The Impact of Technological and Climate-Related Financial Risks on Regulatory Approaches

In today's fast-paced world, the Global Financial System is undergoing some of the most profound transformations in recent times, primarily driven by technological disruption and climate change. At our September event, BANKLEX 2023, we will discuss this in depth with members of the European regulatory bodies, and top executives from the banking and financial services industry.

In this article, we discuss the impact of these two developments on the financial system and how policymakers can safeguard the financial system's adequate functioning.

Technological Disruption

Technological disruption is causing three main structural changes in the financial services market:

• A modification of production processes for traditional financial services which now rely more on data and digital delivery channels, as well as services provided by third parties
• The availability of new products like digital or tokenized assets that leverage a more decentralized approach to trading and settlement procedures
• The emergence of new players in the market like tech companies that benefit from data and technological superiority to compete with traditional financial institutions in providing some financial services

While these developments generate many opportunities, they also bring some risks for the adequate functioning of the financial industries, which might impede their ability to support social welfare.

However, there is still no consensus on the appropriate regulatory response to these risks. Often, there is a relatively complacent view on the scale and nature of the required regulatory response, with slogans such as "same activities and regulations." While adjustment of the regulatory perimeter is an essential first step, it may not be sufficient. For instance, the current rules on operational resilience, in particular, are outsourcing controls that fall short of limiting the risk posed by most financial institutions' increasing reliance on services like cloud computing offered by a few typically big tech providers.

Therefore, regulatory authorities must remain flexible enough to respond to the challenges posed by the rapid pace of innovation.

Climate-Related Financial Risks

Climate-related financial risks manifest themselves through standard risk categories of prudential rules, such as credit, market, and operational. The Prudential regulation's structural skeleton may need to be revised to address the impact of physical and transition risks on institutions' balance sheets, which could have detrimental effects on some climate-related financial risks, particularly transition risks.

While regulatory actions aimed at addressing the impact of physical and transition risks on institutions' balance sheets may have implications, not necessarily positive implications, on the ability to support a smooth transition towards a more sustainable economy. It is essential to consider bespoke entity-based rules for multi-activity players when there are interdependencies, frictions, and conflicts of interest across activities that may not be addressed by activity-based rules.

In conclusion, technological disruption and climate change are two of the most significant drivers of change in the Global Financial System. Policymakers must remain flexible enough to respond to the challenges posed by these changes, and regulatory authorities must adopt a significant regulatory bump to adapt to the new technological environment. Furthermore, regulatory authorities must take a fresh look at the existing regulatory framework to assess its effectiveness in addressing climate-related financial risks.

Join the Discussion

When you are active in banking and financial services, or in policy making, and you want to join 150+ industry executives in Amsterdam, please check out the BANKLEX 2023 event, where we will discuss the EU Regulatory Outlook. SO not only the ESG Reporting Requirements, but also 6AMLD, PSD3 and more. When you are interested in speaking, or joining a panel discussion, let us know.

Morten Kriek is the founder of?Wisselbanck ??, co-founder of?The Banking 50, and holds a Masters Degree in Positive Leadership and Strategy from?IE Business School?in Madrid. He also completed on-campus executive programs at some of the world's leading business schools including?Columbia Business School,?Yale School of Management,?The Tuck School of Business at Dartmouth?and?Cornell Johnson Graduate School of Management. Morten is also a certified Positive Psychology Coach from the?Wholebeing Institute.