IMF calls for regulatory scrutiny on FinTech’s growth and neobanks’ risk appetite

In a blog post on its website, the IMF noted that while most FinTechs can scale up very rapidly and aggressively, across both riskier clients and business segments than traditional lenders.

“This combination of fast growth and the increasing importance of fintech financial services for the functioning of financial intermediation can come with system-wide risks,” wrote authors Antonio Garcia Pascual, Deputy Chief in the Global Markets Analysis Division, and Fabio Natalucci, Deputy Director of the Monetary and Capital Markets Department.

The global FinTech market is expected to reach $334 billion by 2026, growing at a compound annual rate of more than 25% between 2022 and 2027, research consultancy Market Data Forecast said in its FinTech report. The spike follows the growth in demand for digital financial services during the pandemic, as more people use online banking services to transfer money and pay for e-commerce transactions.

Digital banking startups in particular are more exposed than their traditional counterparts to risks from consumer lending, which usually has fewer buffers against losses because it tends to be more uncollateralised. Their exposure also extends to higher risk-taking in their securities portfolio, as well as higher liquidity risks.

“These factors also create a challenge for regulators: the risk management systems and overall resilience of most neobanks remain untested in an economic downturn,” they added.

The spill-over effect from FinTech also puts pressure on long-established industry rivals. As an example, the IMF points to the US mortgage industry, where fintech originators follow an aggressive growth strategy in periods when home lending is expanding, such as during the pandemic. “Competitive pressure from fintech firms significantly hurt the profitability of traditional banks, and this trend is set to continue.”

Their exposure of FinTech also extends to higher risk-taking in securities portfolios, as well as greater liquidity risks, specifically in terms of liquid assets held relative to their deposits as they tend to be lower than what traditional banks hold, IMF said in its Global Financial Stability report.

The article argues that policies that target both FinTech firms and traditional banks proportionately are needed. “For neobanks, this means stronger capital, liquidity, and risk-management requirements commensurate with their risks,” wrote Pascual and Natalucci. “For incumbent banks and other established entities, prudential supervision may need greater focus on the health of less technologically advanced banks, as their existing business models may be less sustainable over the long term.”