How banks can manage the new risks arising from fintech automation

May 24, 2017 Risk Management
Financial risk management can utilize advanced data analytics and automation programs from Fintech companies.

Banks have always been keenly aware of managing industry-specific risks. However, the rise of fintech and automated services presents new risks that need to be quickly identified and effectively mitigated. These new challenges in the financial sector should not be used as an excuse to shy away from fintech innovation and automation. Rather, banks must build relationships with the right fintechs to successfully navigate this new financial landscape and leverage intelligent risks for growth opportunities.

Riskier business

While the past decade, and especially the past five years, witnessed a major upheaval in banking, the next 10 years will see even more sweeping changes impacting the industry. Much of this revolves around the increasing role of automation. According to research from McKinsey, a typical bank currently uses about 50 percent of its staff for credit administration and other risk-operational processes, and it only devotes about 15 percent to analytics. However, projections indicate that by 2025 the former will hover around 25 percent with the latter taking up 40 percent. That's a big swing in staff allocation over a relatively short period.

One risk that gets a lot of media attention is the fear that reliance on technology will make banks more vulnerable to cyberattackers seeking sensitive, personally identifiable information. At the same time, banks are introducing ever-evolving technology and advanced analytics that utilize machine learning to handle new financial risk-management techniques.

Data analytics will play an even larger role in the future of banking.Data analytics using AI will play an even larger role in the future of banking.

One of the trickier risk functions to manage will be providing real-time responses to customer requests, as this requires not only automated processes but also automatic risk assessment, and all without any human intervention. The AI handling these requests must be capable of synthesizing large swaths of quantitative and qualitative factors, calculating the path of least risk and providing a profitable path forward – all in a manner of seconds.

Partner with a fintech

Building a relationship with a fintech company creates better opportunity for banks to effectively mitigate new risks without sacrificing resources. This allows fintechs to do what they do best – serve a riskier market, automate manual processes – and lets banks focus on what they do best – build a customer base and ensure accurate and timely service.

Two-thirds of banks and financial services companies have immature or fairly informal third-party risk management programs, according to a recent Crowe Horwath LLP/Compliance Week survey. It's understandable why some banks would be hesitant to jump into a partnership with an outside company, as this raises it own set of risks, such as providing unparalleled access to the bank's data, customers, intellectual property and more.

"Banks and technology companies make natural partners."

However, the advantages of building a relationship with a fintech outweigh the potential for risks. In fact, banks and technology companies make natural partners. Banks have deep wells of customer, financial and industry-specific data as well as capital, branding and scalability. Unfortunately, few institutions have truly capitalized on their data or created a seamless omnichannel customer experience across in-person, online and mobile interactions. Fintechs have the capability to achieve these goals for banks.

Fintech companies are successfully experimenting with self-learning algorithms in credit underwriting and fraud detection and utilizing behavioral economics to reduce common decision-making biases and better understand customer patterns. A rise in open-source applications means banks can harness this technology to build their own specific applications. Banks and financial services companies will need these tools at their disposal to compete in the market of tomorrow.

As most software vendors have gone to a Software-as-a-Service model, banks will need to embrace and demand more robust service level agreements from these vendors, as customers and staff expect a seamless experience.

Prepare for the transition to automation

Partnering with a fintech company is a good way to get the ball rolling in preparation for the transition to automation, but it's not enough. While the introduction and evolution of telecommunications and information technology altered the financial services landscape, fintech and automation will transform it completely. Banks need to begin updating their risk-management functions now, before it's too late. These fundamental changes will take time and it's always best to get a head start.

As financial services and fintech companies continue to merge, the level of technology replacing traditional banking functions will necessitate more technical hiring and fewer customer-facing roles. The overall education level required to work in a banking environment is going to increase. With modeling, standardization and automation minimizing manual functions, those responsible for programming these algorithms, servicing the equipment and, perhaps most importantly, translating it into a business model will play a much larger role.

To compete in this automated and fintech-driven industry, banks must start building the right mix of talent and embracing the new risk culture. As noted by Fintech Finance, success of the risk function relies on a corporate culture where detection, assessment and mitigation are standard operating procedures for all employees. In many ways, fintech innovation is doing more to limit banks' exposure to risks than heighten it.