Innovation within the financial services and payments space tends to center around two poles: FinTechs, and cryptocurrency.
In its newly released 2024 annual report, the U.S. Financial Stability Oversight Council (FSOC) took care to illustrate the risks, as well as the potential benefits, of both sectors as they relate to the traditional banking landscape.
The convergence of cryptocurrency, FinTechs and traditional finance represents a significant evolution in the financial ecosystem. This interconnectedness offers numerous benefits but also introduces complex risks.
“Market volatility in the first quarter of 2024 and operational events throughout the year have underscored the need for banks to be financially and operationally resilient through appropriate risk management and contingency planning,” the FSOC wrote.
Per the report, while the crypto market remains relatively small compared to traditional markets, its rapid evolution and FinTech’s expanding role in financial services underscore the need for future regulatory action to maintain stability and transparency.
Read more: Crypto and FinTech Cry Foul Over Debanking — Could Real Issue Lie in Risk?
The total market value of crypto assets stood at just under $2 trillion as of mid-2024, significantly smaller than the S&P 500’s $48 trillion market capitalization. Despite its modest size, FSOC highlighted potential risks if the crypto ecosystem becomes more interconnected with traditional financial markets — which it continues to do. As recently as Tuesday (Dec. 10), Deutsche Bank signed a corporate banking pact with Crypto.com.
Of particular interest to the FSOC were stablecoins, which remain a key area of concern due to their susceptibility to runs, market opacity and high concentration.
A single issuer, USDT (Tether), controls around 70% of the stablecoin market’s value, creating systemic risk if it falters. Many stablecoin issuers, including USDT, operate beyond the federal framework, with limited transparency into their reserve holdings and risk management practices. The FSOC warned that this lack of accountability heightens the risk of fraud and market disruptions.
In its report, the FSOC proposed several actions to mitigate risks in the crypto sector, including legislation for stablecoins; authority over the spot market for crypto-assets that are not classified as securities; supervision over crypto-asset entities and subsidiaries; and continued efforts to inform consumers about the risks of cryptocurrencies, stablecoins, and other digital assets.
Read more: Banks Eye Stablecoins to Accelerate Cross-Border Innovation
PYMNTS covered on Tuesday how, while a wave of funding rounds over the past several months is giving challenger banks fresh financial firepower to position themselves as alternatives to traditional banks, challenges abound across the landscape as watchdogs and agencies continue sharpening their gaze on FinTechs, specifically bank-FinTech relationships and the risks tied to those partnerships.
Per the FSOC report, the bankruptcy of FinTech intermediary Synapse in May highlighted the operational risks involved in banks’ partnerships with FinTechs. While these collaborations can enhance innovation, they also increase the complexity of risk management.
As a result, the FSOC supports the continued work of the Cloud Executive Steering Group (CESG) to analyze and address the risks posed by third-party services to the financial system.
Regarding FinTech-bank partnerships, the Council also made a recommendation that Congress pass legislation that ensures that the FHFA, NCUA and other relevant agencies have adequate examination and enforcement powers to oversee third-party service providers that interact with their regulated entities.
Ultimately, the “so what” of the FSOC report lies in its clear warning: crypto and FinTech are emerging forces in the financial ecosystem that could pose systemic risks if left unchecked. The report signals a pivotal moment where regulatory clarity and proactive oversight has become not just a best practice but a necessity.
Per the council, regulatory inaction risks letting these innovations become threats to the broader financial system rather than tools for its advancement.
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