Bank of England warns on growing threat from fintechs, releases banks’ stress testing results

The Bank of England (BoE) Tuesday published the results of its stress test on banks, which showed that all major lenders passed for the first time ever. It, however, highlighted the growing threat of fintech as something banks must watch out for.

The BoE thinks banks could be underestimating the risks to their business posed by financial technology startups.

Specifically, the BoE wrote in its stress testing results that fintechs could: reduce banks’ overdraft revenues, erode payment services fee income, increase liquidity risk as customers switch accounts more frequently, and make it harder for lenders to attract and retain customers, or cross-sell products.

The BoE speculated that banking profitability could take a £1 billion hit from all this increased competition, although cautioned that these were just thought experiments rather than predictions.

The impact of fintech on the banking industry was included in the central bank’s stress testing scenario for the first time ever this year. The stress tests are “war games” for the financial sector to make sure that lenders could cope with a nightmare economic scenario and ensure another financial crisis doesn’t occur.

Speaking at a press conference Tuesday, Mark Carney, Bank of England governor said that banks “took the good from financial technology and said that will help drive down their costs” when asked about the impact on their businesses.

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But he questioned their “basic assumption” that fintech will allow established banks to lower the cost of acquiring and maintaining customers as it lowers costs.

“Actually, from a consumer perspective, this is potentially a very exciting environment,” Carney said, suggesting customers could switch banks more often and therefore push up their cost of business for traditional lenders.

He pointed to new reforms coming into force in the new year that will make data sharing and accounting switching easier.

“It’s possible that some banks become not front-facing to the customer but utilities behind,” Carney said, adding that new apps that are not even banks could become consumers’ main point of contact with financial services.

This kind of competition is included in the Bank’s stress testing scenario, which speculated that fintech “contributed to the significant squeeze in net interest margins banks experienced in the exploratory scenario, leading to a reduction of £1.1 billion in banks’ aggregate profits by end‑2023 — worth just over 0.2 percentage points of projected return on equity in 2023.”

The Bank also admitted that it may be underestimating the risks posed by fintechs to traditional banks, saying in its stress testing results: “Competitive pressures enabled by FinTech, and in particular the emergence of Open Banking, may cause greater and faster disruption to banks’ business models than banks project. ”

The Bank stressed that they are supportive of the fintech sector, which the government see as a key service to export in post-Brexit Britain, despite the possible threats it poses to traditional banks.

The fintech industry has exploded in the UK over the last decade and is now worth an estimated £7 billion. Banks such as Goldman Sachs, JP Morgan, Barclays, and BNP Paribas have moved to embrace the sector in recent years by investing, partnering, and monitoring startups in the space. They hope that these innovative new businesses can help them reduce costs and future-proof them.

Relatedly, the European Banking Association (EBA) in a report reveals fear of greater operational risk because of increased take-up of fintech in financial services sector

The EBA said perceived operational risks have escalated over the past three years, with banks’ rapid move to fintech fuelling the latest surge.

According to an EBA survey of banks, 55 percent of respondents expected operational risks to increase over the next year. This is jump from the 43 percent that said so in a similar study a year ago, and 35% that said so the year before.

Current concern is driven by the growing reliance on digital platforms to provide customer services, which has increased the likelihood of cyber attacks and IT failures. “[Digital] opportunities are accompanied by a number of new pockets of risk,” said the EBA report. “In this regard, cyber and data security are key risk drivers.

“A high and growing reliance of banking operations on IT platforms, digitalised product channels for banking services, outsourcing to third-party providers of IT-related tasks and functions and communication networks renders banks vulnerable to operational risks.”

The survey also found that 42 percent of respondents identify cyber risk and data security as the main drivers for increasing operational risk and 16 percent cited IT failures as a factor.

The EBA said outsourcing, which banks are using increasingly to access new technology, is also a major risk. Although it is not the only operational function outsourced by banks, IT outsourcing is becoming more significant.