Does Fintech Threaten the Stability of the Financial System?

Fintech is changing how the economy works at the local, national, and global levels—perhaps, in some cases, for the better. Research from the International Monetary Fund’s Nicola Pierri and the US Federal Reserve’s Yannick Timmer highlights one example of how technology can improve the financial system. According to the study, banks that had invested heavily in internal technology systems prior to the 2008–09 financial crisis had fewer nonperforming loans once the mortgage market imploded.

That said, fintech also likely introduces risks, and in a 2022 speech, Fernando Restoy, chair of the Financial Stability Institute at the Bank for International Settlements (and former deputy governor of the Bank of Spain), issued a warning: “The public policy response to such a far-reaching technological disruption has to be commensurate with the magnitude of that disruption. . . . The current regulatory setup, consisting of a series of diverse activity-based requirements accompanied by specific rules only for traditional financial institutions, is simply not fit for purpose.”

Determining what policies or regulations should change requires understanding the potential trade-offs and vulnerabilities. A range of issues are percolating:

Profit-squeezed banks may take more risks. A study from IMF researcher Sami Ben Naceur, University of Louvain’s Bertrand Candelon, and the IMF’s Selim A. Elekdag and Drilona Emrullahu documents a slight decline in traditional banks’ return on equity and return on assets for every 1 percent increase in fintech-lending and capital-raising volume.

This hit to profitability is a function of fintech being faster and cheaper in processing loan applications while operating under generally lighter regulatory requirements, which enables it to take market share from traditional banks, according to the study. Those banks then have to increase spending to hold on to existing customers and attract new ones.

These negative impacts are felt more at smaller cooperative banks, the researchers find. All of this raises the concern that banks facing pressure from fintech competition may be compelled to take on more risk—by paying more on deposits, say, or lowering lending standards—which has potential ramifications for system-wide stability.

Subsequent research by Elekdag, Emrullahu, and Ben Naceur explores this risk. Analyzing fintech lending and capital raising across 57 countries from 2012 to 2020, compared with balance-sheet and income data for more than 10,000 traditional financial institutions (including both banks and nonbanks), the researchers conclude that fintech competition is a net negative for bank stability. The greater the presence of fintech competition, the more risk a traditional bank tends to take on.

Weaker banks and systems could be more vulnerable. The same research also finds that traditional banks in more solid shape—with higher capitalization and liquidity ratios and with diversified income streams—are less susceptible to this pressure, however. And countries with strong regulatory oversight seem to be less inclined to ramp up risk in the face of fintech. As logic would suggest, the greatest risk may come from weaker banks and those operating without robust regulation.

Yet another paper, from the IMF’s Serhan Cevik, measured country-level financial stability from 2012 to 2020 across nearly 200 countries and concludes that digital lending only slightly hurt stability. This was true for both advanced and developing countries. Digital capital raising, which includes crowdfunding by businesses and individuals, was a net positive, but only for advanced economies, providing valuable decentralization and diversification for a country’s financial system.

Fintechs buddy up with banks. Central to all of this emerging research is that fintechs are usually not subject to the same regulatory rules as traditional banks. However, some have formed partnerships. There’s been growth in banking as a service, whereby fintech startups hook up with an existing bank that already has a license to offer regulated services as a means to distribute their loans or other products to front-end customers. BaaS is in part a legal end run by fintechs in getting their products marketed to bank customers without coming under the same regulatory oversight as a traditional bank.

In 2023, the three main US regulators—the Fed, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency—centralized their guidance for how banks should handle third-party relationships to manage operational and customer risk.

A year later, a joint statement from the same regulators reiterated the risks to the system and referred stakeholders to its third-party guidance. This statement also made it clear that the regulators intend to review these issues when conducting routine inspections and oversight of the traditional banks.

With tech, runs can happen faster. The role of mobile technology in the failure of Silicon Valley Bank has sparked interest in whether traditional regulatory rules need to adjust to the speed at which bank runs can form. In 2008, the failure of Washington Mutual Bank played out over months. By comparison, it took just two days of social media news about SVB’s liquidity mismatch for the resulting digital withdrawals to land the bank in receivership.

A 2024 report—by New York University’s Viral Acharya, Bocconi University’s Elena Carletti, the Bank for International Settlements’ Restoy, and University of Navarra’s Xavier Vives—notes that the runoff rate (pace of withdrawals) for deposits experienced by SVB was much higher than the standard assumption used by regulators following the global standard known as Basel III.

“In an era of digital banking where social media exacerbates the speed of information circulation, the current deposit run-offs might need to be reconsidered, in particular those applied to uninsured deposits upwards,” they write.

In a letter accompanying the official review of the failure of SVB, then–Fed vice chairman Michael Barr placed primary responsibility at the feet of poor bank management and poor federal regulatory oversight, while also acknowledging the role of technology. “The combination of social media, a highly networked and concentrated depositor base, and technology may have fundamentally changed the speed of bank runs,” he wrote. “Social media enabled depositors to instantly spread concerns about a bank run, and technology enabled immediate withdrawals of funding.”