt a risk-based, activity-based, and technology-neutral approach.

FinTech is not a panacea or a peril for the financial sector, but a powerful and pervasive force that is reshaping the future of finance. FinTech is here to stay, and it is up to us to make the most of it.

Disclaimer: The views expressed in this blog are not necessarily those of the blog writer and his affiliations and are for informational purposes only.

Read my other posts here: Conventional Finance - FinFormed, Islamic Finance - FinFormed, Takaful - FinFormed, Career - FinFormed and Randow Writings - FinFormed

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