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Bank to the future: supervisors take on fintech innovation

Fintech – technological innovation used to support or provide financial services – has already become an integral part of everyday life. It is now quite normal to apply and get instant approval for a loan on your mobile phone, even during a taxi ride that will be paid for using the same device. Behind the scenes, innovative technologies based on artificial intelligence (AI), big data and blockchain are gaining momentum. In tandem with regulatory initiatives such as the revised Payment Services Directive, these technologies are transforming banking. Fintech has the potential to change business models for the better, reduce the administrative burden facing banks and improve the experience of their customers.

However, the use of innovative technologies by banks goes hand in hand with new risks, which need to be properly addressed. For instance, banks may use AI-based models for credit scoring, enabling better decision-making and the delivery of products and services to a wider customer base, including previously underbanked segments of society. At the same time, these AI-based models can lack transparency, leading to the “black-box effect”. It is crucial that banks understand the processes behind these innovative models. Only then will they be able to evaluate how effective and reliable the models are, and properly assess the risks they pose.

Supervisors must therefore strike a balance: they should neither stifle innovation, nor let it run wild. They need to monitor the landscape, identify and assess new risks and then tackle them, while adhering to the core principle of “same business, same risks, same supervision”. In other words, regardless of whether banks use innovative or traditional methods, they should be subject to appropriate supervision, proportionate to their individual risk profile. The ECB remains neutral with regard to the specific technology that banks use, focusing instead on the risks involved and how to address them as effectively as possible.

Of course, regulated banks are not the only ones that use financial innovation: non-banking fintech firms are also active in this field. These fintech firms may compete or team up with banks in parts of the value chain. At this stage, they do not necessarily need to be licensed, regulated and supervised like banks. However, as soon as they wish to engage in banking business – in other words, take deposits and grant loans – they must be treated like banks and therefore obtain a banking licence.

In this context, the ECB has published a guide to assessments of fintech bank licence applications. The guide focuses on aspects of particular relevance for banks that use fintech, such as the IT skills of members of the management body and the bank’s use of outsourcing.

With a view to fostering a common approach to supervising fintech in the banking sector, in May 2019 the ECB brought together global authorities, supervisors, legislators and supervised banks for the first Fintech Industry Dialogue. The discussions focused on the risks and supervisory treatment of AI-based credit scoring, automated wealth management services – also known as robo-advice – and cloud services.

Participants agreed that banks’ management is ultimately responsible for the data used to feed models used for credit scoring or robo-advice, as well as the decisions made based on them. As for the use of cloud services, participants recognised the potential benefits: cloud service providers offered gains in terms of scalability, time to market and IT security. At the same time, supervisors noted that such providers must be adequately audited, and any associated security and market concentration risks must be taken into account.

For their part, supervisors are ready to step up their game to tackle the new challenges arising from fintech. To reinforce the supervisory approach, the ECB is pursuing an ongoing strategy, which involves adapting to new developments, receiving feedback from the industry and cooperating with regulators and other stakeholders. Supervisors will pay close attention to the impact of new technologies on banks’ business models and the related risks.

The world is becoming increasingly digital. Forward-looking banks and supervisors recognise that fintech is not merely a technology but a new banking reality that needs to be properly supervised. The aim is to ensure that the euro area banking sector is sound, competitive and ready for the future.

Supervision. Explained. How does the ECB supervise banks that use fintech?
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