The European banking system is confronting fundamental structural changes and challenges that are going to shape its future and its ability to serve the financial needs of the real economy.
In a new report entitled “Will video kill the radio star?”, the ESRB’s Advisory Scientific Committee (ASC) takes stock of the many forces currently affecting Europe’s banking system (including climate change, the growth of non-banks, overbanking and the COVID-19 pandemic) and looks at how digitalization could change the way that financial and banking services are provided in the future.
Digitalization could give rise to new financial products and services, resulting in benefits for customers. However, it could also mean that banks face greater competition from new providers of financial services in the form of fintech companies and big tech firms. That could result in the emergence of new risks, both financial and non-financial.
New providers entering with bank-like intermediation models would be exposed to the known risks in banking (liquidity risk, credit risk, market risk, etc.), affecting, in turn, system-wide risk. While more competition could enhance stability over the long term, concentration (particularly with big techs) could result in new too-big-to-fail institutions, and a stronger focus on transaction-based intermediation could make the system more procyclical.
Furthermore, incumbent banks may take greater risks to compete with new providers. Cooperation between big techs and incumbent banks might lengthen intermediation chains, moving them towards the originate-and-distribute model, which raises concerns about incentives and risk distribution.
In addition to financial risk, digitalization also poses significant non-financial risks, both for banks and for fintech and big tech companies. These risks stem from (i) greater concentration on providing basic services, such as cloud computing; (ii) broader use of AI in finance; (iii) overly automated or IT-oriented services that may be more prone to cyberattacks; (iv) trust in a leading technology that might suddenly turn obsolete; and (v) a false sense of security from overleveraging insights from AI.
The impact that those risks have on the overall level of systemic risk will depend on how banks interact with fintech companies and big tech firms – something that is still the subject of considerable uncertainty.
The report defines three hypothetical scenarios for the EU financial system in 2030 and discusses the appropriate macroprudential policy response. In the first scenario, banks continue to dominate, retaining their central role in the areas of money creation and financial intermediation. In the second scenario, banks retrench while big tech firms capture the lending market, leading to a structural shift in the financial system. And in the third scenario, the issuance of retail central bank digital currencies results, under certain specifications, in financial intermediation shifting away from banks.