The EU Fintech agenda; challenges and opportunities for banks Marios Katsavras Officer Supervision Division Central Bank of Cyprus 31 January 2019 1st Digital Banking & Payments Conference 1
Overview Fintech Definition The European Commission (EC) The European Central Bank (ECB) The European Banking Authority (EBA) Challenges and opportunities for banks 31 January 2019 1st Digital Banking & Payments Conference 2
Fintech Definition FinTech is defined as technology-enabled innovation in financial services that could result in new business models, applications, processes or products with an associated material effect on the provision of financial services (EBA Glossary for financial innovation - FSB) 31 January 2019 1st Digital Banking & Payments Conference 3
European Commission - DSM Source: European Commission 31 January 2019 1st Digital Banking & Payments Conference 4
European Commission COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS Fintech Action Plan: A more competitive and innovative European financial market Enable innovative firms and solutions to emerge/scale-up accross the EU Support the uptake of new technologies and innovation Enhance security and resilience of the financial sector (COM(2018) 109 Final 8.3.2018) 31 January 2019 1st Digital Banking & Payments Conference 5
European Commission Enable innovative firms and solutions to emerge/scale-up accross the EU Clear and converging licensing requirements => more coordinated approaches across the EU/immediate gap for crowdfunding and peer-to-peer lending; crypto assets, ICOs Common/interoperable standards => cooperation/competition between market participants Innovation facilitators => financial services legislation requirements challenge innovative firms/innovation challenges supervisors => Stronger coordination by the ESAs and ECB 31 January 2019 1st Digital Banking & Payments Conference 6
European Commission Support the uptake of new technologies and innovation Suitability review/technology neutrality of the existing EU framework Remove obstacles to the use of cloud services by financial providers/outsourced activities Blockchain: map and assess challenges in the EU; Blockchain Observatory & Forum Build capacity and knowledge of supervisors; EU FinTech Lab 31 January 2019 1st Digital Banking & Payments Conference 7
European Commission Enhance security and integrity of the financial sector Information sharing on cyber threats ICT security and governance requirements in all sectors Cyber resilience testing framework 31 January 2019 1st Digital Banking & Payments Conference 8
European Central Bank ECB approach / roles Oveerseer and policy maker Operator/issuer of fiat currency Supervisor (SSM) 31 January 2019 1st Digital Banking & Payments Conference 9
European Central Bank In March 2018, following a public consultation, the ECB published a Guide to assessments of fintech credit institution licence applications. This ensures that applications are assessed in the same manner across the entire euro area and that specific risks will be assessed appropriately and proportionately https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.201803_ guide_assessment_fintech_credit_inst_licensing.en.pdf 31 January 2019 1st Digital Banking & Payments Conference 10
European Central Bank ECB - Guide to assessments of fintech credit institution licence applications: Suitability of the members of the management body Suitability of shareholders Structural organisation (IT Risk etc) Programme of operations Capital, liquidity and solvency 31 January 2019 1st Digital Banking & Payments Conference 11
European Central Bank ECB - Guide to assessments of fintech credit institution licence applications: Structural organization: The assessment of IT-related risks The assessment of outsourcing (cloud outsourcing) The assessment of data governance 31 January 2019 1st Digital Banking & Payments Conference 12
EBA: Fintech priorities 2018/19 Monitoring the regulatory perimeter. Monitoring emerging trends and analysing the impact Addressing consumer issues arising from FinTech EBA Promoting best supervisory practices on assessing cybersecurity Identifying and assessing ML/TF risks Source: EBA 31 January 2019 1st Digital Banking & Payments Conference 13
EBA Published work 15 March 2018: EBA s Fintech Roadmap (Conclusions From The Consultation On The EBA s Approach To Financial Technology (Fintech) 3 July 2018: EBA s Report on the Impact of Fintech on Incumbent Credit Institutions Business Models EBA s Report on the Prudential Risks and Opportunities arising from Fintech 7 January 2019: Joint report with ESMA & EIOPA - Fintech: Regulatory sandboxes and innovation hubs 9 January 2019: EBA s Report with advice for the European Commission on crypto-assets 31 January 2019 1st Digital Banking & Payments Conference 14
EBA - Cybersecurity Source: EBA 31 January 2019 1st Digital Banking & Payments Conference 15
EBA FinTech Roadmap (March 2018) Source: EBA 31 January 2019 1st Digital Banking & Payments Conference 16
EBA FinTech Knowledge Hub Source: EBA 31 January 2019 1st Digital Banking & Payments Conference 17
EBA Penetration of new technologies in banks EU banks level of involvement in the application of each technology Smart contracts Artificial Intelligence Biometrics Big Data analytics Distributed Ledger Technology Digital/Mobile wallets Cloud computing 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% In use / launched Pilot testing Under development Under discussion No activity Source: EBA Open Banking / APIs PSD2 is perceived as an opportunity with most institutions currently designing their open banking/api strategy Relevant RTS is directly applicable from 14 September 2018 31 January 2019 1st Digital Banking & Payments Conference 18
Use of big data and machine learning for credit scoring Definitions Business Model Advantages Artificial intelligence (AI): the theory and development of computer systems able to perform tasks that traditionally have required human intelligence (FSB*) Machine learning (ML): a method of designing a sequence of actions to solve a problem, known as algorithms, which optimize automatically through experience and with limited or no human intervention (FSB*) Big data (BD): the collection, storage and analysis of large and/or complex data sets, using a variety of techniques, including AI and ML algorithms. Upscaling by leveraging on a much larger pool of data, banks can provide credit scores for clients with limited or no credit history. Consistency automation eliminates human bias. Cost efficiency helps banks to make more efficient use of big data. Capital use efficiency better customer value insight, targeting and management due to increase of model accuracy, data deployment and analytics 31 January 2019 1st Digital Banking & Payments Conference 19
Use of robo-advisors for investment advice Definitions Business Model Advantages Robo-advisory is defined by the Basel Committee on Banking Supervision (BCBS) as: applications that combine digital interfaces and algorithms, and can also include machine learning, in order to provide services ranging from automated financial recommendations to contract brokering to portfolio management to their clients, with limited human intervention or none. Such advisors may be standalone firms and platforms, or can be the in-house applications of incumbent financial institutions. Scope for increasing revenues robo-advice services are often open to clients with a much smaller investable capital, especially when compared to more traditional private banking services. Lower cost of operations robo-advisors often invest in Exchange Traded Funds or mutual funds which enable the construction of worldwide diversified portfolios. 31 January 2019 1st Digital Banking & Payments Conference 20
Use of cloud computing Definitions Cloud computing is defined by National Institute of Standards and Technology (NIST) as a model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g. networks, servers, storage, applications and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction Business Model Advantages Potential for cost reductions turning a large capital expenditure into an ongoing operational expenditure. Flexibility and scalability allowing banks to meet increasing and decreasing demand more efficiently. Cyber-security cloud service providers could prove to offer more efficient and resilient IT systems than incumbent banks. Better client relationships could improve banks ability to handle large volumes of data. 31 January 2019 1st Digital Banking & Payments Conference 21
Reaction of banks Impact of FinTech on banks - reaction: (i) reduce costs, incl closing unprofitable units, (ii) increase digitalization, transformation or disruption (iii) outsourcing (iv) off-shoring or near-shoring, and (v)other, incl changes in governance, culture 31 January 2019 1st Digital Banking & Payments Conference 22
Risk factors to business model The EBA identified five factors, that might significantly affect banks business models from a sustainability perspective. These relate to: i. digitalisation strategies that they pursue to keep up with the pace of a fast-changing environment, ii. challenges arising from legacy ICT systems, iii. operational capacity to implement the necessary changes, iv. concerns over retaining and attracting staff, and v. increasing risk of competition from peers and other FinTech firms. 31 January 2019 1st Digital Banking & Payments Conference 23
Interaction of banks with FinTech Four different approaches have been identified on how banks approach and relate to FinTech: Developing internally Partnering with new entrant FinTech firms Investing in new entrant FinTech firms Collaborating with other stakeholders Plus: i. Servicing new entrant FinTech firms (banking) ii. Do nothing. 31 January 2019 1st Digital Banking & Payments Conference 24
Relationship of incumbents with FinTech 1 Partnering with FinTech firms to embrace new technologies and transform their business Both incumbents and FinTech firms are keen into forming partnerships, as currently it appears to be a win-win situation with the significant majority of incumbents form commercial partnerships or participate in non-commercial partnerships (such as research or knowledge sharing) with FinTech firms. 2 Investing in FinTech firms either through venture capital investments or direct acquisitions Incumbents invest in new entrant FinTech firms: i) via venture capital funds and ii) direct acquisitions. The majority appears to have a rather strategic view when they invest into FinTech firms as such investments do not seem to be short-hold. The EBA RAQ H2 2017 findings support the current trend of incumbents favouring partnerships with FinTech firms compared to direct acquisitions. 3 Collaborating with other stakeholders to develop and test new technologies Collaboration with peers and participation in/form of consortia is another way on how incumbents approach FinTech. This also includes engagement with academic and research institutions. Given the nature and status of the FinTech development, certain technologies such as blockchain require the collaboration of a number of stakeholders to be effective, resulting to the creation of consortia. 4 Developing in-house FinTech solutions With the aim of organic reinvestment and setting the grounds for embracing emerging technologies and new technology-based solutions, many incumbents have initiated a cross-business transformational process through increased ICT investments and digitalisation projects. Moreover, dedicated teams, digital labs, innovation incubators and sandboxes have been established in many incumbents in an effort to trigger internal motivation, bring closer business and IT functions and leverage the technological development. 31 January 2019 1st Digital Banking & Payments Conference 25 Source: EBA
FinTech key players INVESTORS Source: EBA Regulators and Supervisors 31 January 2019 1st Digital Banking & Payments Conference 26
Key forces changing banks business models 1 Heightened competition: The financial technology infrastructure created by the technological developments is leveraged by a number of new entrants (such as digital-based institutions, FinTech start-ups and technology providers) to design and provide financial services in innovative ways, adds competitive pressure on incumbent institutions and facilitate innovation in the banking sector. Customer expectations and behaviour: Significant socio-economic trends and demographic shifts in the population, where consumers are now seeking easy access and speed. The best example is the millennials who are moving quickly towards digital banking rather than walking into their banks' traditional branches. 2 3 Profitability concerns: In today s low-interest rate environment, banks are seeking more ways to increase their revenue sources and reduce costs through the use of new technologies. Source: EBA Regulatory framework: The current regulatory landscape, with the recent implementation of GDPR and PSD2, raises data protection and customer consent as key topics to be respected by all institutions. These pose another multi-dimensional challenge for institutions from a technology, operational and strategy perspective. 4 31 January 2019 1st Digital Banking & Payments Conference 27
Status of FinTech adoption and engagement In terms of the level of adoption of innovative technologies, engagement with FinTech, current digitalisation/innovation strategies, along with the respective stage of development, incumbent institutions seem to fall into three groups: PROACTIVE REACTIVE Proactive/ Front-runners Ambitious or aggressive innovation strategies, high-targeted transformation projects accompanied unclear impact and risk assessments (aiming for first-mover advantage) Well-thought and comprehensive strategies and targets with strong research orientation and focus on governance, organisational aspects, operations and risk management Reactive Followers of technological developments, taking a wait and see approach, with carefully defined strategies and steady-pace on internal changes Institutions reacting to peer pressure, taking a go with the flow approach in combination with the concern of staying behind. PASSIVE Passive Lagging behind technological developments due to other significant priorities, slowly trying to catch up following customer changing expectations Conservative/more traditional institutions reluctant to change 31 January 2019 Source: EBA 1st Digital Banking & Payments Conference 28
Thank you Office address : 80 Kennedy Avenue, CY-1076 Nicosia, CYPRUS Mail: P.O. Box 25529, CY-1395 Nicosia, CYPRUS tel: +357 22714216 Website: http://www.centralbank.cy E-mail: MariosKatsavras@centralbank.cy 31 January 2019 1st Digital Banking & Payments Conference 29