IMF Recommends More Regulation to Reduce FinTech, Crypto Risks

In an April 13 blog post, the International Monetary Fund (IMF) explained the benefits that FinTech companies have brought to consumers, but it also highlighted the challenges that these sometimes lightly regulated entities pose for regulators. The IMF’s recommendation to reduce risks is more regulation.

According to the IMF, while most FinTech businesses are still small, they may expand quickly across both riskier clientele and industry categories than traditional lenders, raising the stakes for regulators and supervisors. This rapid expansion and growing relevance of FinTech services might pose systemic hazards.

“Not only do FinTech firms take on more risks themselves, they also exert pressure on long-established industry rivals,” the post stated.

FinTech services are more vulnerable to consumer lending risks than their conventional equivalents, as they typically have fewer buffers against losses, which tend to be more uncollateralized, the IMF explained. As an example, the IMF described the mortgage market in the U.S., where FinTech mortgage originators pursue an aggressive expansion strategy during periods of increased house financing, as during the pandemic.

The IMF suggested that more regulation could help mitigate these risks, especially because it would reduce regulatory arbitrage (when firms move around to set up operations in less regulated markets). The IMF seemed to imply that many of the new FinTech services are not regulated, and the relationship with traditional banks in some of these areas may bring additional risks because of the provision of liquidity and leverage by banks to FinTech.

For the IMF, one solution for neobanks is “stronger capital, liquidity and risk-management requirements commensurate with their risks.” But the IMF also had recommendations for traditional banks.

“[P]rudential supervision may need greater focus on the health of less technologically advanced banks, as their existing business models may be less sustainable over the long term,” according to the post.

The international organization continues with another innovation that may pose challenges for regulators and bring systemic risks, decentralized finance (DeFi).

After praising the new technology for having the potential to deliver more innovative, inclusive and transparent financial services, the IMF stressed that it is also “particularly vulnerable to market, liquidity and cyber risks.” Cyberattacks, which may be devastating for traditional banks, are frequently fatal for these sites, taking financial assets and shattering user confidence, the IMF argued. DeFi’s absence of deposit protection is particularly concerning. Large customer withdrawals have often occurred in response to reports of provider hacks.

Here, the recommendation to mitigate risks is, again, more regulation but with the additional challenge that there is no entity governing DeFi platforms. Therefore, the recommendation (and regulation) focuses on the entities that contribute to the rapid growth of DeFi, such as stablecoin issuers and centralized cryptocurrency exchanges. Additionally, the IMF recommended that the supervisory authorities should encourage robust governance, which could include industry codes or even self-regulatory organizations.

While the IMF’s recommendations are not binding and they may not have a significant impact in most developed countries, they may carry certain weight for the recipients of funds, as request for loans and financial aid from the IMF may come with strings attached, some of which may be regulatory reforms.

This is not the first time the IMF has warned about the regulatory risks associated with crypto assets. Early this month, the IMF said countries with more corruption tend to have more people using cryptocurrencies.

Read more: IMF Study Finds Corrupt Countries Use More Crypto, Argues for Crackdown

In January, the international organization told El Salvador that in order to access a $1.3 billion loan, the country should drop bitcoin as legal tender first.

See more: IMF’s Silence Signals El Salvador Needs to Abandon Bitcoin to Secure $1.3B Loan