Regulators ‘working through’ systemic risks posed by fintechs

Speaking at the Bund Summit on FinTech in Shanghai, Reserve Bank of Australia assistant governor, financial system, Michelle Bullock acknowledged that innovations such as distributed ledger technology, artificial intelligence and cryptography could improve payment experiences, support new payment instruments and boost competition in the financial system, but she warned that there are inherent risks associated with introducing new technologies to unproven markets that regulators need to mitigate.

One area of consideration for regulators, according to Ms Bullock, is “stored value products”, where fintechs hold their clients’ funds in their books as “stored value”, which the assistant governor said raises a number of policy questions.

The RBA assistant governor said in her speech: “Should the funds being held be treated like deposits? If not, do the firms holding the funds need to be regulated in some other way to protect consumers? If the new entrants are very large, like the big technology companies, they could potentially hold substantial amounts of value in their closed systems. What are the implications for systemic risk of such a market structure?

“Regulators are still working through these questions.”

Ms Bullock noted that the resilience of new technologies is an important thing to get right, noting past instances where unexpected disruptions have negatively impacted businesses and customers alike. She referenced the recent technical issues experienced by major banks Commonwealth Bank and National Australia Bank which affected access to ATMs, EFTPOS, internet banking and mobile banking services.

“An outage at a major bank recently meant that its merchant customers had to turn customers away if they didn’t have cash (and many didn’t). These sorts of outages disrupt commerce and erode trust of consumers in payment systems,” the assistant governor said.

“Regulators are therefore starting to focus on the operational risks associated with retail payment systems and whether the operators and the participants are meeting appropriately high standards of resilience.”

With crime evolving with technology, Ms Bullock also pointed out the opportunities for new types of fraud that could accompany nascent technologies, adding that it’s important to ensure that fintechs eventually meet the same security requirements as other financial institutions, especially given the amount of customer data that is being generated, captured and stored by the industry. 

“The strength of the system is only as good as its weakest link, so it is essential that all participants in payment systems and the financial system more broadly manage and mitigate these risks. Regulators may have a role to play in encouraging the adoption of minimum standards,” Ms Bullock said.

A similar sentiment was recently communicated by Australian Prudential Regulation Authority (APRA) chairman Wayne Byres, who said that advancements in technology will also introduce new risks such as cyber attacks.

He added that the “accelerating threat of cyber attacks to regulated entities” has pushed APRA to propose its first prudential cross-industry standard on information security, which is currently being consulted and is expected to come into effect on 1 July 2019.

While it’s important to ensure the security, resilience, efficiency and compliance of new-to-industry and emerging fintechs, the RBA is also considering how it can ensure fintechs have access to the payments infrastructure — including payment clearing systems — required to be able to adequately compete with more established financial services providers.

Ms Bullock noted the need for new entrants to have affordable access to critical infrastructure, as well as the importance of limiting the control incumbent financial services have over such infrastructure as it could diminish competition.

“Non-bank providers of payment services already have access to accounts at the Reserve Bank for the purposes of settlement. But they will also need access, either direct or indirect, to payment clearing systems. While they might be able to commercially negotiate an agency arrangement, this could add to their costs and they might therefore prefer direct access,” the assistant governor said.

“If incumbent financial institutions control access, they might seek to put up unreasonable barriers to entry. Regulators will need to be alert to potential anti-competitive conduct.”

[Related: Future financial services will be built around human behaviour]