WEF: Here are the 6 biggest risks in fintech

The World Economic Forum is calling for governments, established finance players, and fintech (financial technology) startups to band together and draw up more rules and regulations to stop the wave of new fintech players becoming a systematic risk to economies.

In a report co-authored by consultancy Oliver Wyman, the Davos organiser says: "As legacy business models and long-held value propositions in financial services are reshaped by these new ideas, key actors in the system must work to ensure economic growth does not come at the expense of systemic stability."

The report, titled "Understanding the impact of technology-enabled innovation on financial stability", says that: "The financial sector is at an inflection point", with nimble fintech startups "disintermediating" the jobs traditionally done by big banks.

In other words, finance is moving from being a bunch of one-stop-shops where you can get your mortgage but also trade shares and take a pension, to a bunch of specialised players that can focus on one area thanks to the lower overheads allowed by technology.

The report says:

Use of technology in finance is not new, nor are many of the products and services that are offered by new entrants to the sector. Rather, it is the novel application of technology and its speed of evolution that make the current wave of innovation unlike any we have seen before in financial services.

WEF and Oliver Wyman identify six big advantages to fintech: increased access to financial services through things like your smartphone, lower cost, improved risk management, diversification of risk, increased collaboration, and increased competition.

But the report warns that "technology-enabled innovations bring a new set of risks to the financial system, both conduct and prudential, and has implications for human capital (e.g. increased automation leading to fewer employees)."

Here are the six key risks WEF and Oliver Wyman identify:

1. Alternative lending: The report warns that consumers could face big losses from things like peer-to-peer lenders, which lets people lend their money directly to businesses and people. "Even if alternative sources of credit are monitored appropriately, many actually shift risk to the end consumer - which has the potential for sizeable losses to be directly incurred by average investors who may not understand the product or its associated risks."
2. Market electronification: The report says that high-frequency trading, dark pools, and the use of alternative trading platforms "remains an area of intense scrutiny."
3. Data security: "As businesses increase their reliance on technology and continue to amass larger stores of data, it becomes increasingly important (and difficult) to ensure resilient systems are in place to safeguard information."
4. Misconduct: "While technology-enabled innovation has the potential to support oversight functions in monitoring employee activities, it may simultaneously act as an amplifier of illicit actions that have evaded detection (e.g. predatory algorithmic trading activity). Moreover, heightened shareholder expectations and intense competition may incent the mainstreaming of new technology-enabled innovations before the requisite control environment for risk and compliance is in place."
5. Payment effectiveness: New methods of sending money, such as using the rails of bitcoin or other distributed ledger technology, "may actually impact effectiveness of monetary policy and transmission mechanisms."
6. Regulatory arbitrage: "In many instances, the pathway to compliance when deploying a new type of innovation is unclear. Furthermore, the regulatory remit is often not consistently defined across countries and is based on a company's legal entity designation vs the financial activities that it engages in. This rigid definition of the regulatory remit allows for some businesses to fall through the supervisory cracks, reduces portability of business models and stifles innovation."

Adair Turner, the former Chairman of the Financial Services Authority, issued a similar warning to the WEF's on peer-to-peer lending, saying in February: "The losses which will emerge from peer-to-peer lending over the next five to 10 years will make the bankers look like lending geniuses."

However Samir Desai, CEO of peer-to-peer small business lender Funding Circle, has defended the industry, telling the AltFi Europe conference: "I don't agree with some of the credit assessment stuff and I think many platforms have invited Lord Turner in to view our processes, reassure him, because I think it is important that we tackle this criticism head-on rather than just shout him down."

The WEF and Oliver Wyman have four key recommendations for stopping fintech in all its guises transforming into a systematic risk. They are: a debate on the ethical use of data; setting up a global public-private forum for discussion of technological innovation in finance; international standards for monitoring fintech startups; and setting up a private sector standards body that enforces good conduct at new players in the market.

You can read the full WEF and Oliver Wyman report here.

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