FinTech is Destabilizing Finance, Former Bank Head Warns

The introduction of technology at every level of banking is bringing additional risk and instability to finance, says author and former banker Kevin Rodgers.

Also read: Bitcoin Price Dives 22% After $60 Million Bitfinex Hack

More Efficiency, Fewer Players, More Risk

Speaking about his book on banking technology titled “Why Aren’t They Shouting?”, Rodgers commented on its destabilizing impact in an interview with The Economist’s Money Talks podcast yesterday.

Automated trading was at least partly responsible for the financial crises in 1997-8 and 2008 – said Rodgers, Deutsche Bank AG’s long-term former global head of foreign exchange (FX) who retired in 2014.

Automation in FX markets replaced traditional “voice” brokers within a few years and led to an arms race in the industry, he said, fundamentally changing the nature of the system.

It led to massive efficiency and transparency gains but the sheer expense of building trading technology led to only the largest players being able to compete. High-frequency funds from the equities markets soon moved into FX and transformed the ways currencies were traded.

With fewer players creating liquidity, the system became more fragile. Spot traders are now more likely to be “Russian or Israeli computer scientists” these days than the macho traders of last century. Rodgers continues:

The increased power of computers allowed banks to just take much more risk.

As well as complicating the products on offer (like derivatives) technology made the system more fragile by introducing a false sense of security – with techniques like value-at-risk (VAR) and computerized risk management.

What he calls the “risk-perception gap” hid the true level of risk from bankers, similar to a pilot flying a powerful aircraft purely on instruments that were “frankly wrong” rather than having a true understanding of the environment.

With computer power rising exponentially, Rodgers concluded, its destabilizing effect could not be stopped and new problems will arise where least expected.

FinTech & Non-Bank Finance Spreads Risk Further

Rodgers also touched on the emerging role of FinTech – of which Bitcoin is a growing part. This is gradually fragmenting finance by moving technology and computer talent outside the traditional banking world – which could increase risk even further.

At present Bitcoin trading is just a tiny microcosm of the wider FX universe. With many in the space coming from an FX background, and deploying similar technologies, they may be bringing similar risks.

Bitcoin exchanges face the added security risk of bitcoin storage and relentless hacking attacks, which can be devastating when successful – as popular exchange Bitfinex learned the hard way today.

One positive Rodgers mentioned is that the added transparency of automated trading systems could allow operators to identify and stop a serious crisis before it even happens – if, that is, the problem is something they can actually identify.

In any case, trading in the cryptocurrency world is only going to get more complicated in future and “risky” technology isn’t going to go away – it’s just something we’ll all have to live with.

Is technology actually making finance, and the entire world, less safe? Is the problem worth worrying about, or is it just something else to be studied?

Images courtesy of Pixabay, bloomberg.com