Financial and Monetary Systems

Technology is driving new risks in financial services. It will also be key to mitigation

Technology is driving new risks in financial services. It will also be key to mitigation

What are these risks and how can we approach mitigation? Image: Photo by Markus Spiske on Unsplash

Drew Propson
Head, Technology and Innovation in Financial Services, World Economic Forum
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Financial and Monetary Systems

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  • A new report from the World Economic Forum explores how the acceleration of technology in financial services is driving new risks.
  • These risks are accumulating and beginning to form systemic risks.
  • Here are three action areas critical to mitigation approaches.

The advancement of technology in financial services has undoubtedly been a net positive over the past decades. For firms, technology and innovation have helped to streamline operations and offer new digital financial products and services to customers at low cost. Consumers, then, have benefitted through a combination of improved access to financial services, convenience, and greater selection. At the same time, as with all innovation, the increased use of technology is giving rise to new risks, risks that if unchecked, can become systemic and put into question the stability of the global financial system.

What are these risks and how can we approach mitigation? This is the focus of a newly-launched report by the World Economic Forum, in collaboration with Deloitte. The report, Beneath the Surface: Technology-driven systemic risks and the continued need for innovation, engaged over 150 experts through interviews and seven virtual global workshops over the past year. Participants included senior leaders from financial services, technology firms, academia and the public sector.

As highlighted in the report, to fully understand the technology-driven systemic risks that are developing, it is useful to begin by first considering the sources of risk. That is, situations that create loss or drive uncertainty in the financial services ecosystem. A straightforward example of this would be lagging cybersecurity tools and methods. While not systemic on their own, sources of risk may build upon one another to form systemic risks.

Sources of risk can be mapped into five key categories. Three of these – Economic and Fiscal, Cyber and Data, and Societal and Climate – directly contribute to the formation of systemic risk. The other two – Structural and Composition and Technology Utilization – are foundational and cross-cutting in nature.

The formation of systemic risk
The formation of systemic risk Image: World Economic Forum

Several pressing systemic risk themes are quickly arising as the accumulation of sources of risk within and across categories grows. One such risk theme is Digital Interdependencies. As the financial services ecosystem becomes increasingly digitally interconnected, any entity that plays a critical role in enabling financial services can cause ecosystem disruptions and cascading implications. Taking into consideration, as well, the consolidation of vendors that offer core capabilities (e.g., cloud service providers), and complex supply chains that limit visibility into nodes of a network, one can comprehend the severity of the risk.

Another technology-driven systemic risk theme that is forming is Emerging Sources of Influence. Social media platforms are providing new opportunities to drive activities and behaviors that pose risks to consumer protection and market stability. Individual actors and malicious programs (e.g. bots, deepfakes) can influence sentiment and, thus, investing behavior and other financial decisions. Given the reach and scale of these platforms, combined with the speed of information sharing and limited protection mechanisms, the implications are significant.

Other emerging system risk themes include Risk Model Vulnerabilities, Gaps in Entity-based Regulation, Conflicting National Priorities and New Drivers of Financial Exclusion. Diving into these risks may give the impression of a highly pessimistic future for our increasingly digital financial system. It is sensible to be concerned, however, there is also plenty good news – strategic and immediate action can help with risk prevention, intervention and resolution. Here are three ways in which we must approach mitigation, ideally simultaneously:

1. Entity-level efforts

Individual entities need to take thoughtful action against new systemic risks surfacing, with deep consideration for their role in the ecosystem and relation to each risk. Though entities cannot fully resolve risks independently, responsible steps to protect one’s organization will also benefit the ecosystem as a whole.

Building on traditional approaches to risk mitigation, entities can explore novel tools and applications that enhance current practices. Numerous opportunities to increase efforts are developing - for example, implementing geospacial network mapping to strengthen mitigation for Digital Interdependencies. This is an emerging application that allows an entity to better detect and manage vulnerabilities as they arise. Organizations can connect geospacial data with network maps to monitor their physical and digital footprints. This helps in quick identification of service disruptions or cyberattacks interfering with operations, allowing for real-time intervention.

Geospacial network mapping
Geospacial network mapping Image: World Economic Forum

2. Multilateral efforts

Since systemic risks are challenges that affect the whole ecosystem, multi-stakeholder cooperation is essential to driving solutions. There is appetite and ability to expand on current collaborative efforts. These can be public-private, private-private and/or public-public in nature.

Many of these opportunities can be easily envisioned. Take, for example, multilateral scenario planning. Public and private sector players can collectively create enhanced scenario planning exercises and develop extensive stress tests with a broader ecosystem orientation.

In addition to expanding efforts around more easily envisioned collaborations, it is also important to explore the potential of more ambitious inventive mitigation applications. Imagine, for example, that ecosystem actors develop a multilateral financial market alert system: Big Techs and regulators collaborate on an advanced false-information detection system with a shared live feed, which is then leveraged for the identification of “red flag events” and broader market warnings. Deep learning techniques could be the foundation of such a system, as they are robust and well-equipped to deal with complex interaction patterns between social networks and financial markets.

3. Technology

While the increased use of technology in financial services is giving rise to new risks, technology is also an apt tool for mitigation. We have already observed this through the examples above, where technology is embedded in the entity-level and multilateral opportunities outlined.

The possibilities for technology to support mitigation are plentiful. Yet, as the previous examples also demonstrate, we must consider that there is always a human component to the implementation of technology. To fully mitigate the risks surfacing today, and those that will inevitably take shape as unintended consequences follow even newer innovations, collective action will be key.

The World Economic Forum’s report further delves into the individual and collective approaches that are needed for a successful convergence of mitigation efforts. With strategic planning and cooperation, along with a healthy dose of optimism, technology can continue to be a powerful and beneficial force in financial services.

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