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The International Monetary Fund says fast-growing finechs pose challenges for both regulators and less technologically advanced banks, whose long-term viability may be under threat.

In a report, the IMF notes that while most individual fintech firms are still small, they can scale up very rapidly across both riskier clients and business segments than traditional lenders.

"This combination of fast growth and increasing importance of fintech financial services for the functioning of financial intermediation can come with system-wide risks," say authors Antonio Garcia Pascual and Fabio Natalucci.

Digital banking startups in particular are more exposed than their traditional counterparts to risks from consumer lending, which usually has fewer buffers against losses because it tends to be more uncollateralized. Their exposure also extends to higher risk-taking in their securities portfolio, as well as higher liquidity risks.

"These factors also create a challenge for regulators: the risk management systems and overall resilience of most neobanks remain untested in an economic downturn," states Pascual and Natalucci.

The spill-over effect from finech cherry picking also exterts pressure on long-established industry rivals. As an example, the IMF points to the US mortgage industry, where fintech originators follow an aggressive growth strategy in periods when home lending is expanding, such as during the pandemic.

As the report observes: "Competitive pressure from fintech firms significantly hurt profitability of traditional banks, and this trend is set to continue."

The document argues that policies that target both fintech firms and traditional banks proportionately are needed.

"For neobanks, this means stronger capital, liquidity, and risk-management requirements commensurate with their risks," say Pascual and Natalucci. "For incumbent banks and other established entities, prudential 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."

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