Bigtech pose risks

Bigtech pose risks

Subject :Economy

Context ‘Bigtechs’ pose systemic risks to financial stability: RBI paper–‘’Bigtechs’ in the Financial Domain: Balancing Competition and Stability’.

Details:

• They pose challenges to financial stability due to their  technological advantages, large user base, wide-spread use by financial institutions and network-effects.
• The complex governance structure of bigtechs limits the scope for effective oversight and entity-based regulations.
• It can easily acquire cross-functional databases which can be exploited for generating innovative product offerings including shadow banking activities.
  • Involvement in shadow banking by them can lead to operational risk due to any failure of non-financing services and further disruption of financing activity.
  • Increasing complex inter-linkages between financial institutions and tech-companies needs the regulatory frameworks to be updated.

Concept:

Big techs

• Large non-financial technology firms, referred to as “bigtechs”
• Example-  Alibaba, Amazon, Facebook, Google, and Tencent.
• They usually hold service licenses through subsidiaries or JVs with varying levels of ownership control and jurisdictional regulatory advantages.
• Bigtechs’ core businesses are in information technology and consulting, including cloud computing and data analytics. Other services include shadow banking and financial intermediation.

Shadow banking:

• It  is a term used to describe bank-like activities (mainly lending) that take place outside the traditional banking sector.
• It is also referred to as non-bank financial intermediation or market-based finance.
• Generally, it is not regulated in the same way as traditional bank lending.
• The term ‘shadow bank’ was coined by Paul McCulley in 2007.
• Example: Private equity funds, credit hedge funds, exchange-traded funds, credit investment funds, structured investment vehicles (SIV), NBFCs and hedge funds are some of the entities included in shadow banking.
• These institutions function as intermediaries between the investors and the borrowers, providing credit, thus, leading to financial inclusion and hence generating liquidity in the system.

Types of Risks in Banks 

A bank faces many different types of risks and these need to be managed very carefully.Broadly speaking, Risks in the Banking sector are of two types namely Systematic Risks and Unsystematic Risks.

• Systematic Risks:
  • Systematic risk is also known as Undiversifiable Risk or Volatility and market risk.
  • Systematic risk affects the overall market and not just a stock or industry in particular.
  • Examples of it include interest rate changes, inflation, recessions, and wars.
• Unsystematic Risks:
  • It is also called Nonsystematic Risk, Specific Risk, Diversifiable Risk, and Residual Risk.
  • This type of risk refers to the uncertainty inherent to a company or industry investment in particular.
  • Examples include a change in management, a product recall, a regulatory change that could drive down company sales, and a new competitor in the marketplace with the potential to take away market share from a company in which you’ve invested.
• Other specific risks 
  • Credit of Default Risk:-The Basel Committee on Banking Supervision defines credit risk as the potential that a bank borrower, or counter-party, will fail to meet its payment obligations regarding the terms agreed with the bank.
  • Market Risk:-The Basel Committee on Banking Supervision defines market risk as the risk of losses in on-balance or off-balance sheet positions that arise from movement in market prices.
    • Interest Risk: It causes potential losses due to movements in interest rates.
    • Equity Risk: It causes potential losses due to changes in stock prices as banks accept equity against disbursing loans.
    • Commodity Risk: It causes potential losses due to changes in commodity (agricultural, industrial, energy) prices.
    • Foreign Exchange Risk: It causes potential loss due to changes in the value of the bank’s assets or liabilities resulting from exchange rate fluctuations
  • Liquidity Risk:-It can be defined as the risk of a bank not being able to finance its day-to-day operations.
  • Operational Risk:-The Basel Committee on Banking Supervision defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people, and systems or external events.There are three main causes of this risk:
    • Human Intervention & Error
    • Failure of the IT/internal software & systems.
    • Failure of Internal Processes to transmit data & information accurately