Financial technology—or fintech—has become a key enabler of more efficient and competitive financial markets, helping expand access to finance for underserved consumers. Especially in times of social distancing to reduce the spread of COVID-19 and ramping up of digital cash transfer programs in many countries, the benefits of fintech and digital financial services have never been so evident. But fintech doesn’t come without risks to consumers.
Increased instances of digital fraud, peer-to-peer lending platform collapses, and borrower distress as a result of irresponsible digital microcredit lending practices illustrate such risks. While some of these risks are new, many are new manifestations of risks that already existed in financial markets. They include not only those arising from the underlying technology enabling fintech, but also from new business models, product features, and provider types.
Identifying new manifestations and addressing them
Authorities responsible for financial consumer protection (FCP) are increasingly facing the challenge of addressing these risks but often lack the technical expertise or tools to do so. A new World Bank policy research paper, Consumer Risks in Fintech: New Manifestations of Consumer Risks and Emerging Regulatory Approaches, seeks to directly address this need, by identifying new manifestations of consumer risks posed by fintech and providing a range of emerging policy approaches that can be used to address them.
The paper focuses on four major fintech offerings: digital microcredit, peer-to-peer lending, investment-based crowdfunding, and e-money. These were selected as fintech examples that can address key basic needs of first-time, inexperienced financial consumers, such as making payments, borrowing, or saving and investing money.
These are some highlights of identified risks and approaches:
Fintech operator fraud or misconduct: Because fintech business models can be innovative, opaque, or complex—and many consumers are not familiar with them—they can lead to heightened risks of loss from fraud or misconduct by operators or related parties. Establishing competence requirements for these market players, as well as mandatory licensing/registration and vetting, can help address the issue.
Platform/technology unreliability or vulnerability: If a fintech platform or other systems underpinning a fintech offering are unreliable or vulnerable to external threats, they can expose consumers to higher risks of loss and other harm, including from third-party fraud. Approaches to address these challenges include technology and outsourcing-specific risk management, operational reliability, and competence requirements for operators.
Consumer disclosure and transparency in a digital context: The standard risks arising from consumers not being provided with adequate product information are heightened when new types of pricing, product features, and risks are introduced, and when digital channels for communication pose challenges to consumer comprehension. Adapting disclosure formats for digital channels and ensuring that the order and flow of information and user interfaces are increasingly recognized as necessary to address these issues.
Increased risk of product unsuitability: Fintech can increase access to riskier or complex financial products to consumers who lack the knowledge or experience to assess or use them properly, leading to greater risks of harm due to product unsuitability. Possible solutions include limits on individual investments or other exposures for less knowledgeable consumers and product suitability and product design obligations for fintech operators.
Conflicted fintech business models leading to conduct that is not in consumers’ interests: Fintech business models may give rise to conflicts of interest under circumstances not foreseen by regulators or expected by consumers. Emerging approaches to address this include conflict mitigation obligations and a range of restrictions targeting specific conflict types.
Algorithmic decision-making leading to potentially unfair outcomes: The use of algorithms for consumer-related decisions is becoming particularly prevalent in highly automated fintech business models, and some scoring decisions may lead to unfair, discriminatory, or biased outcomes. Applying anti-discrimination rules to algorithmic scoring and requiring appropriate procedures, controls, and safeguards during development, testing, and deployment of algorithms are emerging approaches being proposed to address risks.
Taking a balanced, step-by-step approach is critical
Regulators contemplating any of these measures will need to tailor approaches to their country context, considering not only risk-mitigation concerns but also possible implications for financial sector development and innovation.
A step-by-step approach will be crucial. This should include assessing the market, consumer experiences, and current regulatory framework; and determining the right regulatory approach based on that assessment (including considering alternatives to regulation when appropriate). Ensuring effective, adequately resourced supervision of measures implemented; and implementing complementary measures—such as efforts to increase consumer awareness and industry capacity and understanding—are also crucial steps.
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