Digital banking: A necessity, an option or a risk?
By Jonny Williams, partner, and Emma Radmore, legal director, at law firm Womble Bond Dickinson
Banks are at the forefront of constant technological innovation to offer bigger, better and more user-friendly services to their customers. But with innovation and change comes risk. And with cyber-criminals ever adapting to the opportunities they see to benefit from any security loopholes, consumers are right to worry. Regulation is also constantly evolving, in an attempt to minimise the risks and maximise good customer experience. Jonny Williams and Emma Radmore of Womble Bond Dickinson look at the pace of change and current initiatives.
Why so much change?
Online banking is obviously not new, with many customers using it regularly for quite some years. However, the pandemic undoubtedly led to existing customers using the service more, new customers signing up, adjustments to the way the services operated and, perhaps more crucially, the rise in mobile banking apps.
Surveys have shown gradual increased usage over recent years, and that the ease and quality of the online experience is critical when selecting a bank. And, it seems, the younger the consumer, the more likely they are to bank using their smartphones or even smart watches rather than their computers – older customers have been slower to convert to banking by smartphone, maybe because of concern over scams and other financial crimes.
What are the regulatory risks?
Any customer experience that does not happen face to face involves a number of regulatory risks. Key among these are:
- impersonation risk – that an account is opened in the first place using a false identity or that login details and passwords are stolen
- transaction risk – that the legitimate account holder is tricked into making payments
- cyber risks – that data breaches and cyber attacks reveal secured details
- theft risk – that the device will be stolen and manipulated before the customer can alert their bank
- harmful links being clicked on, whether in messages purporting to be from the customer’s bank or otherwise and how banking apps can respond to this
While consumers are of course responsible for being sensible, the regulators, particularly the Financial Conduct Authority (FCA) and Payment Systems Regulator (PSR) are constantly striving to make the digital experience as safe as it can be, and to ensure consumers don’t lose out when they have not been at fault.
What are the regulators doing?
The UK regulatory requirements on the onboarding of customers, in particular on identifying them, verifying their identity and understanding the likely patterns of their transactions are stringent. But, concerningly, we continue to see FCA imposing large fines on banks whose procedures and systems have failed to spot the potential for, or actual, money laundering. Additionally, although so far falling short of published regulatory action, FCA’s review of the financial crime controls at challenger banks, particularly digital banks, highlighted serious shortcomings of some business models including in the onboarding process. This is particularly concerning considering the popularity of digital banks especially among younger consumers.
Separately, regulatory initiatives around authorised push payment (APP) scams and frauds have been ongoing for some time. The Government is now looking to use the Financial Services and Markets Bill, currently going through the legislative process, to require mandatory repayment to customers who have lost out.
Increasingly, banks are introducing as many safeguards on payments as possible, and many payments now require two-way or multi-factor authentication. Again, the requirement stems from legislation – in this case the Payment Services Regulations 2017, but banks are left to work out the best way of implementing controls to enhance the security of payments. For many customers, though, this now means authenticating via an app – whether the payment is initiated by the app, by online banking or otherwise. It makes the smartphone an accessory which is both powerful and potentially dangerous.
FCA is also taking great account of consumer behaviour in its initiatives. It will be aware that younger consumers expect to be able to do everything quickly, and that banks wanting new customers will not want to risk losing them through overly complicated onboarding and transaction approval processes. Yet it is crucial for consumer protection that banks carry out proper due diligence and that safeguards are in place so that consumers understand and agree the payments they are making.
We can expect to see more changes in future. As mentioned above, the Financial Services and Markets Bill is looking to address APP fraud, as is the Online Safety Bill in respect of scams stemming from use of online platforms and social media. FCA will continue its close inspection of banking models and its engagement with firms who do not meet its standards. The Consumer Duty, which must be implemented by all regulated firms by the end of July 2023, will require banks to take yet another look at how they provide their services. They must comply with the new overarching principle to act to deliver good outcomes for retail customers, which requires a deep dive into every element of products, pricing and customer service. Digital banking will only increase in popularity, and FCA also set up a “digital sandbox” to enable firms to test digital products and solutions. While in testing phase, it looked at solutions to address the prevention of fraud and scams.
So the future probably holds an uncomfortable mix of more prescription for banks, more clicks and taps for consumers, and continued consumer education, all continually battling against new criminal techniques.
Top banking trends of 2023 and global outlook of banking and fintech for the year ahead
Author: Professor Marco Mongiello, Pro Vice-Chancellor, The University of Law Business School
You’d be forgiven for assuming that the global outlook for banking and fintech will be dominated by the usual suspects:
Artificial Intelligence – AI plays an increasingly prominent role in banking and fintech by enabling personalised services, fraud detection, predictive analytics, use of chatbots and robo-advisors.
Blockchain and Cryptocurrency – the secure, decentralised and swift system for financial transactions that blockchain has brought to the fore a few years ago, is now becoming ubiquitous. An increasing number of transactions are recorded through blockchains technology, primarily in the cryptocurrency market.
Digital Banking and fintech – accelerated by COVID-19 pandemic, the adoption of digital banking is a trend that will persist as customers have become accustomed to the convenience and efficiency of digital banking. Moreover, fintech enables access to financial services for previously underserved populations in developing countries or less affluent social groups in more affluent societies. This includes mobile banking services, peer-to-peer lending platforms, and microfinance solutions.
Open Banking – another global trend is the use of open APIs (Application Programming Interfaces) that allow third-party developers to build apps to facilitate customers’ access to financial data and services from banks.
Nonetheless, the challenges posed by these rapid changes are reminders that banking, an industry that by its very nature needs to be conservative, risk averse and solid, wobbles on the unchartered grounds of fast and turbulent innovation, where entrepreneurship instead thrives. The underlying rationales of banking and fast digital innovation are not incompatible but do need solid operations and thought-through decision-making to avoid causing catastrophic collapses.
The recent examples of Silicon Valley Bank, Silvergate, FTX and Wirecard are stark reminders that digital entrepreneurship applied to banking doesn’t just bring to customers the visible transformation of valuable new services, but also dents (perhaps as an unexpected consequence) the rationale itself of the role of banks in the global economy. Moreover, the central banks’ ability to contain the effects of single banks’ defaults is no longer a certainty, as experienced just over a decade ago and more recently. The markets’ sentiments are hardly reassured by the commitments of even the most coveted players, such as the European Central Bank, the Federal Reserve, and the President of the United States himself.
Regulators are lagging behind and their attempts to catch up may cause further seismic shocks to the global banking system. For example, another trend that is emerging is one of artificial intelligence decision-centres (i.e., decentralised offices of banks which take autonomous decisions on behalf of investors) outside the most stringent regulatory environments, enabling banks to operate globally more efficiently and more competitively. And we can expect that regulators will close the gap either abruptly, as it is currently happening in China, where private banks are subject to an escalation of regulatory and monitoring restrictions, or more gradually as it is happening in Europe and in the US.
The questions we face, as individual or trade customers of our high street banks, as direct investors or clients of managed funds, are whether banking will become more user-friendly yet, for our daily use but riskier, too, or is it simply becoming more efficient, transparent and also safer.
I’m afraid that the answer is by no means an obvious one. Therefore, caution, level-headed decision- making and critical thinking have never been as important as these days. Whether you are looking after your family savings or growing your pension reserve, the imperative is that you keep updated about the providers of the financial services you rely upon as well as about the general regulations that apply to your financial transactions. This is where, for example, you need to be familiar with your rights in case of cyber fraud, as well as learning how to minimise the risk of becoming a victim thereof. Also, taking additional steps to evaluate the credibility, solidity and reliability of the online provider of that app that was recommended by a trusted friend, may prove a very good move.
Similarly, whether you are the CFO of a medium or large company, or are a sole trader wrestling with your own business’s finances, you need to reflect on what you really want from your bank in the first place. That is before you started to be swayed by the whirlpool of offers of ‘opportunities’ to multiply your financial investments. Chances are that your initial approach to your bank was dictated by either a need for financing your working capital, as per your budget and strategic plans, or to find a safe place for your temporarily idle liquidity. Perhaps you were also after some basic treasury services such as swift payments and debt collection. Maybe some other financial services closely related to your business operations, e.g. factoring. The advice is to give very careful consideration to services that are more remote from your business, because the trend for the next years is that more and more of those will be offered to you. But many new services will disappoint those who, sadly, cannot afford financial mishaps as they look to run and grow their business.
Will ‘Britcoin’ change the way we bank?
The Treasury and Bank of England recently announced a state-backed digital pound is likely to be launched in the UK later this decade, following the popularity of cryptocurrencies. However, the ‘Britcoin’ will be backed by the central bank, ensuring the digital pound will be much less volatile than its sister, cryptocurrency. Could a digital pound backed by the central bank be the answer to utilising technological developments in the finance system for the better?
Ross Thompson, Accountancy and Finance Lecturer at Arden University, considers what we can expect from ‘Britcoin’, how this will impact consumers, businesses, and the economy, and whether ‘Britcoin’ could be the revolution to restore our confidence in the banking system.
Trust in our financial system hit an all-time low post the 2008 financial crash. Even ten years on from the collapse of Lehman Brothers, a survey found 66% of adults in Britain still don’t trust banks to work in the best interests of society.
This means there remains to be apprehension for people to sign up to and use a bank to help manage their money. The UK doesn’t seem to struggle too much in this arena, however, as according to the Financial Conduct Authority (FCA), most UK consumers (96%) have a current account from a bank or building society. Regardless, there is still a significant number of adults who do not have a bank account or are what is known as ‘unbanked’.
The lack of trust plays a big part here. More people want better control over their money and to cut out the middleman, hence why cryptocurrencies and blockchain became a tempting option, as it can potentially remove the need for banks for any transactions. However, the volatility of these currencies has been a cause for concern for many investors and regulators.
Blockchain and cryptocurrency are gaining more traction and are becoming more of a viable option for businesses, especially due to talks of regulations coming into fruition. This is especially true with cryptocurrency, with the government announcing crypto assets will be subject to FCA rules in line with the same high standards that other financial promotions such as stocks, shares, and insurance products are held to.
The “Britcoin” aims to solve the issues traditional Bitcoin presents. It would be backed by the central bank, which would ensure its stability and reduce its volatility, making it a more attractive option for investors and providing greater confidence in the stability of the financial system. Britcoin will be as stable as the inherent stability of the British economy and political system. It would also provide an opportunity for the UK to stay at the forefront of technological developments in the finance system – a system in which it can sometimes be slow to react.
One of the key benefits of a digital pound is that it would be much faster and more efficient than traditional banking systems. Transactions could be completed almost instantly, regardless of where the parties involved are located. This would make cross-border transactions much easier and could even help to boost international trade.
The Bank of England’s Governor, Andrew Bailey, stated: “a digital pound would provide a new way to pay, help businesses, maintain trust in money and better protect financial stability”, pointing toward the other advantage of a digital pound. It would offer more security as transactions would be recorded on a distributed ledger, which would make it much more difficult for hackers to tamper with the system. It would also provide greater transparency, as all transactions would be recorded on the ledger and could be easily traced if needed.
However, there are also some potential drawbacks. One concern is that it could lead to a reduction in the use of cash, which could have implications for those who do not have access to digital technologies or who prefer to use cash for privacy reasons. There are also concerns that a digital pound could be used for illicit activities, such as money laundering or terrorism financing. On top of this, more details are required in relation to the levels of personal account privacy; the potential to usher in ‘big brother’ banking systems is a growing a concern regarding state digital currencies.
Around 85 central banks are currently engaged in projects to create digital currencies, according to figures from the Bank for International Settlements. But as it stands, many feel there is probably little need for a digital pound; with a growing amount of people using their debit cards, phones and watches to fulfil the same function, a digital pound is deemed unnecessary. On top of this, many of the public fear that a government digital currency could potentially infringe on their privacy – despite the BoE stating the currency would be subject to rigorous standards of privacy and data protection.
And in countries where a digital currency has already been established, there has been little uptake – widely due to the lack of trust between central banks and citizens. It seems gaining users’ confidence should be the Bank’s first priority. The House of Lords economic affairs committee stated last year that a digital pound would pose “significant risks” such as state surveillance, financial instability as people convert bank deposits to CBDC during periods of economic stress, an increase in central bank power without sufficient scrutiny and could be exploited by hostile states and criminals; it is safe to say that the nation’s ‘Britcoin’ will need to be very well thought out.
It has the potential to revolutionize the finance system, however, and could provide significant benefits to investors and consumers alike. However, the potential risks and drawbacks must be carefully considered before any decision is made to launch such a currency. Having said that, if it is implemented correctly, a digital pound could be a powerful tool for utilising technological developments in the finance system for the better.
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