Fintech companies on the radar: EBA publishes its first reports within the Fintech Roadmap

The financial supervisory authorities have recently taken various actions to explore the impact of fintech on the financial industry and the need to react at a regulatory level. The latest step in this regard are the two reports which the European Banking Authority (EBA) published on 3 July 2018 within its Fintech Roadmap of March 2018 setting out EBA’s priorities in respect of the fintech industry. The reports focus on (i) the impact of new entrants in the fintech business on incumbent institutions and (ii) the prudential risks and opportunities for incumbent institutions caused by the activities of fintechs.

New entrants vs market incumbents: the ‘win-win’ approach

The EBA report on the impact of fintech on incumbent credit institutions’ business models explores the current tendencies in relationships between the market incumbents and fintech companies and identifies key risk factors affecting the sustainability of incumbent business models.

According to the EBA’s report only 5% of the respondent incumbent institutions have no ongoing commercial or non-commercial relation (e.g. research, share knowledge etc.) with fintech firms. The most prevalent way of interacting with the fintech companies is forming joint ventures and other commercial partnerships (92%), it being assessed by EBA as a ‘win-win’ situation.

As far as investment strategies are concerned, venture capital investments (ca. 76%) overtake direct buyouts (34%). This suggests that the investors currently prefer acquiring minority shareholding and memberships in the corporate governing bodies rather than directly and completely acquiring fintech firms. Among the other approaches taken by the market incumbents in relation to fintechs, EBA identified participation in consortia (useful in particular whenever development of a technology requires collaboration between various stakeholders such as blockchain) and development of fintech solutions internally (by way of organic growth and reinvestment in R&D departments).

Finding sustainability factors

Although EBA identified five major factors which may negatively affect the sustainability of incumbent business models, digitalization/innovation strategies are reported to be the first and most important one. Based on the stage of development of digitalization/innovation strategies, EBA divides the incumbent institutions in three groups: the proactive front-runners, the reactive (‘go with the flow’) ones and the passive (‘left behind’) ones. EBA emphasizes the twofold nature of the digitalization factor. On the one hand, digitalization may negatively affect the reactive and passive incumbents which will not be in position to timely and adequately adapt to the new market conditions; on the other hand, very aggressive front-runners may be subject to digitalization risk due to lack of adequate governance, operational and technical strategy.

Other major sustainability factors are reported to come from the legacy ICT system of incumbents, execution and operational capacity to work on necessary changes, human resources (access and maintenance of key personnel) and increased competition from new market entrants, fintech companies and technology providers.

From biometrics to cloud computing

In its second report, the EBA report on the prudential risks and opportunities arising for institutions from fintech, EBA analyses the subject on the basis of seven major fintech use cases. The seven use cases are: biometric authentication using fingerprint recognition, robo-advisory as a way of investment advice, big data and machine learning in credit scoring, use of distributed ledger technology and smart contracts for trade finance, distributed ledger technology as a means to streamline customer due diligence processes, mobile wallet with the use of near-field communication and outsourcing core banking/payment system to the public cloud.

Although the development and investment in the fintech industry is reported to grow rapidly, ‘no significant implementation of sophisticated technologies’ has been noted. A possible reason for this could be cautious attitude of incumbent institutions and security concerns caused by, among others, dependency on external device and systems providers, over which the institutions have no control.  

As far as the risks and opportunities are concerned, on the one hand, EBA refers to increased operational risk on the part of incumbent institutions caused by the lack of adequate expertise, technology and staff (other risk factors are ICT security issues such as cyber-security and digital fraud risks). On the other hand, EBA emphasizes a number of opportunities both to the incumbent institutions and customers that are likely to result from the application of the new financial technologies. These are in particular efficiency gains, cost reduction and improved customer experience.

Conclusion

The opportunities and risks for the financial industry caused by fintech as well as interactions between fintech companies and the incumbent institutions will in all likelihood be further scrutinized by EBA. New developments in the fintech industry will remain on the EBA’s radar, as they fall within its monitoring competence over the financial market. One does not need to be a visionary to anticipate that it is only a matter of time that special legislation at an EU or at a national level will follow to address specific risks related to fintech.

The full EBA’s reports can be downloaded here.