Fintech – beware of ‘geeks’ bearing gifts?

There has been much hype recently about the potential for fintech[1] to transform financial services, and improve consumer welfare. But, there have been few objective assessments of the potential impact. Therefore, today we are publishing a discussion paper to generate better informed debate.

In the paper we consider: what is changing and not changing in financial services due to fintech; the potential benefits and risks; and conclude with a set of policy questions which need to be answered to ensure the benefits are harnessed, and risks mitigated.

The primary roles of financial services (banking and payments, asset allocation, credit creation, insurance and risk management) will not fundamentally change. But, what is changing is how these primary roles and activities are carried out. The complex ecosystem of financial institutions and financial professionals will change and new types of organisation, roles, and professionals with different skill sets are emerging. Consumers will be forced to change, too, and they will have to develop new skills.

All the main retail financial sectors (banking and payments, credit, pensions and asset management, life and general insurance) are being ‘disrupted’ by fintech – some more than others. The huge capital, wholesale, institutional and reinsurance markets that make up the global financial system and markets and sit behind more visible retail finance are also affected. Fintech is also becoming an economic success story for the UK – particularly the City of London.

But we cannot assume fintech is beneficial just because it is new and exciting. We must objectively consider: the potential risks and benefits; and whether fintech will improve the economic and social utility of financial markets and services by enabling those primary roles and activities to be undertaken more effectively for the benefit of households and real economy.

Proponents have been almost evangelical in their beliefs about fintech – and we agree that there will be real benefits for some consumers able to access better value, more suitable, personalised products and services. Used effectively fintech could reduce the costs of gathering and processing information so aiding financial inclusion. Fincapps[2] could be deployed intelligently to improve financial behaviours to bolster financial capability and financial resilience. Fintech also has the potential to help consumers better understand how their money is invested to promote more sustainable markets and hold corporates to account.

But, despite the claims about fintech (particularly about blockchain technology), not much tangible benefit has emerged yet. At the aggregate level, so far we see little reason to believe fintech will produce the same stepchange as, for example, the humble ATM, debit card, and direct debit. To be fair, it’s early days. We hope we are wrong and fintech delivers the much needed transformation of retail financial services. But the hype does not match even a cursory objective assessment of the potential.

However, there are numerous potential very serious risks and detriments which have not been considered in any real detail. We group these risks and detriments into: outright scams and fraud; greater difficulties with rights and redress; higher costs, greater value extraction in the supply chain; major conduct of business risks including greater risk of misselling and misbuying by consumers[3]; transition risks, disruption of established financial services; greater financial exclusion and discrimination; corporate governance and cultural risks; and regulatory risks. These risks and detriments exist in the ‘analogue’ financial world. But, fintech and big data analytics will heighten these risks.

Open Banking and the coming into force of the 2nd Payment Services Directive (PSD2) presents a serious imminent risk which regulators, the financial services industry, and consumers are simply not prepared for.

In an era of more complex, fragmented, fast moving financial markets financial regulators face a much more difficult challenge protecting consumers and making those markets work for consumers and the real economy. We need to upgrade our analogue financial regulation for the digital finance world.

Growth in fintech isn’t occurring because fintech is guaranteed to generate beneficial creative destruction or is truly ‘progressive’[4]. Nor will it be consumer demand led. Rather, fintech will grow because so many opinion formers and influencers (investors, fintech developers, policymakers, regulators, media, and consumer groups) believe in it. The fintech genie cannot be put back into the bottle but it should be contained. The challenge now is to harness the potential for good, and identify more precisely how risks will materialise in different sectors, the potential scale of the risks (which all depends on take up), and how to manage the risks.

We have set out a series of questions which we believe will help us deal with those challenges. We look forward working with partners over the coming year on this hugely important issue.

The summary of the paper can be found here: Fintech – Beware of geeks bearing gifts FIC Discussion Paper Summary

The full paper can be found here: Fintech – Beware of geeks bearing gifts FIC Discussion Paper Full

[1] When we refer to ‘fintech’ we include the full range of digital finance technologies, big data analytics, artificial intelligence/ machine learning, algorithmic trading, distributed ledger technology and so on.

[2] Financial inclusion and financial capability apps

[3] It is important to note that these conduct of business risks will be an issue in wholesale and institutional markets, not just retail financial services

[4] In that it will significantly improve the financial and social welfare of households and the efficiency with which financial markets serve the real economy – although we are at pains to emphasise there will be some benefits

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