The Fintech Transformation - Challenges & Opportunities

Dr. Mattia L. Rattaggi, Senior Fintech Advisor and Chair Regulatory Policy, Crypto Valley Association

Dr. Mattia L. Rattaggi, Senior Fintech Advisor and Chair Regulatory Policy, Crypto Valley Association

Fintech is affecting the business of banking in various forms and with an impact which in many ways will at least match the transformational effect triggered on the business model by the financial crisis of 2008–and related regulatory reform. Digitalization is affecting payment services; blockchain technology is transforming the handling of transactions; robotization is altering customer relationships; peer-to-peer and crowdfunding solutions are changing lending procedures; intelligent algorithms are modifying trading systems; data analytics/Regtech applications are reforming the backoffice. The common denominator is disintermediation. Digitalization (apps, contactless technologies) questions the purpose of branches and affects the handling of cash; Blockchain technologies are transforming wholesale transaction services, trade finance and funds management (increasing efficiency), and compliance activities (automating areas such as AML, KYC, monitoring and surveillance); Robotization changes the customer / advisor experience and the range of trading strategies.

Banks have traditionally implemented and maintained their business models in a fully integrated way. Only recently and under cost pressures-to an extent triggered by the post-crisis regulatory reform-banks have begun to develop their business models, promoting large scale outsourcing programs and organizing back office services susceptible to be shared with other banks in the future. The current Fintech age of complex, interconnected, and rapidly changing technology accelerates and amplifies the need to evolve the model. Tactically, banks can mitigate potential revenues losses and remain competitive by joining networks of Fintechs and other providers in various areas of their business and function, as part of larger ecosystems, in a partnership of interests-exploiting Fintechs' expertise while Fintechs gain access to the client base. Strategically, banks should become innovators on a continuous basis, learning from the culture of today’s new digital companies. This development may prove more arduous the bigger the financial institution is, because a large ship cannot be maneuvered as easily as a boat.

To evolve their business model, banks must seek skills and talents in the areas of artificial intelligence, data analytics, cybersecurity and distributed ledger technologies. This development will resemble the one witnessed in the nineties during the derivatives revolution, when the HR profile of banks began to show increasingly higher proportions of specialists supporting derivatives transactions, risk management activities and second/third level of internal control tasks such as processing, monitoring, reporting, controlling, and auditing activities.

To evolve their business model, banks need to establish open source it frameworks in partnership with fintech ventures without compromising the performance and security of their environment.

The key difference is that Fintech is a substitutive, and not an additive, development and the increase of Fintech expertise will go at the expense of branch personnel, retail client advisors, traders and back office operation personnel-with an overall net headcount reduction at banks. Banks need to upgrade their recruitment strategies and procedures accordingly. But banks’ foremost need is to redefine their internal educational and talent promotion programs to shape the HR base of the future. Fundamentally, the in-house effort is warranted to mitigate the cultural change triggered by the advent of Fintech. A look back at the cultural change brought into banks by the derivatives revolution in the nineties is a useful review in this context.

To evolve their business model, banks need to establish open source IT frameworks in partnership with Fintech ventures without compromising the performance and security of their environment. This imposes material running and changing costs to banks, not least due to the need to run parallel systems for a certain period and ensure continuous backup and recovery systems. The Fintech transformation impacts incrementally operational-type of risks at banks-such as cyber risk, third party reliance risk, legal/ regulatory risks, ‘new business initiatives’ processes-as well as the interplay between the three lines of defense (risk management, control, and internal audit). The principles governing a sound internal control system are not affected. But because the transformation brought about by Fintech is comparatively stronger and faster at the revenue-generating level, the way the three lines of defense interact with each other must evolve from the typical sequential way to a more 'time-to-market' focused approach. This may require upgrading governance procedures, changing reporting and supporting systems (incorporating Fintech's tools), and boasting the visibility and impact of new business initiatives procedures.

Regulatory authorities have proposed an environment supportive of Fintech, generally by introducing ‘sandboxes’ and ‘innovation hubs/accelerators’, privileging a pragmatic approach and avoiding potentially regrettable stances. Process-wise, the official and private sectors need to interact in a structured way to identify pertinent issues, monitor developments, foster positive and responsible innovation, set clear regulatory expectations and introduce smart regulation-to pursue the underlying goal to promote innovation and harvest the upsides while addressing risks. Regulators should take the lead in validating and setting requirements for Regtech applications, which can provide banks with more effective ways to improve their compliance and risk management activities such as streamlining KYC processes, meeting AML requirements and automating regulatory reporting. Within Fintech, blockchain applications (and ICOs) deserve dedicated regulatory attention and input to create the necessary legal certainty on issues including the enforceability of smart contracts, the validity of digital signatures, the legal status of digital data, the legal validity of financial instruments issued in the blockchain and the designation of a coin as a security or not.

Fintechs, banks, and authorities have embarked on a long term, impactful and highly interesting transformational path, which creates opportunities and guarantees rewarding professional experiences. However deep, the transformation will not end up any time soon in a revolution. While Fintechs boast digital expertise and don't carry legacy infrastructure, banks boast clients' trust and financial markets' expertise in what remains at the core a relationship business.