BoE stress testing framework has been a tool that the central bank and regulators have used to keep the banks honest since the recession. Stress testing driven by CCAR in the US, EBA and BoE in Europe and UK respectively is used to assess if banks have the required capital to withstand extreme market moves.
It checks if the UK banking system is resilient to deep simultaneous recessions in the UK and global economies, large falls in asset prices and a separate stress of misconduct costs.
As part of the 2017 Stress testing framework, Banks have been asked to explore the impact on their business models from an extended low growth, low interest rate environment with increasing competitive pressures in retail banking due to disruptive technology.
When BoE published the 2017 stress testing results for UK’s top banks namely, HSBC, Barclays, Lloyds, RBS, Santander etc., they included a scenario in which these banks would deal with a seven year downturn and increased pressure from Fintech. We have been discussing qualitatively on what the impact of the Fintech industry on banks would be, but now BoE is expecting banks to come up with a quantitative framework to assess this impact.
The central bank also expressed concerns that the banks were grossly underestimating the effect that Fintechs would have on their business models, revenues and growth opportunities. The stress test measured how resilient banks would be to a stress scenario which included a 4.7% fall in UK GDP, a 33% fall in house prices, interest rates increased to 4% and a 27% fall in the value of the pound.
The scenario to assess how banks would manage and respond to Fintech disruption will be part of the BoE stress testing framework and will be repeated every other year. This exercise would result in an impact assessment of Fintech disruption (Open banking and PSD2) on Banks’ financial and business models.
Speaking at a conference, Mark Carney mentioned that the business models of incumbent banks would have consequences due to Fintech SMEs leveraging open banking to create new opportunities for customers. This could lead to greater and faster disruption to banks.
For example, with Personal Finance Manager applications using AI gaining traction, Banks may start to lose overdraft revenues that contribute £2.6 Billion. The other major fear is that with PSD2, Fintech firms could weaken the Banks’ relationships with customers due to weakened/minimum engagement model (from the banks).
While there is still a group of commentators expecting banks to step up their Fintech play, I believe, they can do that partly through buying out innovation. However, trying to replicate a Fintech, or transforming itself to deliver like a nimble Fintech firm, is not a feasible change that a bank could achieve. The culture within banks would need a massive overhaul to even start resembling a Fintech firm.
The BoE governor had stressed that, while Brexit hasn’t affected the position of UK and London as Global Fintech hub, there is still a lot of work to be done to quantitatively assess the impact of Fintech on banks.
Arunkumar Krishnakumar is a Fintech thought leader and an investor.
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