Payments, processes, and economic fluidity…

The global payments and transaction processing system has historically been dominated by banks, centralized processors (such as SWIFT), or networks such VISA or Mastercard. More recently, a number of specialized entities such as Worldpay (which had its origin as a unit of RBS) have begun to encroach.

However, as Izabella Kaminska, a columnist for the Financial Times recently pointed out (Why transaction laundering is turning into a huge financial blindspot- FT Alphaville, March 17), the rise of “FinTech” has begun to cause a level of fragmentation and loss of control which raise serious questions about the ability of payment processors and banks to adapt.

This is because, whereas major banks and their peers (while not perfect in terms of systems and compliance) are now truly paranoid about understanding who their conventional customers are and the source of funds which pass through their accounts (with a number of them having suffered huge fines and reputational losses as a result of prior negligent or complicit behaviour by their staff), they have increasingly used third parties as a source of retail and SME client acquisition.

As a result, they have, in effect, delegated much of the “KYC” and screening or “onboarding” process to supposed specialists, who promise to improve efficiencies and cut acquisition costs. In doing so, not only have they added another layer of complexity, but unless they and their regulators are able to understand and manage an ever evolving economic environment, they run the risk of stifling the sorts of creativity, innovation and adaptation which generate new businesses and economic growth.

All of this begs the question, as with any process with multiple layers, of whether it has vulnerabilities and weaknesses which can be exploited. In this case, the so-called “gig economy” and the rise of platforms such an AirBnB or Uber, has led to a rising number of micro-businesses, each of which seeks access to the payments system, while the number of websites that purport to sell often intangible goods or services has also proliferated. There is, of course, nothing inherently wrong with this, but it is worth asking whether banks, with their legacy systems and circumscribed processes, are truly capable of adjusting to a world in which the very definition of what is a “business” or what it means to be “employed” has become fluid.

The regulated entities currently at the top of the chain, namely the banks, have delegated much of their risk management obligation to a diverse and usually unregulated ecosystem, which may rely wholly on algorithms to screen for potential fraud or criminality. One could argue that a properly-constructed algorithm may be more effective than a fallible human being, even if there will be circumstances in which a more comprehensive due diligence “overlay” is needed. It is all a question of judgement and balancing the risks, rather than being dogmatic that there is only one “correct” approach.

And clearly there are reasons why insurers and reinsurers should begin to think about this issue in some depth. After all, D&O and E&O insurance covers form the core of most Financial Lines business units; so, if the nature of the risks and their sources are moving and mutating, it begs the question as to whether historic pricing and loss experience data remain relevant.

While, at Awbury, we have no direct involvement in underwriting such products, nevertheless, we aim to remain “ahead of the curve” in understanding and assessing emerging risks, as they can have a material indirect impact, even if they seem tangential, and in themselves potentially offer new avenues to explore in terms of our own product development. In a “connected” world, understanding the nature and consequences of complex systems is essential to minimizing the risk of being caught unawares and unprepared.

The Awbury Team

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