This piece was written by Amanah Ramadiah, a Data Scientist at FNA and published in the Jakarta Post 02/11/20.
The Jakpost FinTech Fest webinar hosted by the Jakarta Post last September concludes that FinTech innovation in Indonesia has the full support from Regulators Bank Indonesia and Financial Services Authority (OJK). As we have now observed an increasing trend of growth in the sector, the remaining challenge for regulatory and supervisory authorities is to balance out innovations while maintaining, at the same time, prudential practices.
In addition to the FinTech-sector related challenge, authorities at the same time are facing unprecedented disruptions caused by the COVID-19 pandemic. The crisis in particular has raised significant concerns about effective actions and priorities for the financial system supervision. This brings up a question: is now the time for authorities to focus on traditional banking supervision, and to stop the growing trend of FinTech innovation? I would argue that the opposite is true. In fact, I believe that it has never been more timely for authorities to harness the power of FinTech to support supervision. This specific application of FinTech is called Supervisory Technology or SupTech.
The Financial Stability Board in its recent survey has highlighted a significant increase in the number of authorities that consider SupTech as their strategic priority. However, as discussed in a 2019 report by the Bank for International Settlements (BIS), the majority of the current strategies are still in either research or development stages. This implies that the SupTech sector is still in its infancy but starts to gain momentum.
In the following, I will first examine how the COVID-19 crisis has pointed out the importance of supervising the interconnectedness between the real and financial sectors of the economy. I will then look at how SupTech can help authorities meet this unprecedented challenge.
We are now living in an interconnected economy. Rivoli (2009), for example, traces a t-shirt’s life story from a cotton field in the United States to a Chinese manufacturing company after which re-entering a United States storefront before being exported to a used clothing market in Tanzania. Moreover, according to the United Nations COMTRADE database on international trade, Indonesia in 2019 had a total export of 27.9B USD to China, 17.7B USD to the United States, and 15.9B USD to Japan.
In addition to the global economic network, interconnectedness can be also observed in the financial system. Financial institutions, for example, are interconnected through credit relationships (Ramadiah, Caccioli, & Fricke, 2020), derivative contracts (Heise & Kühn, 2012), ownership relationships (Elliot, Golub, & Jackson, 2014) and common asset holdings (Caccioli, Ferrara, & Ramadiah, 2020). This complex interconnectedness implies that we are all susceptible to systemic instability: A breakdown of one or a few organizations (e.g., banks, firms, countries, regions) may trigger unexpected impacts elsewhere. The 2008 Global Financial Crisis (GFC) illustrated how sudden disruptions in a single country’s financial market could then spread to the rest of the world economy.
The COVID-19 crisis we are now facing is different compared to the 2008 GFC. The latter was endogenous, meaning that it was mainly created by and amplified within the financial system itself. Meanwhile, the former is exogenous to the financial system and has caused immediate damages to the real economy. Therefore, the big concern for authorities is to oversee whether the COVID-19 shock will, in turn, perturb then get amplified within the financial system, and trigger another episode of the global financial crisis. In a recent Op-ed published in Nikkei, Hyun Song Shin, Economic Adviser and Head of Research at the BIS, shared the same sentiment. He argued that “Although banks were not the origin of the crisis, they cannot expect to remain unscathed.”, as they can potentially be affected by “… the wave of bad loans and insolvencies affecting weaker businesses …”.
In response to this unprecedented challenge, I argue that SupTech can play an important role by providing authorities with technology to map and monitor the complex interconnectedness. This technology will allow authorities to easily navigate through large datasets, and to quickly identify risks and anomalies that could result in a catastrophic breakdown of the financial system. In particular, I will provide two different use cases of SupTech solutions to enable proactive real-time monitoring.
First, authorities can draw conclusions and early warning signals about liquidity and solvency of the banking system by making use of transaction-level data from interbank payments. The idea is to map the data into a network that consists of nodes and links, where a node represents a bank, while a link between two nodes represents the flow of money between the two banks. This solution allows authorities to easily identify the most central nodes in the network that are associated with the most systemically important banks in the financial system. Moreover, it allows authorities to track the unusual change of banks’ behavior over a specified period.
Second, authorities can discover non-obvious credit risk concentrations in the banking system by applying the above methodology on the granular loan-level data. For this particular solution, the network will consist of two distinct sets of nodes: one set represents banks and the other represents corporations. This solution empowers authorities with tools to discover a group of banks that have relatively high portfolio similarities that can potentially lead to a riskier system. Furthermore, it facilitates the design of a knowledge graph of the system, in a way that can help authorities to answer important questions, such as: To what corporations have a bank lent? Is the loan secured by collateral? What is the quality of the loans a bank has made?
Unfortunately, as mentioned above, the recent report by BIS revealed that most SupTech initiatives are still in the early stages of development. Some possible explanatory factors for the barrier are the data quality, the availability of talent, and the gap between research and production. Therefore, it is important for authorities to actively seek innovative collaboration and engage with a range of external parties, such as academic institutions and deep technology companies.
Concerning the latter, the BIS Innovation Hub and the Saudi G20 Presidency had recently invited the industry to take part in developing new innovative SupTech solutions. FNA won the challenge by developing “The G20 Monitor” that helps authorities to better understand the interconnectedness and emerging risk within the economy and global financial system.
Ultimately, stronger collaboration between authorities, academic institutions, and deep technology companies in leveraging technology to support supervision may be one silver lining of the COVID-19 crisis.