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LONDON, June 27 (IFR) - National authorities and international bodies should consider the impact of fintech on financial stability when undertaking regulatory risk assessments and developing regulatory frameworks, the Financial Stability Board has warned.
In a report on fintech's financial stability implications, the FSB said that higher consumer expectations, evolving technology and changes in financial regulation and market structure had driven rapid growth in the fintech industry, leading some firms to develop without the necessary risk management expertise, while many may underestimate the level of risk they are taking on.
"Regulators need to understand the impact that developments in fintech can have on financial stability, especially given the rapid rise of innovation in this space," said Carolyn Wilkins, senior deputy governor at the Bank of Canada and chair of the FSB's fintech issues group.
The FSB identified three priorities to improve international monitoring of the new breed of players that include retail payment systems, fintech credit, robo-advisers, blockchain-based wholesale payment systems, privately issued digital currencies and artificial intelligence. It called on authorities to manage operational risk form third-party service providers, mitigate cyber risks, and monitor macro-financial risks that could emerge as fintech activities continue to expand.
The FSB also noted a dearth of data for monitoring the sector as many firms fall outside of the regulatory net. That has forced authorities to rely on consultant estimations in their regulatory responses to the growing sector.
A stock-take of the regulatory approaches across 26 jurisdictions found that while 20 have taken some fintech-specific measures, only eight explicitly mention financial stability as part of policy considerations to-date, focusing instead on consumer protection and micro rather than macro-level regulation.
Potential fintech benefits were identified, including decentralisation, increased intermediation by non-financial entities, efficiency, transparency and competition, but the sector was deemed vulnerable to a variety of financial and operational risks that could be amplified by fintech business models and pose a risk to the provision of critical financial services.
For example, large and unexpected losses incurred on a single fintech lending platform could lead to contagion across the sector, the FSB warned. Many firms are also prone to pro-cyclicality as the presence of retail investors on lending platforms may exacerbate large sentiment swings, while social trading and robo-advice can lead to herding behaviour.
The quest for speed and efficiency can also give rise to excess volatility. Algorithmic traders, for example can rapidly withdraw from the market during periods of stress when liquidity demands are high.
The FSB raised concerns around the evolution of fintech business models if expansion continues at the current rate. The report highlighted a growing number of fintech lending platforms offering "sell-out" options that allow investors to exit investments prior to maturity for a fee. The FSB said such clauses could lead to maturity mismatches.
The report said some fintech lending and crowdfunding platforms are able to borrow funds to finance temporary holdings of bonds or equities, while some are beginning to add leverage by using their own balance sheet to fund loans.
Cyber risks were also singled out for concern given the increased susceptibility when more systems are connected.
"Although many of these issues are not new, they may be accentuated given the speed of growth of fintech, new forms of interconnectedness and increased dependencies on third-party service providers," said the report.
"All of the issues identified are building blocks for ensuring a strong, sustainable and resilient financial system as innovations in financial services evolve and are adopted." (Reporting by Helen Bartholomew)