Fintechs and their risks

You went shopping. Made a purchase. But there is no cash in hand. No worries. Pay bills instantly through a mobile app or card. 

Besides, you do not have to go to the bank again and again to open a bank account. You can open an account at home. All of these are technology-enabled financial services, popularly known as fintech. 

Fintech is financial technologies used to provide financial services quickly, in a simple and cost-effective manner. It is now considered an alternative to traditional financial transaction methods, as it is playing a revolutionary role in providing efficient customer service through Artificial Intelligence, API, blockchain and data analytics. 

Examples of fintech include mobile banking, open banking, crowdfunding, stock trading, online financing, etc.

How does fintech work? 

Suppose you start a takeaway food business. But for this, you need to invest significant time and money. Various regulations must also be followed. You need to rent premises, buy equipment, hire staff and ensure you comply with health and safety regulations. To sell food items, you have to design marketing policies, create menus, manage bookings, hire delivery men and vehicles, and much more! 

But there is another option: you can share it with a third party.

An established professional cooking business can give you access to their premises, cooking equipment, highly trained staff, and ingredients, and ensure health and safety, for a fixed fee. Apps like FoodPanda can manage customer orders and deliveries. 

Simply put, you can focus on designing a great product based on someone else's infrastructure, knowledge, and expertise. Through this, you can be freed from the trouble of thousands of operations. 

Embedded finance works in the same way.

A banking-as-a-service (BaaS) provider operates like an established professional kitchen. Like choosing the favourite food from the kitchen's food menu, using their API (Application Programming Interface), businesses can also choose an app to provide financial services to their customers. Through embedded finance, businesses provide digital financial services to their customers. 

The Banking-as-a-Service (BaaS) platform is offering financial solutions that were previously unimaginable. 

For example, Germany's Solaris – a techno firm with a banking licence from Germany's regulator BaFin – is acting as Samsung's banking partner. It is facilitating the process of providing financial services to customers through the Samsung pay app.

This combination of finance and technology (Fintech) is facilitating the financial system of the whole world and its scope is also increasing day by day. 

As banks are now playing the role of service providers on behalf of various institutions, their foundation is also getting stronger. According to Vantage Market Research, the global fintech market was valued at $112.5 billion in 2021, and is expected to grow to $332.5 billion by 2028. 

But without taking into account the associated risks, sustainable growth cannot be achieved in this case. The main operational risks associated with fintech use are: (1) regulatory risk, (2) data privacy, (3) cyber security, (4) product risk, (5) third-party service risk, (6) money laundering risk, (7) fraud risk, (8) geopolitical risk, (9) technology risk and (10) system disruption issues.

The regulator wants fintech firms to follow their rules and regulations and give due importance to risk management. As technology changes rapidly, their regulations also change rapidly. 

Therefore, fintech organisations should take care to avoid non-compliance. GDPR (General Data Protection Regulation) and PSD (Amended Payment Services Directive) have been introduced in many countries to protect data and security system infrastructure. In case of failure to comply with these instructions; fines, sanctions and increased surveillance may be put in place by the regulator.

The nature of operations of fintech firms is such that they are prone to a high risk of cyber-attacks. The inadequacy of IT professionals has increased the likelihood of this risk. Failure to keep pace with the influx of new products and services can expose existing fintech to customer service risks. 

Failure of third-party services can create personal and management-liability risks. Excessive movement of funds for transactions in this system creates the risk of money laundering, internal fraud, and external fraud. Unexpected market events arising from geopolitical risk can put fintech firms at risk because those events are highly uncertain.

They also face the risk of losing revenue and customers if customer service is limited, due to a lack of innovative technology and system failures. According to reports, the biggest challenge faced by fintech is the lack of technical skills. Building a high-quality, secure fintech solution with sophisticated functionality like a banking app requires deep knowledge and expertise.

Kazi Naim Morshed is a banker, risk and economic analyst, and former university teacher.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.