Fintech Risks and Benefits--DR. Emmanuel Moore ABOLO

DR. EMMANUEL MOORE ABOLO
GMD/CEO, The Risk Management Academy Limited
President, Institute for Governance, Risk Management & Compliance
Professionals
President, Professional Speakers Society of Nigeria &
Director General, The Economic Thinktank Centre
Benefits and Associated Risks of Fintech Operations

OUTLINE
 WHAT IS FINTECH?
 FINTECH ECOSYSTEM
 BENEFITS OF FINTECHS
 ASSOCIATED RISKS IN FINTECHS
 MANAGING FINTECH RISKS
BENEFITS AND RISKS OF FINTECH 2

WHAT IS FINTECH?
 Financial technology [fintech or FinTech] is the technology and innovation that
aims to compete with traditional financial methods in the delivery of financial
services.
 It is an industry that uses technology to improve activities in finance.
 The use of smartphones for mobile banking, investing, borrowing services,
and cryptocurrency are examples of technologies aiming to make financial
services more accessible to the general public.
 Fintech companies consist of both startups and established financial
institutions and technology companies trying to replace or enhance the usage
of financial services provided by existing financial companies.
 The BCBS has opted to use the Financial Stability Board’s (FSB) working
definition for fintech as “technologically enabled financial innovation that could result
in new business models, applications, processes, or products with an associated
material effect on financial markets and institutions and the provision of financial
services”.

FINTECH VARIANTS
• Bankingtech – Also known as banktech refers to the new age technologies
created for the banking systems typically using methods like Artificial Intelligence
[AI] and Machine Learning [ML].
• Wealthtech – They offer a new way of investing money by leveraging technology
and expert financial knowledge.
• Insure tech – Also known as insurtech is the use of technology innovations
designed to improve the efficiency of the insurance industry.

WHAT IS FINTECH?

FINTECH ECOSYSTEM

DRIVERS OF FINTECH GROWTH

BENEFITS OF FINTECHS
Price • Advice and risk assessment automation reduces the need for human
intervention, lowering costs and reducing barriers to entry.
• Single and targeted offerings rationalize the cost of maintaining and
servicing multiple systems and legacy contracts.
• Collective intelligence distilled through data analytics offers
customers insight without the cost of high-touch activities.
• Dashboards offer users real-time feedback on investment activity and
performance.
Convenience • Fintechs utilize big data analytics to offer quick, paperless credit checks
that can draw on numerous sources including social media to assess credit
applicants online.
• User-friendly online tools allow users to configure their repayment amounts
and repayment schedule based on their capacity and needs.
Access • Demographics locked out of high-barrier investment activities can gain
access to capital and investment opportunities.
• Pooling resources allows shared investment and returns, and donations
and subscriptions are easy to manage for investors and entrepreneurs.
• Integrating systems and investment activities with social media means
projects are visible to others, shareable, and easy to access.

Choice • Decision support systems automate comparison, making product
features visible and comparable in relation to the customer’s needs.
• Referral fees can be lucrative and comparison business models can be
easily adapted to new markets.
• Integration with other platforms further personalizes comparison
services.
Community • Networked communities generate engagement through gamification
mechanisms that emphasize recognition for contributions and performance
(e.g. status, rewards, follower metrics, leaderboards).
• Community-run platforms enable low-cost services that attract a wide
range of users.
• Word-of-mouth from active communities works to attract new users.
Financial
inclusion
• Digital finance has improved access to financial services by under-
served groups. Technology can reach remote locations. Only six out of
10 adults have a bank account, but there are more mobile devices than
people in the world. The promise of digital finance to reach scale,
reduce costs and, if coupled with the appropriate financial capability,
broaden access is unprecedented. Financial services could be
provided to more people with greater speed, accountability, and
efficiency.

Better and more tailored
banking services
Banks are already regulated and know how to bring products to a regulated market.
Fintech companies could help the banking industry improve their traditional offerings
in many ways. Banks may, for example, provide white-label robo-advisors to help
customers navigate the investment world and create a better and tailored customer
experience. Partnerships with fintech companies could also increase the efficiency of
incumbent businesses.
Lower transaction costs
and faster banking
services
Innovations from fintech players may speed up transfers and payments and cut their costs.
For instance, in the area of cross-border transfers, fintech companies in some cases can
provide faster banking services at lower cost.
Improved and more
efficient banking
processes
Innovation may allow the conduct of operations in a safer environment thanks to the use of
cryptographic or biometric technologies and more interoperable systems decreasing the
chances of failure.
Potential positive impact
on financial stability due
to increased competition
The entry of new players competing with incumbent banks could eventually fragment the
banking services market and reduce the systemic risk associated with players of systemic
size;
Regtech Fintech is being used to improve compliance processes at financial institutions. Regulation is
increasing globally but the effective development and application of “regtech” could create
opportunities to, for example, automate regulatory reporting and compliance requirements as
well as facilitate more cross-sectoral and cross-jurisdictional cooperation for improved
compliance [e.g. AML/CFT].

RISKS ASSOCIATED WITH FINTECHS

RISKS ASSOCIATED WITH FINTECHS:ENTITY-WISE
Lack of consumer
understanding
Consumers may not fully understand the nature and risks of the
fintech-related products and services they are being offered.
Mis-selling of products and
services
The adoption of new fintech solutions could inadvertently, or intentionally,
provide new or different ways for manufacturers and distributors of
financial products and services to mislead consumers, or to expose
consumers to fraudulent activities. More complex value chains may also
complicate the responsibilities and accountabilities for redress and
remediation when misconduct occurs.
Financial exclusion The increasing use of big data analytics offers scope for greater price and
availability discrimination, while increasing digitalization may exclude older
and other vulnerable consumers.
Data privacy, security and
protection
Consumers are vulnerable to the loss of data, and may not understand
the ways in which their data are being used.
Reduced competition although the initial influx of new entrants has increased competition, and
niche players are likely to continue to provide competition in some parts of
the value chain, natural economies of scale in technology and data
handling may eventually result in some markets being dominated by a
small number of large firms.
Risks to consumers

Business model
viability
Fintech developments have increased the competitive pressures on many
financial services firms. Some will struggle to survive.
Governance The boards and senior management of firms may not have sufficient
awareness and understanding of fintech and of fintech-related risks, and
may therefore be unable to identify, measure, manage and control these
risks effectively. Responsibilities and accountabilities for fintech and risk
management may also not be sufficiently clear.
Technology risk
and operational
resilience
The increased reliance on technology, the increasing use of outsourcing to
third party providers of technology and data, and other forms of increasing
interconnectedness all serve to heighten risks around operational failures,
control over third party providers and cyber security. Financial institutions
are becoming increasingly vulnerable to internal and external attacks,
including cyberattacks, and to operational failures that may arise from
inadequate business continuity planning for IT systems and processes, or
poor processes relating to IT change management – especially for firms
with multiple and old legacy IT systems.
Risks to Regulated firms

Data handling As customer data become even more valuable this increases the potential for
misuse and concerns about data privacy and protection. In addition, data
limitations may make it difficult for firms to validate outcomes, not least where
artificial intelligence is used to analyze data sets and to generate solutions
Conduct and AML Fintech adoption and the resulting changes in how firms operate could result in firms
struggling to meet conduct of business, market dealing and anti-money laundering
requirements.
Legal Some fintech applications raise difficult legal questions, some of which remain to be fully
resolved, not least where cross-border operations extend across different national legal
and regulatory frameworks.
Risks to Regulated firms

Risks to financial stability: Although mostly still at a stage where the risks to financial stability remain
small, regulators are paying increasing attention to the potential risks to financial stability from a number
of fintech-related - developments. There is also the more general concern of whether there is sufficient
information available to track accurately the magnitude and precise nature of some of these
developments.
• Concentration–– successful fintech firms (and fintech adopters) and a small number of
dominant third party suppliers may emerge as being of systemic importance. Alternative
channels of financial intermediation–– non-bank - providers of credit, payment systems and
other financial activities may grow rapidly while not being regulated appropriately.
• Herd-like behavior–– this may arise from the widespread use of similar machine learning and
other strategies for lending or trading.
• Use of crypto assets –– although the use of crypto assets is relatively low, there are concerns
that an increasing use of crypto assets could lead to financial instability as a result of price
volatility and the potential impact of crypto assets on payment systems.
• Vulnerabilities–– from the increasing levels of operational risk and cyber risk in the financial
system.

LIST OF RISKS AND OPPORTUNITIES EMANATING FROM FINTECHS

RISKS ASSOCIATED WITH FINTECHS: RISK TYPES
Strategic risk The potential for rapid unbundling of bank services to non-bank fintech or
bigtech firms increases risks to profitability at individual banks. Existing
financial institutions could stand to lose a substantial part of their market
share or profit margin if new entrants are able to use innovation more
efficiently and deliver less expensive services that better meet customer
expectations. In today’s environment, a deterioration of profitability due to a
lack of anticipation and agility, and the loss of profitable direct customer
relationships and/or margin compression might weaken the ability of
incumbent institutions to weather future business cycles, for example, if
banks react to falling profits by engaging in riskier activities, such as moving
down the credit spectrum.
High operational
risk – systemic
dimension
The rise of fintech leads to more IT interdependencies between market players
(banks, fintech and others) and market infrastructures, which could cause an IT
risk event to escalate into a systemic crisis, particularly where services are
concentrated in one or a few dominant players. The entrance of fintech firms
to the banking industry increases the complexity of the system and introduces
new players which may have limited expertise and experience in managing IT
risks.

High operational
risk – idiosyncratic
dimension
• A proliferation of innovative products and services may increase the
complexity of financial services delivery, making it more difficult to
manage and control operational risk.
• Legacy bank IT systems may not be sufficiently adaptable or
implementation practices, such as change management, may be
inadequate. As such, some banks are using greater numbers of third
parties, either through outsourcing (eg cloud computing) or other fintech
partnerships, thereby increasing complexity and reducing the
transparency of end-to-end operations.
• This increased use of third parties and partnering may increase risks
surrounding data security, privacy, money laundering, cyber-crime and
customer 28 Implications of fintech developments for banks and bank
supervisors protection.
• This is particularly the case if banks are less efficient in applying the
required standards and controls to manage those risks, or where fintech
firms may not be subject to the same stringent security standards. In
addition, use of third party service providers could increase banks’ step-in
risks: banks may find themselves in the position of having to support a
provider in financial distress or face discontinuation of critical services
that they provide

Increased difficulties
in meeting
compliance
requirements and
especially AML/CFT
obligations
• Banks will need appropriate AML/CFT monitoring processes in place if
they process transactions on behalf of fintech companies’ customers.
If the customer makes payments with a bank card or account, the bank
currently has some level of responsibility for authenticating the
customer and may be responsible for covering fraudulent transactions
under several regulatory regimes.
• The higher level of automation and distribution of the product or
service among banks and fintech companies can result in less
transparency on how transactions are executed and who has
compliance responsibilities.
• This can increase conduct risk for banks as they may be held
accountable for the actions of fintech partners if a customer suffers
loss or compliance requirements are not met
Compliance risk with
regard to data privacy
The risk of not complying with data privacy rules may increase with the
development of big data, more outsourcing due to tie-ups with fintech
firms, and the associated competition for ownership of the customer
relationship

Outsourcing risk • If more parties are involved in the offering of financial products and services
than at present (distributed bank, relegated bank, disintermediated bank),
ambiguity could arise regarding the responsibilities of the various actors in the
value chain, potentially increasing the likelihood of operational incidents.
• Within banks, a proliferation of innovative products and services from third
parties could increase operational complexity and risks, if controls fail to keep
pace.
• A key challenge for financial institutions will lie in their ability to monitor
operations and risk management activities that take place outside their
organizations at third parties.
• Outsourcing risk would be even more prominent if some part of the services
provided by third parties were to become dominated by globally active players,
resulting in a concentration of risk.
• Where specialized fintech companies are the service providers, business
partners or provide the primary customer interface, incumbent banks will need
to consider the appropriate processes to conduct appropriate due diligence,
contract management and ongoing control assurance and monitoring of
operations in order to safeguard the bank and its customers.

Cyber-risk • Cyber-risk is likely to rise in all scenarios. New technologies and business
models can increase cyber-risk if controls do not keep pace with change.
Increased interconnectivity between market players can create benefits for
banks and consumers, while amplifying security risks.
• Heavier reliance on APIs, cloud computing and other new technologies
facilitating increased interconnectivity with actors or sectors not subject to
equivalent regulatory expectations could potentially make the banking
system more vulnerable to cyber-threats, and expose large volumes of
sensitive data to potential breaches.
• This emphasizes the need for banks, fintech firms and supervisors to
promote the need for effective management and control of cyber-risk.
Liquidity risk and
volatility of bank
funding sources
The use of new technology and aggregators creates opportunities for customers
to automatically change between different savings accounts or mutual funds to
obtain a better return. While this can increase efficiency, it can also affect
customer loyalty and increase the volatility of deposits. This in turn could lead to
higher liquidity risk for banks.

DRIVERS OF FINTECH RISKS
• Financial services firms are becoming increasingly reliant on
technology and on the use of large data sets. The use of technology is
not new, but the pace of change has picked up markedly and expanded
into areas that are new for many firms, including data collection and
analytics, artificial intelligence, automation, robo-advice, cloud computing
services, platforms, blockchain and crypto assets.
• The financial sector is becoming increasingly interconnected and
complex. Examples of this include the outsourcing of many fintech-
related functions and services, and the increasingly platform-based nature
of many financial services
• Economies of scale tend to be strong in IT applications, leading to a
natural tendency for a highly concentrated market with a small
number of large providers. Use of the same or similar IT solutions by
financial services firms may generate herdlike behavior.

PRINCIPLES FOR EFFECTIVE MANAGEMENT OF FINTECH RISKS
Tone at the top It’s imperative for a company’s board of directors and executive management to
understand the organization’s critical processes, internal controls, and mitigation
plans and to spearhead the creation of an organizational structure and culture in
which “risk appetite” is both understood and adhered to.
An end-to-end
perspective with
strong focus on
risk-based actions
It’s important to define and document a risk framework that aligns with the
regulatory and operational risks identified through a formal enterprise risk
assessment. Once the framework is established and regulatory risk processes and
programs are in place, periodic testing should be performed for risk identification
and control mitigation.
Effective incentives With clear risk tolerances established and communicated throughout the
organization by the board, management, and risk committee, employees at all levels
should be empowered to step forward if they have risk-related concerns.
Risk management
baked into new
products
As new products and services are developed across the organization, and as new
relationships with outside parties are formed, all the dimensions of risk should be
considered and incorporated.
Accountability Stakeholders across the organization, inclusive of revenue producing and non-
revenue producing support staff, should be responsible for adhering to established
risk tolerances.

ERM FRAMEWORK IS KEY

Fintech Risks and Benefits--DR. Emmanuel Moore ABOLO

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