Regulating Fintechs

Brave New Financial World
Banks and their ATMs may be falling out of fashion, but they'll never die out completely.
  • Why it matters

    Why it matters

    Traditional banks have to adapt to survive the new digital era, but so will digital startups that face tougher regulation if they want to behave like banks.

  • Facts


    • Andreas Dombret has been a member of the Bundesbank’s executive board since 2010.
    • The Bundesbank, Germany’s central bank, is in charge of financial supervision in Germany together with the financial authority BaFin.
    • Mr. Dombret says any digital startups that want to move into the financial sphere should expect tougher regulation along the lines of what faces traditional banks.
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If you want to see the destructive side of digitalization, just take a look around your own loft or basement. Typewriters, vinyl records, photographic paper – many items we used to use every day have all but disappeared from daily life and are only kept as mementoes. With these products, whole industries that did not survive the digital revolution have now vanished.

If digitalization can turn entire sectors upside down, we may be curious about what it holds in store for banks and savings banks.

After all, banking activities largely involve intangible services that can be digitized comparatively easily. Germany’s banks and savings banks were caught up by the wave of digitalization long ago; many customers now carry out banking transactions from home or while on the go using a smartphone. Some banks can only be reached online.

Almost a third of Internet banking customers no longer go into a branch, according to a recent survey by Bitkom. Trips to the ATM are also becoming necessary increasingly less often for many customers, thanks to alternative payment methods. In short, banks as physical buildings are not set in stone.

While financial services were previously regarded as a bastion of human ability because of the challenging tasks they involved, it now seems conceivable that even activities such as advice and risk analysis could be performed at least in part by a computer.

Computers and programs are coming to resemble their human creators more and more – today it is claimed that they have intelligence, communicative abilities and even creativity. Many experts are anticipating further leaps in progress with artificial intelligence and the processing power of computers.

That means that financial services could increasingly be offered by machines in future.

To imagine that banks and savings banks could become a thing of the past once technologies have matured is to misjudge their importance within the financial system.

Some banks are already using algorithms to examine immense streams of financial data for suspicious patterns, for example in order to detect attempted fraud or attacks from the network at an early stage. Self-learning programs could help computers gain even more recognition in the financial sector.

But since Bill Gates declared “banking is necessary, banks are not,” it’s been about more than that. IT-driven financial innovations could make the role of banks superfluous, according to reports. Examples that are cited include Internet platforms that allow borrowers and lenders to meet and providers of cyber currencies.

In the midst of this wave of digitalization, questions are being asked about the future structure, form and role of banks and savings banks. Will they actually be needed at all in a digital financial world?

One thing is certain: changes in technology and society mean that banks will have to question many aspects of their usual services and processes. With digitalization, customers are changing their behavior and their expectations of banking services. New companies, including financial-technology firms known as fintechs, can apply for banking licenses or play a bigger role in banking business as external service providers.

More efficient, faster, more practical and more customer-oriented – pressure is mounting on all those involved. The image of the sector will in all probability undergo a drastic change.


The Fintech Sector in Germany-01


It is unlikely that every bank will be able to keep up. From society’s viewpoint, on the other hand, competition for quality is a good thing. It is therefore entirely possible that some banking processes and products will soon be consigned to the attic, figuratively speaking.

However, to imagine that banks and savings banks could become a thing of the past once technologies have matured is to misjudge their importance within the financial system. The concept of a “bank” and a “savings bank” is protected by law – it will stand and fall with certain tasks. Among other things, banks help us to store money safely, offer payment services, provide resources for economic and social projects with loans and manage and spread the risks that these involve.

As long as we make use of services such as lending, custodial services and payment transactions, as individuals or companies, there will be banks. Banks and savings banks are also an integral part of our monetary system. Overall, therefore, the requirements of our economic and financial system make the existence of banks necessary.

There are good reasons for the special legal status of banks; they play an influential role in the economic and financial system, involving a large amount of trust. Legislators and regulators must make sure that these rights and duties are exercised in the interests of society.

And it is becoming clear once again as digitalization progresses that reliability and trust cannot be taken for granted, despite, or perhaps because of, technology.

I would warn against the idea that our financial system could function in the digital age without its supporting pillars being regulated and supervised.

Firstly, we must not treat technology itself with blind trust. Why should programs created by humans always be infallible and unbiased? Even without their own will, computers can be misused. Only recently, it emerged that lending practices had been manipulated on a U.S. loan brokerage platform.

Secondly, even the most refined IT system cannot prevent damage from occurring. Cyber attacks on banks often exploit human weaknesses and errors. Regulators therefore require banks and savings banks to have comprehensive security management systems in place.

The advance trust that is placed in some financial technology can thus quickly dry up. I would therefore warn against the idea that our financial system could function in the digital age without its supporting pillars being regulated and supervised.

There are also key aspects of the financial sector, such as the assumption of risks, which cannot be taken over by computers at all. Financial issues are by their nature associated with risks – even intelligent IT can only prepare and simplify decisions; responsibility must be assumed by humans.

Moreover, computers do not appear to fulfill all customer requirements in terms of service. The best example of this is an American “Robo-Advice” provider, which also offers a service hotline available for customers, staffed by employees. Customers are obviously particularly likely to request contact with humans when the investment products the computer has found are losing value significantly.

Ultimately, we cannot always rely on self-regulation through the “wisdom of the crowd” or through computers that carry out reciprocal checks on their book entries. A theft recently occurred in a financing network intended to manage without a human supervisory body, due to a flaw in the code that had been overlooked. The damage ran into millions.

Despite the countless possibilities for technological design, it is legal and economic issues that will prove crucial in the end. Even the most libertarian fans of the Internet recognize this – financial matters will not work without an overriding legal system.

It is therefore only logical to oblige all financial institutions to take extensive measures to protect the trust placed in them as banks. Technology must be neither gullibly promoted nor rejected due to fear of change. Each individual application will have to prove itself. Requirements that are not related to technology, such as management’s responsibility, incentive systems and the principle of redundant supervision, shall remain “state of the art.”

Consumers, who are sometimes all too carefree, should also learn to take a grown-up approach to the possibilities of digital technology. Their own willingness to pay for digital products should reflect the many essential tasks that go on in the background. Because despite the easy and free availability of many things in the digital world, security and reliability do not come for free.

As our legal system protects the concept of banks, the perceived contrast between banks and startups in the financial sector, so-called fintechs, is also robbed of its mystique. What banking business, payment transactions and financial services are and what is associated with the corresponding licenses is determined by the law.

There is no simple dividing line between “the banks” and the high-tech newcomers in the world of finance. Instead, the challenge currently faced by financial regulators lies in stipulating for the numerous new business models whether they need a license as a credit institution, a payment institution or a financial service provider.

Banks and savings banks will remain a necessary part of our financial system. Instead of “Do we still need banks?” the question should be “What will the banks of the future look like?”

In future, banks will need to be geared towards the requirements of those whom the financial system serves: members of the public and companies. The creative destruction that we have seen in the photography and music industries may also leave its mark on the banking sector.

In future, we can expect a lively mix of mobile banks and on-site service, specialist service providers and universal banks, cooperation and competition with financial startups. But just as people are still taking photographs and listening to music, the essential needs for which people depend on banks will not cease to exist.

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