In its annual Sector Views report, the UK's Financial Conduct Authority warns of the growing risks to consumers in the retail banking and payments sector, as regulatory protection struggles to keep pace with technology-driven innovation and incumbents grapple with legacy limitations.

Providing a view of how each financial sector is performing, the findings show that the prevalence of advancing technologies continues to cause unease for consumers and institutions operating in today’s dynamic financial landscape.

Identifying a cluster of potentially harmful areas across financial sectors, the FCA observes that these concerns stem from a number of “drivers of change” such as the economic environment (for instance low interest rates, retail investment exposure and high debt to income ratio) and the social environment which includes forces such as the pressure of an aging population and climate change.

Technology is another driver for change as Open Banking and Open Finance, fintech, big data, AI, data use and new technologies for interaction, are depicted not only as a core catalyst of innovation and progress, but as instigators of concern and uncertainty across the industry.

Vulnerabilities surrounding increased data sharing and how firms are collecting and using this data are underscored by the FCA as a few of these technology-based concerns.

The report observes: “Global investment by retail banks in fintechs more than doubled in 2018, reaching £85.6 billion with 2,196 deals. […] These changes may improve customers’ experience or security but could also present challenges for oversight and the perimeter of what is and is not regulated.”

The FCA also warns that the EU withdrawal will cause significant disruption to financial services and require cumbersome regulatory changes which may fundamentally alter the way the industry functions.

Christopher Woolard, executive director of strategy and competition, FCA, says: “We are committed to reducing harm in the markets we regulate. Our analysis of markets ensures that we do this effectively, helping us to decide where to focus our attention.

“We expect firms to be similarly focused on preventing harm and assisting us where they can, and we will continue to actively supervise all firms to ensure they achieve this.”

Retail banking and payments

“Macro-economics, regulation and technology are driving change in this sector,” the report finds, as low interest rates reduce the appeal of saving, regulatory initiatives such as PSD2 and its strong customer authentication component serve to boost consumer confidence and promote innovation in the space.

First, the proliferation of new payment firms entering the sector may pat consumers at risk in areas that lack specific regulatory protection..

Firms such as account information services (AIS) or payment initiation services (PIS) may also fail to comply with regulation and when failing to safeguard customer funds consumers may face financial or data loss.

Second, the scale of financial crime is growing and while many fraud victims are reimbursed by their providers a lack of clarity remains around the reimbursement of fraud losses to victims when neither the consumer nor the bank is at fault. Authorised push payment fraud is a large area of concern with consumers losing £168.2 million to APP fraud in H1 2019.

The FCA is also concerned about service interruptions undermining consumer confidence, causing inconvenience and financial loss to consumers and SMEs who increasingly rely on 24-hour services.

Several factors are contributing to this, not least the large-scale business transformations away from legacy systems many major banks are undergoing which poses a threat to the operational security.
The watchdog says firms reported 459 technology and cyber incidents in the sector in 2019. The most common root causes in the same period were change management issues, third party failures, and failures in hardware or software

The report explains: “The growing number of financial firms using third-party technology providers, such as cloud service providers, where a small number of firms dominate the market, has increased the risk of technological disruption at one of the firms having widespread effects. These factors are also driving increased exposure to cybercrime.”

Woolard adds: “What is clearly apparent from the Sector View, is that many of the harms we are seeing are created by a significant number of smaller firms we regulate or firms beyond our remit.”

Overdraft fees, which have drawn scrutiny and action by the FCA from mid 2019 as they try to “fix a dysfunctional overdraft market” remains a key concern as between Q1 2018 and Q3 2019. “Banks’ complex charging structures means that 80% of people cannot correctly choose the most affordable overdraft deal.”

The trend toward a cashless society also concerns the FCA. While innovation often breeds financial inclusion, a lack of cash accessibility could negatively impact the 1.9 million customers who use notes and coints as their dominant payment method.

Woolard says the report’s findings will contribute to the FCA’s upcoming Business Plan and influence “decisions we make affecting consumers, market integrity and competition.”