For growing FinTechs, risk technology will be a must to appease tougher regulators

For growing FinTechs, risk technology will be a must to appease tougher regulators

In striving for growth, many FinTech firms enter different markets with solutions that use the same underlying technology. As highlighted by recent AML-related issues, however, this technology is seldom regulation-friendly. To withstand deeper inbound regulatory scrutiny, FinTechs must adopt robust risk technology.

Iga Pilewska ([email protected])

Fintech

An increasingly watchful eye

Last year was a phenomenal one for the FinTech sector. Global venture-capital investment in FinTech firms reached a record $36.6 billion in 2018, a 148% increase year-on-year, while the number of FinTech unicorns grew sharply.

As this rapid growth continues, one question is becoming more pertinent: what are the regulatory implications? FinTechs are still relatively small, and as such have so far been exposed to regulators’ more benign side, largely via ‘sandboxes’ developed in several countries, including the UK, Singapore, Hong Kong, Australia, Canada and the US (in Arizona, Wyoming and Utah). Sandboxes improve FinTech firms’ awareness of regulation by helping them better understand the regulatory environments they operate in. (One of the European authorities’ goals in developing sandboxes, for example, is to 'seek assurances that appropriate risk-mitigation measures are in place before permitting the commencement [of initiatives].')

Moreover, these projects are also an opportunity for regulators to learn more about FinTechs. So far regulators have been relatively friendly to FinTechs to support their innovation-oriented approach and encourage investment. But as FinTechs grow, they should be prepared to see regulators’ tougher side.

Growth or compliance?

Banks can typically take years to establish operations in new jurisdictions, usually by acquiring local financial institutions (FIs). Start-ups, by contrast, often build for one jurisdiction, identifying scale as their most important objective. FinTechs’ business model is about rapidly scaling their technology, and to save time and cost they often enter new markets with the same technological model as they use in existing markets.

In some cases this gives them an advantage – they can onboard customers much quicker, for example. But their technology is often not regulation-friendly, and in some financial areas FinTechs may find themselves on the wrong side of the regulators. Recent controversies surrounding two FinTechs (Revolut and N26), for example, have raised concerns around firms’ ability to manage anti-money laundering (AML) in particular.

In some areas, such as AML, while regulators only investigate intermittently, when they do the cost to offending FIs can be high. But building an AML infrastructure is a time-consuming process, and as FinTechs search for growth it may be tempting to omit it from their priority list. The desire for short-term growth among many FinTechs could be seen as the source of their undoing, boosting their size but restricting their strategic view and increasing their appetite for risk. It is important for Fintechs to prove otherwise.

RiskTech will be a key differentiator

Risk technology will be vital for FinTechs going forward. The cost of compliance is relatively low for FinTech start-ups, but it increases rapidly once they leave the safety of their sandboxes, and particularly when they expand into new markets. Furthermore, since FinTechs usually stick to the same technology models as they scale, they must ensure that their risk technology covers all the jurisdictions in which they operate.

Inevitably, once FinTechs reach a certain size, they will have to face increased regulatory scrutiny. To address this they must be proactive, demonstrating that they have the required strategy and capital to invest in proper AML, anti-fraud and Know Your Customer (KYC) systems from the outset. There is also a competitive advantage in addressing regulation, as some cryptocurrency exchanges have discovered after going out of their way to comply and cultivate a ‘safer’ image.

For FinTech firms it’s easy to scale without being concerned with regulation. The later they embrace regulations, however, the more costly and disruptive compliance could be. FinTechs will need to strengthen their risk management capabilities as they grow. RiskTech will become a key differentiator for FinTechs, both supporting their scaling ambitions and helping them nurture a positive relationship with regulators.

Further reading

Financial Crime Risk Management Systems: AML and Watchlist Monitoring 2019

Financial Crime Risk Management Systems: Know Your Customer

Financial Crime Risk Management Systems: Enterprise Fraud 2018

Fintech: Growth and Deregulation (edited by Diane Maurice, Jack Freund and David Fairman); published by Risk.net in February 2018

Points of View are short articles in which members of the Chartis team express their opinions on relevant topics in the risk technology marketplace. Chartis is a trading name of Infopro Digital Services Limited, whose branded publications consist of the opinions of its research analysts and should not be construed as advice.

If you have any comments or queries on Chartis Points of View, you can email the individual author, or email Chartis at [email protected].