The proliferation of fintech companies and their growing share in financial transactions across the world is making the risk of financial instability more real, warned a report by International Monetary Fund (IMF).
“Their fast growth into risky business segments, combined with sometimes inadequate regulation and/or supervision, gives rise to systemic risks and potential financial stability implications,” the fund said in its report on global financial stability.
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Fintech companies encompass a wide variety of firms ranging from digital-only banks called Neo banks to cryptocurrency exchanges across the globe. Various private studies estimate that the global fintech industry could grow to $600-700 billion in the next ten years. Fintechs have shown explosive growth ever since the pandemic hit mobility across geographies by forcing countries to impose restrictions and even complete lockdowns. The IMF report noted that fintechs are penetrating in almost all financial activities, disrupting traditional banking.
Fintechs bring cost efficiencies through competition, greater financial inclusion, and innovation. But at the same time, their rapid growth is raising the spectre of instability of the financial system.
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What’s more is that light touch regulation of fintechs could be an enabler of risk. “The business model of fintechs relies on rapid growth, which— in the absence of appropriate regulations—can lead to excessive risk-taking, including by banks trying to defend their market position,” the IMF said.
Neo banks target borrowings with riskier credit profile than traditional banks. With loose underwriting standards, the exposure of such banks is to borrowers with lower income for financing riskier assets such as a new business or commercial real estate. Further, these loans are unsecured and borrowers have lower credit scores.
The risk to stability comes from the growing linkages between fintech firms such as Neo banks with traditional banking system. The IMF report notes that Neo banks act as lenders to traditional banks through the interbank market sometimes. Moreover, a bunch of small fintech firms provide critical services to banks and an impact on these services could in turn hurt banks.
The fund also highlights the extent of disintermediation of banking due to fintech companies. “The compet- itive pressure on traditional banks can be significant. As the case study of the US mortgage market shows, there is strong evidence of a negative impact on banks’ income as a result of competition from fintechs,” the report noted.
The IMF’s warning comes even as the risks associated with fintechs seem to have caught up with investors. Stock prices of some of the big fintech companies came under fire in advanced economies recently. The valuation multiples of most fintech companies have dropped over the past one year in the US. Chinese regulators have sharpened their gaze over fintech companies and curbed activities.
The IMF believes that regulators should catch up fast with the fintech advancements and greater oversight could mitigate some of the risks to stability.
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