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Basel Committee on Banking Supervision Issues Consultative Document Highlighting Implications of Fintech on Banks

Posted in AI and Machine Learning, Big Data, Cybersecurity, FinTech, Payments, Privacy
Brianne Paulin

On August 31, the Basel Committee on Banking Supervision (the “BCBS”) published a consultative document on the implications of Fintech for the financial sector. The consultative document was produced by BCBS’s task force mandated with identifying trends in Fintech developments and assessing the implication of those developments on the financial sector.

Parts I and II of the consultative document provide an overview of current trends and developments in Fintech. The report assesses Fintech developments, presents forward-looking scenarios, and includes case studies to better present individual risks and the potential impact of the forward-looking scenarios on banks.

The main findings of the study are presented in Part III, summarized in 10 key observations and recommendations for banks and supervisors, which will be the focus of this blog post.

Key Observations and Recommendations: Implications for Banks and Banking Systems

  1. Banking risks may change over time with the emergence of new technologies.

Banks will need to adapt to new risks emanating from the introduction of new technologies in the financial sector without limiting potential benefits stemming from such technologies. Fintech innovations have the potential to benefit both the bank, by lowering banking costs, allowing for faster banking services and facilitating regulatory compliance, and consumers, by improving access to financial services, tailoring banking services to individual needs and allowing new competitors to join the market.

  1. Key risks for banks include “strategic risk, operational risk, cyber-risk and compliance risk.”[1]

Banks must implement appropriate risk management processes and governance structures to address new risks arising from innovative technologies, including operational risks, data protection and anti-money laundering (“AML”) risks. The report recommends the adoption of the Principles for sound management of operational risk (“PSMOR”)[2] to effectively respond to these risks.

  1. Emerging technologies bring benefits to the financial sector but also pose new risks for banks.

BCBS undertook an in-depth study of the impacts of three Fintech-enabling technologies on the banking industry: artificial intelligence/machine learning/advanced data analytics, distributed ledger technology and cloud computing. Banks will need to adapt risk management plans to address such enabling technologies by implementing effective IT and risk management plans.

  1. Banks increasingly outsource operational support for technology-based financial services to third parties but risks ultimately remain with the bank.

Banks will need to ensure that risk management plans are extended to any operations outsourced to a third party. This will require adapting operational risk management plans to third parties, including Fintech firms.

  1. Fintech innovations will require greater supervision and require further cooperation with public authorities to ensure compliance with regulations, such as data privacy, AML and consumer protection.

The emergence of new enabling technologies in the banking sector provides an opportunity for bank supervisors to further cooperate with public authorities responsible for the oversight of the financial sector and Fintech. Cooperation will facilitate the identification of new risks and facilitate supervision of important risks, including consumer protection, data protection, competition and cyber-security.

  1. Fintech companies can operate across borders. International cooperation between banks and bank supervisors is essential.

BCBS noted that current Fintech firms mostly operate at a national level. However, the opportunities for cross-border services are plenty, and when Fintech firms expand their operations, bank supervisors will need to ensure a level of international cooperation with other bank supervisors.

  1. Technology can bring important changes to traditional banking models. Supervision models need to be adapted to these emerging banking models.

Bank supervisors should ensure that staff are well equipped to deal with the changing technology. Staff should be trained to identify and monitor new and emerging risks associated with innovative technologies and new banking systems.

  1. Banks should harness emerging technologies, such as AI, to increase their efficiency in responding to Fintech-related risks.

Bank supervisors should determine how to use Fintech innovations to better supervise and monitor Fintech related risks and new banking technologies.

  1. Current regulatory frameworks were adopted before the emergence of Fintech innovations. “This may create the risk of unintended regulatory gaps when new business models move critical banking activities outside regulated environments or, conversely, result in unintended barriers to entry for new business models and entrants.”

The BCBS recommends that supervisors review their regulatory frameworks to ensure that regulations protect consumers but do not create barriers to entry for Fintech firms. The BCBS found that many Fintech firms operate outside the realm of traditional banking, and thus, traditional regulatory approaches may not be appropriate for such firms. Regulatory barriers, however, could push Fintech firms to operate outside of the regulated financial industry, causing significant risks to consumers.

  1. Government authorities in some jurisdictions have partnered with Fintech firms to facilitate the use of financial technologies while ensuring adequate regulatory safeguards for financial stability.

The BCBS found that several government authorities have put in place initiatives to help Fintech companies navigate the regulatory requirements of the financial sector. Bank supervisors should monitor developments in other jurisdictions to learn and implement similar approaches, if appropriate.

 

[1] The report identifies these risks for both incumbent banks and new Fintech entrants into the financial industry.

[2] See: http://www.bis.org/publ/bcbs292.pdf

 

For more information about our firm’s Fintech expertise, please see our Fintech group’s page.