Financial institutions are becoming increasingly nimble in responding to fast-changing customer expectations and competitive forces. The EBA highlights the risks of being too passive – and too aggressive – in the pursuit of digital transformation, and in some cases, digital disruption.
EBA’s first fintech reports
We have now seen the first reports issued by the EBA under its Fintech Roadmap. The first looks into how fintech will affect incumbent banks’ business models. The second focuses on the prudential risks and opportunities arising from fintech.
Rethinking business models
In the Impact of Fintech on Incumbent Credit Institutions’ Business Models, the EBA draws on evidence from its supervisory community and the EBA Fintech Knowledge Hub to examine the input of fintech on incumbent business models. The EBA highlights that changing consumer expectations and the push for operational efficiency are driving the adoption of new technologies. That is expected to continue and, likely, accelerate.
Specifically, the EBA has identified two key trends:
- digital transformation of internal processes to digitise and optimise operations; and
- digital disruption of incumbent business using innovative technologies.
Some business lines more affected than others
The EBA finds that payments and settlement business lines currently appear the most affected by new entrants, particularly in relation to cross-border, micro and card payments. Retail banking is the second most affected, according to the EBA, given increasing competition in the space.
New technologies bring new opportunities
The EBA notes that institutions are finding the cost reduction and revenue growth returns difficult to quantify at this stage. That said, the current wave of technological change remains exploratory for the moment. Institutions are still at an early stage of use of big data, machine learning and blockchain technology
It is not all doom and gloom, however. The EBA notes that new business models are developing. Mobile wallets, aggregator services, robo advice, data analytics and SME tools are all identified as areas of promising opportunity.
Engaging with fintech firms
The EBA notes that incumbent institutions are keen to adopt new technologies without necessarily engaging with fintech firms. Incumbent firms can develop new products and services internally.
The EBA notes that incumbents consider engaging with fintech in different ways, potentially in parallel. For example:
- partnering with Fintech firms
- investing in Fintech firms through venture capital or via direct investments
- collaborating with other banks and stakeholders (consortia) to develop new technology
- developing fintech solutions internally
Of these the EBA notes that partnership is the currently the leading model which both parties see as a “win-win”. We’ve also considered options for established companies to engage with fintech companies – see our recent client briefing Get involved or get left behind: how established companies can access the technology revolution for more details.
Fintech firms and incumbent institutions do not seem in direct competition, even though Fintech firms are reaching maturity in some cases. Rather, competition is amongst incumbents, looking at first-mover advantage in adopting new technologies.
Change of governance
The EBA notes that incumbents have been changing their governance and organisational models in a response to fintech developments. Notably, some have established innovation teams and adopted an agile approach to digitalisation/innovation projects. A supportive top-down culture and a positive staff mindset is considered important to the implementation of innovation strategies.
Prudential risk and opportunities
In its Report on the Prudential Risk and Opportunities arising for Institutions from Fintech, the EBA aims to provide a balanced analysis of the risks and opportunities of innovative technology in financial services. Given that the fintech revolution could fundamentally change the risk profiles of credit institutions, those institutions will need to review their risk management frameworks and strategies.
The objective of the report is to share information without making regulatory recommendations. It provides regulators and the industry with guidance on seven potential fintech use cases:
- Biometric authentication using fingerprint recognition
- Robo-advisors for investment advice.
- Big data and machine learning for credit scoring
- Distributed ledger technology and smart contracts for trade finance
- Distributed ledger technology to streamline customer due diligence processes
- Mobile wallets with the use of near-field communication
- Outsourcing core banking/payment systems to the public cloud
Balancing exercise in risk management
The EBA suggests the new opportunities presented by fintech could potentially outweigh the associated risks provided that effective governance structures are put in place together with appropriate risk management processes.
Incumbents will need to consider micro-prudential risks connected with to relevant fintech use cases. These will need to be weighed against the opportunities presented by those use cases. The report suggests various examples of both and, as the table below shows, many opportunities have a corresponding risk.
|Example opportunities||Example risks|
|Improved customer experience, e.g. more convenience, efficiency and transparency||Operational risk, including risks associated with IT changes|
|Efficiency gains and automated processes reducing risk of human error||Legal, regulatory and conduct risk, including regulatory fines and customer redress|
|Lower operational costs and administrative burden||Third party dependencies, notably outsourcing of critical functions|
|Reduced transaction time and costs in the financial system||Business risk, e.g. more competitive pricing|
|Potential for new business models||Reputational risk|
|Greater data accuracy and efficiency and improvements to data security, e.g. via encryption and strong customer authentication||Increasing risks and costs relating to data integrity, security and privacy|
What is happening next?
The race is on between incumbent banks to adopt new technologies. Will this lead to a spate of strategic fintech acquisitions by banks as some fintech companies approach maturity?
A key trend noted by the EBA is the shift in governance at incumbent institutions, with core innovation teams and strong support from top management. Balancing speed of adoption while maintaining strong risk assessment will be key.
The first wave of fintech innovation and disruption has already hit payments and retail banking. The second wave is ongoing, and is potentially more transformative, as institutions grapple with AI, data analytics and blockchain technology.
For the time being, the EBA has reserved its position on whether it needs to make recommendations to regulators to promote consistency and coordination on fintech. We will follow the EBA closely as it continues to monitor fintech developments in the financial services sector.