- CONTRIBUTION
Adapting to technological shifts: supervision in the evolving financial landscape
Contribution by Elizabeth McCaul, Member of the Supervisory Board of the ECB, for Eurofi Magazine
10 September 2024
A major strength of the European banking system is the diverse business models and governance structures that in turn enhance resilience and ability to meet the needs of customers. As supervisors, it is our duty to ensure each bank’s soundness and safety by assessing the effectiveness of their risk management, the appropriateness of their technology investments and the sustainability of their business models, among other things. At the same time, it is not our task to defend supervised entity market shares. Neither do we favour specific business models or technologies. This role requires careful calibration amid technology and societal shifts that are continually reshaping the business of banking. Banks and supervisors must both adapt, especially in the face of the unprecedented speed of technological progress that is driving customer demand for digital solutions from banks and the entry of new competitors.
So what does this mean for the role we need to play in the sector’s digital transformation?
Simply put, we look to answer at least two questions:
- How do we ascertain whether banks are managing the long-term sustainability of their business model effectively as well as risks from digitalisation and non-bank partnerships, and provide appropriate supervisory responses to any weaknesses?
- How can we maintain an effective regulatory and supervisory framework amid constantly reshaping financial value chains, un- and re-bundling of financial services and decentralised financial services provision?
Our focus is on how banks formulate, execute and monitor their digital strategies, emphasising timely identification and adequate mitigation of risk. We are incorporating digitalisation into our supervisory priorities so we can answer these questions, and are publishing criteria and best practices for banks’ digital activities as we continue to learn[1].
Going forward, we will expand our supervisory work and review the use of specific technologies such as artificial intelligence, constantly striving to better understand how banks’ efforts to devise digitalisation strategies, investment decisions and ecosystem interactions are linked, especially in terms of impact on business models and operational resiliency risks.
The financial landscape is shifting, and so should regulation and supervision. To evolve properly, collectively we need a holistic understanding of the new contours of the financial system. We need robust risk assessment capabilities to apply a proportionate and fair approach while enabling innovation. Calibrating supervisory actions properly should be based on the economic and societal impact of services, not the technology or licences used.
A major restructuring is under way in financial services: integrating financial services into non-financial ecosystems, changing the risk landscape, blurring traditional industry lines and challenging conventional regulatory boundaries. Against this rapidly evolving backdrop, we also must continuously reassess the effectiveness of our supervisory framework.
Bigtechs and fintechs are reshaping customer experiences using technology and data not only to compete with traditional banks, but increasingly to collaborate with them by delivering their products as customer interfaces. Mobile apps and platforms are the new norm for providing financial services. Licensing-as-a-service delivering these apps and platforms via partnerships extends the reach of banks by leveraging fintech innovation. There is much that is good about this.
But partnerships with non-bank intermediaries pose new challenges when they act as the primary consumer interface while banks bear legal responsibility. Sound practices about reliance on third-party providers should be applied to these partnerships, even if they must be framed differently in the world of partnerships.
And here’s why: fintech providers tend to prioritise customer convenience, efficiency and growth, without demonstrating knowledge of what robust bank risk management practices entail. Banks need to exercise control over customer onboarding, operational resilience, liquidity and legal risks. They must consider the interaction between their own innovative business models and their partners’ risk profiles, prepare for intermediary and vendor failures and oversee the soundness of partners who may take excessive risks or become sources of concentration or interdependency risks.
There is another, not inconsequential twist. Bigtech conglomerates where the primary business is technology rather than banking are entering the financial sector through e-commerce and payment platforms, and subsequently expanding into retail credit, mortgage lending or crypto services. These actors may also explore alternative, less-regulated lending forms like crypto lending using peer-to-peer platforms, ultimately mimicking the economic functions of banks without being subject to the same comprehensive oversight.
We need to expand our tools and surveillance to prevent gaps in oversight. They need to be robust and yet versatile enough to oversee disintermediated, interdependent and possibly distributed-ledger-based business models. We must adapt regulation and oversight of bigtech conglomerates, for entities mainly active in non-financial services. This necessitates a thorough understanding of the financial activities of large non-bank groups across jurisdictions and sectors.
Our preferred response to such challenges involves creating global standards for supervising non-banks, fostering cross-border cooperation and promoting information sharing among supervisory authorities. We should avoid the kind of regulatory “race to the bottom” that is often driven by a myopic vision of prioritising innovation and attracting large firms which may not contribute to the good of society. This may require the EU to continue leading the regulatory evolution in the oversight of bigtechs, conglomerates and crypto-asset services.
Bank Ċentrali Ewropew
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