Why is Risk Management so Important in Fintech?

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By Mark Metzler posted 06-08-2021 10:42 PM

  

Digitizing and transforming financial services through innovation and advanced technologies offers a financial inclusivity that was not available using conventional approaches. Fintech offers readily accessible financial services to everyone and there is a compelling case for the democratization of financial services. 

However, it is important to manage these innovations in a way that protects the safety of the industry and strengthens it as a whole. Unprecedented changes are taking place in financial systems and risk management needs to evolve with them. 

The critical balance between fostering progress while mitigating risk 

Investors in fintech demand growth and this often means less investment in compliance and risk management. FINCAD is a company that provides pricing and risk analytics to fintech partners and financial institutions. Mark D'Arcy, President and CEO, believes there is a need to establish “guardrails” across the financial industry. 

He says that like any car, the fintech company will at some point need brakes in the form of risk management and compliance. This may be prompted by things like a major equity investor requiring it for a funding round or by a large capital call. 

Fintech firms need to be proactive and begin ensuring that they develop the necessary frameworks, tools and skillsets so they can identify and mitigate emerging risks. 

Consternation in the financial sector

When the users of chat forum website Reddit dramatically pumped up the share price of GameStop, Robinhood trading app was faced with a crisis. The app claims to democratize finance by letting ordinary people trade shares. It managed to survive the crisis and navigated the capital call with the help of its venture capital investors. 

There was such concern about the potential effect of such a situation that it attracted the attention of the White House and financial regulators. The unprecedented battle between thousands of small traders and multi-billion dollar investment houses also caused consternation in the financial sector. It’s quite likely that the roller-coaster market movements caused by the actions on Reddit could just trigger new financial regulations. 

Unprecedented changes require new risk management structures 

There was a period in history when part of the American dream was the right of everyone to own a home. Financial services typically needed to finance home purchases and before the global financial crisis, they were handing out mortgages. After the crisis, there was a period of significant regulatory changes. 

At every time when unprecedented changes occur, the risk management function has to expand and evolve as traditional risk management structures are usually not sufficient. As new fintech technologies develop, such as cloud offerings, distributed ledgers and robotics, new frameworks are necessary to enhance monitoring of risks. It is important to test risk tolerance levels and acceptable risks may have to be revised. 

Strong risk management offers a competitive advantage 

D’arcy believes it is important that fintech does not see compliance as the cost of doing business or a necessary evil. He sees it as having the potential to offer a competitive advantage and be a differentiator. Financial services need strong risk management because this enables people to take calculated risks so they can earn higher returns. 

D’arcy’s advice for the fintech crowd is that it must apply the same level of innovation to risk management as it applies to consumer application development. 

Firms who double down on risk management tools and systems will not only have more chance of staying ahead of the competition but will help to protect the stability of the system. This would help to bring about financial democratization in a way that benefits everyone. 

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