The outcomes of human interventions can be even harder to anticipate than health and environmental risks in financial services, because fintech innovations are changing markets so rapidly. Philip Whiteley talks to financial services risk adviser Dennis Cox
Behavioural changes in response to disruptive technologies can be even harder to model and anticipate than health and environmental risks, according to financial services risk analyst Dennis Cox. He heads the Risk Reward advisory service, based in London, which provides consultancy services to banks and others in the financial services industry.
Climate change and pandemics are known unknowns – present in risk models, although with an unpredictable trajectory. It would be a mistake to assume that market responses to some fintech innovations powered by artificial intelligence (AI) are easier to anticipate.
‘The corona virus is a pandemic, it’s a risk that everyone has been modelling since scenario modelling was developed. Firms should just be implementing plans that they already have … there are existing models for that. It is operating under standard distribution for a pandemic, perhaps with greater global spread and a fear factor that exceeds the risk factor.’
Employers who have been prepared for pandemics will have been better equipped to deal with the widespread lockdowns and economic recession following the coronavirus outbreak this year. A key priority when large numbers of staff are working from home to minimize contagion risks, is to ensure that there is compliance with GDPR compliance, as potentially sensitive personal data may be accessed in a non-office environment. Similarly, climate change has potentially a major impact, but the science is increasingly well understood and, while unpredictable in certain aspects, it is subject to modelling.
The impact of fintech, however, can be quicker and even less predictable, he reports. The two top priorities in terms of risk assessment in financial services are disruptive technologies, and the closely related issue of how markets respond. The rise of app-based services, low-cost loans and zero-fee instant transaction services such as Zelle (https://www.zellepay.com/) pose a competitive challenge to a conventional bank. During the pandemic, even more business transactions and communications have switched to being digital and whether these will return to previous activity patterns must be open to significant doubt.
‘Everything has to be fast, instantaneous, as a consequence of these [technological] changes,’ says Cox. ‘Banks will have to look at their business models, to see if they are robust. There is so much that is going on at the one time.’
In the loans business, AI can automate the processing and approval of a standard product, such as a car loan for a salaried individual, slashing the costs and margins for new entrants and established companies alike. While an established brand has huge value in the case of deposit banks, because customers want reassurance that their savings and current accounts are safe, this is less of an issue for money transfers and lending, where new specialist entrants are not holding any of the customers’ money. In addition, the rise of cryptocurrencies is continuing, with an estimated 3,000 now in existence. Regulatory risks will continue to hover over such currencies, but in the case of transaction and loans business, new entrants are already regulated.
Many innovations in financial services have an impact on the profitability of established financial institutions. Their business model needs to undergo continual reassessment and updating. Whereas in the past a firm’s leaders might hold a strategy day or mini-conference once a year, such an approach would be hopelessly sluggish today, as the strategy requires continual updating. Rapidly changing technology and customer behaviour ‘force them [business leaders] to look at their business model … that’s the challenge: to find the areas where profitability is retained,’ says Cox.
One opportunity is in niche financial services for non-conventional customers, such as the self-employed, where automation is trickier; but this still requires innovative capacity and investment. It is well established in management practice and theory that large, established firms struggle to innovate in a disruptive way, and that they need to set up separate companies or incubation hubs to do this, and some banks are doing this. ‘But you have to give it an amount of freedom,’ he warns.
With risk, generally there is opportunity, but businesses can only respond to either by being nimble and responsive. It is a counter-intuitive reality, but some of the risks humans create through innovation within an industry can be harder to map than external threats.