Denser interconnectivity among financial entities poses broader financial stability risks such as higher contagion and amplification of procyclical behavior in times of stress
FinTech BizNews Service
Mumbai, June 27, 2024: The Reserve Bank on Thursday released the 29th issue of the Financial Stability Report (FSR), which reflects the collective assessment of the Sub-Committee of the Financial Stability and Development Council (FSDC) on the resilience of the Indian financial system and risks to financial stability.
The Chapter III of this report highlights Regulatory Initiatives in the Financial Sector. Global regulatory initiatives are increasingly concentrated on fortifying the resilience of the financial system against new and emerging sources of risk. Concurrently, efforts continue to focus on reinforcing the resilience of both bank and non-bank financial intermediaries. Domestically, the regulatory endeavor has emphasised enhancing the soundness and resilience of the financial sector, fostering the development of deeper and more sophisticated financial markets and implementing global best practices while keeping in view country-specific circumstances.
FinTech and Financial Stability
Widespread adoption of digitalization has spurred innovation and has led to the emergence of new business models alongside increased dependency of traditional financial players on third party technology providers as many financial services get increasingly provided through new distribution channels. The application of distributed ledger technology (DLT), application programming interfaces (API), cloud computing, artificial intelligence (AI) and machine learning (ML) in finance - broadly referred to as ‘fintech’ - has pertinent implications for financial intermediation process as well as for banks and regulators. The report of the Basel Committee on Banking Supervision (BCBS) on the implications of digitalisation of finance for banks and supervisors covers three broad areas, viz., (a) stocking of ‘fintech’ penetration in the banking sector; (b) benefits and risks of new technologies and their suppliers on the financial services provided by banks; and (c) policy recommendations to mitigate potential risks. The report states that while cloud computing has been widely adopted, banks appear to be using AI/ML technologies cautiously, especially for customer-facing services and for revenue generation.
The report notes that digitalization has created new sources of vulnerabilities while amplifying existing risks to banks, their customers and to financial stability. Banks are facing ‘strategic risk’ as they need to adapt their business strategies to an increasingly digital environment in which higher dependence on third parties and automated processes has heightened ‘reputational risk’ and ‘operational risk’. Denser interconnectivity among financial entities poses broader financial stability risks such as higher contagion and amplification of procyclical behavior in times of stress. The regulatory and supervisory implications for banks and supervisors include: (a) effective monitoring of evolving risks and adopting a responsible approach to innovation; (b) safeguarding data and implementing robust risk management processes; and (c) building technological expertise to assess and mitigate risks from new technologies and business models.
Global regulatory bodies and multilateral organizations such as the Financial Action Task Force (FATF) and the IOSCO have been examining developments in the field of Decentralized Finance (DeFi), prompted by concerns that rapid growth in such segments could have implications for broader asset market and global financial stability. To create a regulatory framework for digital assets, the United States is considering the ‘Financial Innovation and Technology for the 21st Century Act (FIT21)’, which is intended to provide market certainty, grant legal recognition to digital assets and allocate jurisdiction to Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) over involved assets, venues and entities. Meanwhile, the SEC approved the trading of exchange traded products (ETP), based on select cryptocurrencies, to create a level playing field for such ETP issuers and ensure customer protection.
