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Lois Osei-Sekyereh
UGSOL ’24
Abstract
Traditional banking and finance methodologies are rapidly being replaced by advances in financial technology (Fintech). That traditional finance is being eclipsed by new offerings – from artificial intelligence (AI), distributed ledger technologies (DLT), peer-to-peer lending offerings, robo-advisors, crowdfunding and other developments – is for many reasons as the new technology is faster and more convenient making the more centralised data and resources of banks seem antiquated. One of the most important reasons for this rise is that of globalisation, spurred on in part by the 2007/2008 Financial Crisis. The lack of transparency, a flawed but widely-accepted faith in the self correcting nature of markets, and a belief in the ability of financial institutions to police themselves, had been factors leading to the crisis, which among other things sparked a seismic shift in the delivery of financial services. This essay begins with a discussion of what Fintech entails, discusses the relationship between Fintech and economic development, and closes with suggestions on regulatory measures.
Introduction
Fintech is the use of technology to deliver financial services and seeks to bridge the gap between traditional banking and new methodologies to meet evolving consumer needs. Until recently, the banking sector was predominant in the delivery of financial services across investment options, savings and loans. With new technologies in past decades came innovations such as automated teller machines (ATMs), credit and debit cards, and the internet. It was the 2007/2008 Financial Crisis, however, that prompted the introduction of stricter regulations, higher fines and greater barriers to entry in the banking industry coupled with declining consumer confidence in the banks which stymied banks from further innovation compared to what was offered by increased digitalisation from new entrants. Technology companies, many of them startups, saw this gap and sought to create new technologies better able to meet growing consumer needs in more efficient and convenient, cheaper, ways using digital data and mobile technology.
The relationship between Fintech and economic development
According to the Global Findex Database 2021 Reports, about 1.4 billion adults remained without access to banking facilities (unbanked). This meant that no-one in the reporting household had a bank or credit union account. The impact of the Covid-19 pandemic on the financial sector worldwide however served as a catalyst for the expansion of financial technology (Fintech). In developing countries, about 40 per cent of people who have made a digital payment did so for the first time during the pandemic. It is estimated that by the end of 2022, the annual growth rate of Fintech had reached 24.8 per cent, nearly a quarter of all people. A major reason for Fintech’s rapid growth is the increased accessibility it affords users regardless of their financial status, thereby allowing people without regular incomes or a fixed residence to build wealth through digital savings, loans, budgeting tools, and investments without the barriers found in traditional banking. For instance, M-Pesa in Kenya has helped raise about two per cent of the Kenyan population out of poverty. The impact of Fintech on economic development cannot therefore be overemphasised as it is a major means to reach those without access to banking, whether from remote geographical locations, illiteracy or financial hardships. This expansion has also developed modern economic opportunities which has helped to close the gender gap from nine down to six per cent in account ownership in developing countries. Another impact of Fintech on economic development is the transformation of loan offerings. With the creation of systems that help to compare credit card loans such as on peer-to-peer lending platforms or crowdfunding apps, information inequalities are reduced and funding can be raised more cheaply both of which can assist in applications for home mortgages and other needs. As a result, the barriers that existed with traditional banks for individuals without the requisite paperwork or collateral security have been reduced or removed – new avenues have been opened up. Additionally, Fintech has revolutionised traditional credit card lines by opening up opportunities that would otherwise be unavailable from poor credit scores through methods offering alternative means to determine a person’s creditworthiness such as their employment history. Economic development has increased from increased investment in Fintech seeing about US$300bn invested worldwide at the end of 2022. This increase has also been fomented by robo-advisors that allow investors with little or no experience to initiate trades, study investment reports and manage a portfolio. Although it has been argued that Fintech and its attendant disruption has and will continue to displace traditional banking jobs, it also brings employment opportunities, arguably sufficient to offset any displacement.
Suggested regulatory measures
Given the progressive nature of Fintech, a blanket approach to its regulation will yield few results. Rather, regulatory measures must be tailored to adapt to the nature of the particular Fintech model. The following suggestions are categorised into three based on stakeholder analysis: Fintech companies, consumers and the government.
Fintech companies
More than a quarter of all Fintech companies have experienced a security breach, a factor behind the need for more elaborate regulatory mechanisms. Cryptocurrencies have also been the Fintech payment method most susceptible to scams, with over US$1bn reported stolen in the 18 months between January 2021 and June 2022. Using DLT protocols which by their nature provide for a certain level of network security, the cross-border nature of cryptocurrencies and their inherent anonymity has made them challenging to regulate or police. Rather than depending on centralised data structures with traditional banks and their record-keeping methodologies, a network of decentralised data systems connected to – and dependent on – the users is used. Transactions are then processed through encrypted network tokens which could be in the form of any digital asset to incentivise network actors to validate network transactions as for example, used by Bitcoin. Behind this are smart contracts which are code containing defined transaction rules that are automatically enforced when predefined conditions have been met. Agreement is reached through a private key which functions as a signature and is a personal cryptographic identification password. As cryptographic systems are designed to be transparent and leave data trails of personal and business transactions, however, while the DLT networks are not yet fully anonymous, the privacy of network actors may be breached because its decentralised nature enables transactions to be viewed live by actors with a personal node. As such, if hackers are able to detect a security flaw or identify vulnerabilities on the Blockchain network where a smart contract is operating, they can steal money from users without being detected. From this, it is important to develop tools to monitor transactions. The tendency for a security flaw to exist in the creation of a DLT increases as they develop, thereby increasing the chances of identifying vulnerabilities by hackers. The biggest challenge, however, lies in the ability of hackers to engage in fraudulent activity undetected, given that even fraudulent transactions cannot be altered. If a network actor can have only one personal and distinct digital address and private key required for every transaction and especially used during ‘signing’ smart contracts, hackers could more easily be detected. As they are performed directly between users without the need for a third party, these transactions can incorporate cryptographic tools which verify the identity of both parties before the transactions can be completed. This will then allow transactions to be traced back to the accounts, which may be frozen in the interim and reversed without altering the DLT. Moreover, the privacy and transparency, characteristic of cryptocurrency, will be maintained. Secondly, the use of AI to develop information about a user’s payment history to detect unusual transactions and verification systems that help to identify fraud can be better developed to identify suspicious transactions. If inbuilt into the distinct digital addresses of network actors, AI can be developed to track transaction histories and even a daily transaction limit determined by the user, such that unusual transactions can be rapidly identified and perhaps stopped. This can also be applied in other Fintech innovations such as peer-to-peer lending platforms and digital mobile apps. Fintech apps hold consumers’ personal and financial information ranging from their addresses to credit card and bank account information targeted by cyber criminals. A tactic employed by hackers is that, rather than launching attacks against individual consumers, they take advantage of vulnerable API endpoints of Fintech companies. This allows them to gain access to users’ financial information and exploit it to their advantage. A solution to this is for Fintech startups and established companies, right from launching their apps and software, to hire professional hackers to try to hack into their systems. This will serve to expose vulnerabilities and enable Fintech companies to better secure them before cybercriminals have the opportunity to do so after their launch. Although this might be an additional cost incurred by Fintech companies, the loss that will be borne in the event of fraud and cybercrime by hackers will cost the company much more and therefore should be seen as a necessity rather than a luxury.
Consumers
Ordinary consumers are often the victims of cybercrimes such as phishing attemps, ransomware attacks, password spraying and others. Some cybercriminals use stolen credentials to access consumer accounts on Fintech apps which allow them to steal profiles and other information. A common tactic is the use of API attacks to compromise authentication tokens and other verification methods meant to keep accounts secure. Modern phishing attacks also include cybercriminals acting as legitimate entities to lure users to share their personal or financial information. To prevent these attacks, consumers need to be alert and informed because it is difficult to protect against user negligence sharing sensitive data with a hacker, through which financial fraud can easily be committed. Money laundering schemes for instance that have been carried out via Fintech apps include cybercriminals misrepresenting themselves or using anonymisation techniques and redirecting funds through fraudulent email correspondence with email parties. The only way to avoid falling prey to such schemes is to not share passwords or other sensitive financial information such as credit card details regardless of how legitimate the imposter may appear. Additionally, in the event that a user wants to verify the credibility and legitimacy of an entity, the user may first input wrong personal or financial information such as an incorrect password or credit card details and check the outcome. Extra background research such as research on the entity, confirming from verified sources about the legitimacy of those entities among others are also an added necessity to avoid being a victim of such schemes.
Government
It is predominantly IT engineers and experts who write the codes that operate the apps and Fintech software. Fintech functions however transcend technological questions into more complex legal, ethical and economic questions. As such, in order to create and design Fintech tools that are both user friendly and that protect the users rather than the Fintech companies, laws and policies must be made to ensure that such persons are factored in. This is particularly important as a reason for the decline of traditional banking is the ability of the centralised authority to control the financial resources of the users and profit from it to the disadvantage of the users. For Fintech companies such as Blockchain technology-based companies not to make risky investments as FTX did, leading to its collapse and the loss of billions by users, governments must step in to introduce regulations that make sure such occurrences cannot happen.
Conclusion
Fintech is rapidly transforming the financial sector and has become a primary contributor to economic development of countries. However, with its positive impact grows a proportional increase in the risk of more elaborate cybercrime schemes which must be regulated by all stakeholders involved.
