IMF calls for policies to drive benefits, curb risks of neobanks on traditional banks

BY CHARLES ABUEDE

The International Monetary Fund (IMF) has said policies that target both FinTech firms and traditional banks proportionately are needed so that opportunities offered by FinTech can get fostered while associated risks are contained.

A new blog posting on the challenges posed by fast-moving FinTech, asserts that the world is already seeing major advances when it comes to innovation in financial activities, often referred to as FinTech.

As more financial-services activity moves from regulated banks to entities and platforms with little or no oversight, so do the associated risks, and the IMF notes that fintech disrupts core financial services offered by banks and pushes them into innovation to remain relevant.

Despite FinTech stepping in to challenge traditional banks on their own playing field, it stated, they bring more than the competition, adding that both often remain intertwined, including through the provision of liquidity and leverage by banks to FinTechs.

“These pose challenges for financial authorities in the form of regulatory arbitrage (in which firms move or set up operations in less-regulated sectors and regions) and interconnectedness that may require supervisory and regulatory action, including better consumer and investor protection,” it stated.

Lending credence to policies to help take due advantage of these opportunities being presented by fintech and traditional banks, the fund highlighted that stepped-up regulation and policies that target both FinTech firms and traditional banks proportionately are needed, stressing that in this way, the opportunities that FinTech offers are fostered, while risks are contained.

“For neobanks, this means stronger capital, liquidity, and risk-management requirements commensurate with their risks. For incumbent banks and other established entities, prudential supervision may need a greater focus on the health of less technologically advanced banks, as their existing business models may be less sustainable over the long term.

“The absence of governing entities means DeFi is a challenge for effective regulation and supervision. Here, regulation should focus on the entities that are accelerating the rapid growth of DeFi, such as stable coin issuers and centralised crypto exchanges. Supervisory authorities should also encourage robust governance, including industry codes and self-regulatory organisations. These entities could provide an effective conduit for regulatory oversight,” it added.

Technology sometimes moves at a dizzying pace. When it comes to innovation in financial activities, often referred to as FinTech, the world is seeing major advances. Adopting these policies and encouraging financial technology, according to the IMF, for the consumer, could mean potentially wider access to better services. Such changes also raise the stakes for regulators and supervisors—while most individual FinTech firms are still small, they can scale up very rapidly across both riskier clients and business segments than traditional lenders. The Fund also says the combination of fast growth and the increasing importance of FinTech financial services for the functioning of financial intermediation can come with system-wide risks.

Excerpts from the report which lay emphasis on why digital banks, which are also known as neobanks, are growing in systemic importance in their local markets, further gave insights on how they are more exposed than their traditional counterparts to risks from consumer lending, which usually has fewer buffers against losses because it tends to be more uncollateralized.

It says their exposure also extends to higher risk-taking in their securities portfolio, as well as higher liquidity risks (specifically, liquid assets held by neobanks relative to their deposits tend to be lower than what would be held by traditional banks).

“These factors,” the IMF noted, “also create a challenge for regulators where the risk management systems and overall resilience of most neobanks remain untested in an economic downturn.

However, not only do FinTech firms take on more risks themselves, but they also exert pressure on long-established industry rivals, such as in the United States, where FinTech mortgage originators follow an aggressive growth strategy in periods when home lending is expanding, such as during the pandemic. Competitive pressure from FinTech firms significantly hurt the profitability of traditional banks, and this trend is set to continue, the article observed.

Another technological innovation, which has grown rapidly in the past two years, is decentralised finance, a crypto-based financial network without a central intermediary.

Also known as DeFi, it offers the potential of delivering more innovative, inclusive, and transparent financial services, thanks to greater efficiency and accessibility.

Conversely, DeFi also involves the buildup of leverage and is particularly vulnerable to market, liquidity, and cyber risks. Cyberattacks, which can be severe for traditional banks, are often lethal for these platforms, stealing financial assets and undermining user trust. The lack of deposit insurance in DeFi adds to the perception of all deposits being at risk. In times gone by, large customer withdrawals often follow news of cyberattacks on providers.