APRIL 3, 2023
19 min read
The current operating environment is evolving quickly so the risks also appear a lot. In this blog post, I will discuss some significant risks and challenges that fintech companies need to manage effectively to achieve their strategic goals for the year.
Fintech companies are rapidly introducing solutions that leverage big data analytics, artificial intelligence, and blockchain technologies. Race of innovations is engaging but one should not forget about risks. They could undermine consumer protection and financial stability of the company. So, risk management in fintech has become a critical area of focus for regulatory authorities. It necessitates the development of new measures through research and development.
Fintechs need to test how these challenges could affect their operations and to develop sustainable solutions for mitigating their impact over the medium and long term.
What is risk management in fintech?
Risk management in the fintech industry is similar to other areas. But it adds additional responsibility and risk due to the management of other people’s money and data. Risk management here involves recognizing, examining, and reacting to potential risks. Good risk management also involves taking proactive measures to decrease the likelihood of risks and minimize their impact.
The risks financial companies face become more apparent and increase. So, firms need to review or expand their existing risk management programs.
Effective risk management can safeguard revenue generation. The success of these programs will become crucial, as it already is for traditional financial services companies.
Types of risks in fintech industry
How do fintech companies evolve? They usually tend to expand into banking, offer bank-like products, or partner with traditional financial service firms. It is crucial to have a robust risk and compliance framework that addresses the unique obstacles. There are several types of risks that fintech companies need to consider:
- and vendor-associated.
I’d recommend that a fintech company effectively implements risk management services and compliance programs. In this way, they can potentially safeguard their ROI and enhance collaboration opportunities with banks, other financial institutions, and customers. It can ultimately lead to competitive advantages. Let’s take a closer look at the risks and the ways of mitigating them.
Regulatory and Compliance Risks
In some fintech areas there is a lack of stable regulations. It increases few risks. For instance, blockchain and data security are two fields that are still in the process of developing. Their regulatory frameworks are not yet well-established.
This makes it challenging for fintech companies to identify and mitigate potential risks effectively. I am talking not only about the lack of clear regulatory guidelines. The complexity of these technologies further exacerbates the challenges of managing compliance and regulatory risks.
Still, with the implementation of GDPR and PSD2, fintech companies in Europe must adhere to the stringent data protection and system security guidelines. National regulatory bodies in different countries, such as the FCA in the UK, the AMF and ACPR in France, BaFin in Germany, and the SEC and CFTC in the US, enforce regulatory requirements that also impact fintech companies.
How to mitigate regulatory risks?
- Ensure that you, as a CEO or business owner, have a deep understanding of the regulations that apply to the business and operations. This can be done by hiring experienced legal professionals who can navigate the regulatory landscape and help the company stay aware of regulatory changes. This involves conducting thorough due diligence and risk assessments, implementing robust compliance programs. Regularly monitor and test these programs. Ensure that they remain effective.
- Work with regulatory bodies and industry associations to stay up-to-date on regulatory developments and best practices. Collaboration with regulators can help companies build trust and credibility with customers and investors. Demonstrate commitment to operating in a compliant and responsible manner.
- Prioritize regulatory and compliance risks as they navigate the complex and rapidly evolving regulatory landscape. By doing so you can effectively manage risks and continue to drive innovation in the financial services industry.
Operational risk management is a significant concern for fintech companies. Excessive bureaucracy is a common issue, which can slow down decision-making and make it challenging to implement changes quickly. Thus, if a fintech company needs to make a change to its product or service offerings, it may need to navigate a complex and time-consuming approval process before it can be implemented. This can result in missed opportunities and decreased competitiveness in the market.
On the other hand, insufficient bureaucracy can also lead to operational risks. When processes are not well-documented or standardized, it can be challenging to identify potential issues or track progress effectively. This can lead to mistakes and missed opportunities, as well as make it more difficult to comply with regulatory requirements.
How to mitigate operational risks?
- Build clear, concise, and easy to understand processes. Avoid unnecessarily complex procedures or bureaucratic approval processes that may slow down decision-making.
- Describe processes in detail, using clear documentation and standardization. Ensure that all employees are trained on the proper procedures and protocols to follow.
- Monitor the execution of processes regularly, encourage adherence to them, and be sure to penalize non-compliance. This will ensure that processes are followed consistently and effectively.
- Reinforce processes against the human factor through rechecks or other quality control measures. Thanks to that, you will catch any errors or oversights that may have occurred during the execution of the process.
- Build data backup processes, as technology and infrastructure failures can be a significant operational risk. Ensure that backup systems are in place to ensure business continuity in the event of an outage or other disruption.
- Prioritize employee training and education. Your staff must understand their roles and responsibilities in managing operational risks. Regular training sessions can help employees identify potential risks and take appropriate action to mitigate them.
Fintech companies must take a proactive approach to managing operational risks. Establish strong risk management frameworks, invest in secure technology infrastructure, and prioritize employee training and education. Then, your fintech company minimizes the likelihood of operational failures and safeguards its reputation and business operations.
Liability risks refer to the potential legal responsibility that a fintech company may face for any losses, damages, or costs incurred by its clients or third parties. For instance, fntech firms face technology failures that could lead to customers being unable to access their services.
These risks can arise from various situations, such as data breaches, contractual breaches, fraud, or any other financial losses. Fintech companies are particularly susceptible to liability risks since they handle large amounts of money and assets.
How to mitigate liability risks?
- Have clear and transparent policies for handling customer data and transactions. Prevent liability risks associated with misunderstandings or miscommunications about how you use data.
- Obtain appropriate insurance. Consider investing in insurance that covers third-party liability, business interruption, and reputational damage. Additionally, you should establish a strong incident breach response process to manage any potential breaches effectively.
- Continuously monitor and assess potential liability risks associated with operations, and take appropriate steps to mitigate those risks.
Communication risks mean misunderstandings or errors in communication that can impact business operations and relationships. In the fintech industry, communication risks can arise in various situations. For example when there is a lack of clarity or transparency in communication with clients, when there is a language barrier between employees and customers, or when communication breakdowns occur between different departments within the company.
Communication risk management ensures the smooth and secure transfer of information between different parties. When managing communication risk, consider Conway’s law. This concept states that the design of a system will mirror the communication structure of the organization that creates it. The way in which information is communicated within a fintech company can have a significant impact on the design and technology functionality they produce.
Additionally, unpredictable events or disruptions in communication channels are also possible. For instance, power outages. Another risk to consider is the loss of information during any communication, which can lead to errors and misunderstandings.
Finally, the links of subordination between different individuals or departments within a fintech company can also create communication risks. They can lead to a lack of transparency or misaligned goals.
How to mitigate risks?
- Create clear guidelines for how information is communicated within the organization to help reduce the errors or misunderstandings.
- Ensure that all communication channels used are secure and encrypted to prevent unauthorized access.
- Have backup communication channels or redundant systems in place. They help mitigate the impact of unexpected events or disruptions.
- Encourage transparency and open communication within the organization to reduce the potential for misaligned goals.
- Regularly test and evaluate communication protocols and systems. Identify areas of weakness and improve overall risk management.
Cybersecurity is a critical aspect of fintech operations. Data breach can result in the theft of sensitive personal and financial information. Then go phishing attacks and malware. The first is a common tactic used by cybercriminals to obtain sensitive information by tricking users into divulging their login credentials. The second is malicious software that can infect fintech systems, steal data, or disrupt operations.
Insider threats occur when employees, contractors, or other insiders with access to sensitive data intentionally or unintentionally cause harm to the organization. Also, fintech companies often work with third-party vendors, which can introduce additional cybersecurity risks.
How to mitigate risks?
- Implement robust security measures, such as data encryption, access controls, and regular security audits.
- Invest in reliable and secure technology infrastructure. Implement robust cyber risk management to protect against data breaches. Regularly update systems and software.
- Provide user education and awareness training to help users identify and avoid phishing scams.
- Regularly update the software and implement antivirus and firewall software.
- Create strong cybersecurity protocols. Regular data backups, secure data storage, and multi-factor authentication can significantly reduce the risk of data breaches.
- Implement strict access controls and monitor employee activity to prevent insider threats.
- Conduct due diligence on third-party vendors and ensure they meet security standards.
Financial risks are a crucial aspect of any business endeavor. Hence, effective risk management is essential for success.
One of the most significant financial risks faced by businesses is investment risk. Investing in the wrong opportunities or making poor investment decisions can result in significant losses, potentially threatening the viability of the business.
Securing adequate starting capital is another financial risk that businesses must manage. Insufficient capital can hinder growth and prevent the business from achieving its objectives.
How to mitigate risks?
- Conduct extensive research and analysis before making any investment decisions. You should consider factors such as the potential return on investment, market trends, and the financial stability of the investment opportunity.
- Diversify investments across different assets and industries to mitigate the risk of losses in any one area.
- Create a comprehensive business plan that includes a detailed financial analysis. This analysis should estimate the amount of capital needed to start and operate the business, and how long it will take to become profitable.
- Seek funding from multiple sources, such as investors, banks, and government grants, to secure adequate starting capital.
Vendor Choice Risks
In fintech, choosing the right vendors and vendor risk management are essential parts of business. However, selecting the wrong vendor can lead to serious risks such as security breaches, regulatory violations, and reputational damage.
How to mitigate risks?
- Conduct thorough due diligence when selecting vendors. This may include evaluating the vendor’s track record, assessing their security measures, and ensuring that they comply with relevant regulatory requirements.
- Have a clear contract that outlines each party’s responsibilities, liabilities, and expectations.
Vendor Lock Risks
Third party risk management is our next point. Fintech companies rely on third-party vendors for critical services such as payment processing, data storage, and customer service. Still, this reliance can create a risk known as “vendor lock.” In this scenario, the fintech company becomes so dependent on a vendor that they are unable to switch to another provider without significant disruption or cost.
How to mitigate risks?
- Ensure that your company maintains ownership and control of the data, even if it is stored with a third-party vendor. The data can be achieved through strong contractual protections and robust data management policies. That ensures data is always accessible and can be easily transferred to another provider if needed.
Fintech systems are highly complex and require ongoing maintenance to ensure that they remain secure, reliable, and up-to-date. This maintenance can involve regular upgrades, patches, bug fixes, and ongoing support. If fintech companies do not properly plan and budget for maintenance costs, they can quickly become overwhelmed by the expenses required to keep their systems operational.
How to mitigate risks?
- Carefully plan and budget for maintenance costs as part of your overall financial planning process. This planning should include estimating the cost of ongoing maintenance and support, as well as budgeting for periodic upgrades and replacements of hardware and software.
- Choose vendors who provide reliable and timely maintenance services and who are committed to keeping the systems up-to-date with the latest security and technological advancements.
- Always monitor and evaluate the maintenance plans to ensure that they are effective and cost-efficient. This may involve assessing the frequency and cost of maintenance activities, identifying areas where cost savings can be realized, and regularly reviewing vendor contracts to ensure that maintenance costs are reasonable and well-defined.
Client-Facing Support Risks
Fintech companies use digital channels to provide their services to clients. This means that there are certain risks associated with client-facing support, such as chat integration, human factor, and regions. For example, if chat integration is not properly managed, it could lead to misunderstandings between the client and the fintech company, resulting in financial losses.
Similarly, if employees are not properly trained to handle client queries or complaints, this could lead to reputational damage or even legal liability. Lastly, operating in different regions or countries can bring additional regulatory and compliance risks that need to be carefully managed.
How to mitigate risks?
- You need to implement robust processes and systems to manage client-facing support. This could include training and ongoing education for staff, implementing best practices for chat integration, and ensuring compliance with regulatory requirements in different regions or countries.
- Have contingency plans in place in case of unexpected events, such as technology failures or security breaches.
The term “architecture risk” refers to the possibility that a project’s architectural design may not meet the project’s requirements. Such risks may arise from capacity constraints, subpar designs, flaws, and inefficiencies that may result in rejection by the sponsor or hinder project progress.
For example, the Downing platform, a fintech platform created by DashDevs team, enables investors to invest in renewable energy projects. The platform relies on complex algorithms and data analytics to identify and evaluate potential investment opportunities.
One key risk of the Downing platform is the potential for technology failures or errors. If the algorithms used to evaluate investment opportunities were not properly calibrated, this could result in poor investment decisions and financial losses for investors. Similarly, if the platform experienced a security breach, this could compromise sensitive investor data and damage the company’s reputation
How to mitigate risks?
- Implement robust testing and quality assurance processes throughout the development lifecycle. This should include regular code reviews, penetration testing, and other security measures. It’s also important to have contingency plans in place in case of unexpected events, such as technology failures or security breaches.
There are a number of issues that can arise during the development process: unexpected technical issues, budget overruns, or delays in delivery. Being the owner of a fintech company means carefully managing development risks to ensure that their products and services are reliable and secure. How to mitigate risks?
- Implement robust planning and project risk management processes. Include regular status updates and progress reports, as well as contingency plans in case of unexpected issues. It’s also important to have clear communication channels between the development team and other stakeholders, such as senior management, investors, and clients.
- Use agile development methodologies, which can help reduce the risk of surprises by providing greater flexibility and responsiveness. This involves breaking down development projects into smaller, more manageable tasks, regularly reviewing progress, and making adjustments as needed.
How to Make your Company Risk-Proof
Neglecting the risk management software projects can put the final product at risk and have serious consequences for the entire organization, particularly when the project is essential to the company’s operations.
However, there have been lessons learned from previous failures, leading to the development of more effective risk management methodologies. Use the next critical steps to safeguarding your projects from risks and highlighting the significance of proactive planning.
1. Early engagement with key stakeholders
Gaining early buy-in from stakeholders is critical to the success of a software development project. Key stakeholders include end-users, executive management, and change agents in core teams, who can provide valuable input and support throughout the project.
It is important to agree on key objectives and outcomes with stakeholders and ensure that everyone is aligned with the project’s scope. This also allows the project team to understand external factors that may impact the project’s success.
2. Implementation of risk management processes
Although risk management processes are now common in modern software development projects, getting everyone on board can be challenging when there is pressure to move forward quickly. Although risk management can be a common-sense approach, it is crucial for identifying technical and business risks that could impact the project.
- Preparing a risk register is recommended to document identified risks, assess their likelihood and impact, and plan mitigation strategies. The risk register should be regularly reviewed throughout the project’s lifecycle.
3. Define project milestones and objectives with precision
It is essential to define project milestones and objectives with precision. This involves breaking down projects into smaller, more manageable components and setting specific targets for each phase of development.
By doing so, fintech companies can better track progress and identify potential risks at each stage of the project. Clear and measurable objectives also allow for more accurate risk assessment, which enables companies to take proactive measures to mitigate risks before they become significant issues.
In addition, setting precise project milestones and objectives helps establish a clear sense of direction and purpose for the project team. This fosters better collaboration and ensures that everyone involved is working towards the same goal. Moreover, it helps to manage expectations and communicate progress to stakeholders, which is important for maintaining trust and confidence in the project.
4. Collaborate with project financiers and financial team
- Establishing a working relationship with the project’s funding body is crucial when financial implications are tied to the project’s success. This is especially true for teams with strong technical expertise but limited experience in cost management or budgeting.
- The finance team can provide valuable assistance in creating a detailed budget that considers all cost implications, including technical materials and equipment, resource costs, and business overheads. Their prior involvement in other projects can help understand the types of costs that may be encountered.
- If cost overruns occur, the finance team can draw on their previous experience to identify areas where these overruns are likely to happen and make the necessary provisions. They can also assist in securing additional funding if required, despite their best efforts to identify the correct allocations in the initial budgeting process.
- According to a study conducted by McKinsey & Company and the University of Oxford in 2012, half of all large IT projects “massively blow their budgets,” with software projects identified as having the “highest risk of cost and schedule overruns.”
5. Consistently monitoring and sharing updates on advancement
To keep stakeholders informed and engaged, it is important to communicate the progress of a project regularly. This can be done through concise dashboards that provide key metrics and pertinent information, including important activities, progress made towards goals, challenges faced, and potential risks or concerns.
Regular reporting can also help with the following:
- Providing relevant parties with timely information can enable early intervention that can prevent risks from eventuating or minimize their impact.
- Documenting important decisions and actions taken during the project, which can be useful in evaluating the project’s success later and may be required if challenged in the future.
- Incorporating any changes to the project scope that may arise due to evolving business needs or the identification of new challenges or risks.
- Revising realistic timelines for project completion.
6. Effective staff management
To ensure staff stay motivated and engaged in long-term and high-stress software development projects, try to align their personal goals with the project’s goals and incentivize behaviors that lead to success.
The technical expertise and project-specific knowledge of team members become increasingly important as the project progresses, and losing staff before the completion of crucial testing and implementation phases can have a negative impact on the project’s success.
7. Assessing the Success of the Project
During the project’s execution, it is crucial to carry out a formal quality check or audit process to provide an impartial assessment of the project’s progress and potential success. This is particularly useful when core team members are heavily involved in specific areas, making it difficult to see the overall project from an unbiased perspective.
Likewise, at the conclusion of the project, you should always evaluate the results and learnings to enable future projects to benefit from an understanding of what went well and what could have been improved.
Best Practices for Effective Risk Management
We already mentioned a lot of criteria for creating a risk-proof team. So let’s take a look at some best practices for creating a culture of IT risk management and readiness:
Develop a Risk Management Plan.
You should have a formal plan in place that outlines the approach to identifying, assessing, and managing risks. This plan should include clear guidelines for risk management practices, as well as policies and procedures for addressing specific types of risks.
Establish a Risk Management Team.
A dedicated team is responsible for managing and monitoring risks within the company. This team should have the authority to make decisions and take action to mitigate risks.
Foster a risk-aware culture.
All employees should be educated on the importance of risk management and the role they play in mitigating risks. The company should foster a culture of risk awareness and encourage employees to report any risks or concerns they identify.
Conduct Regular Risk Assessments.
Companies should regularly assess potential risks and evaluate their likelihood and potential impact. These assessments should be conducted across all areas of the company and include an analysis of both internal and external risks.
Implement Risk Mitigation Strategies.
Once risks have been identified and assessed, companies should implement strategies to mitigate them. This may include developing contingency plans, establishing controls, or purchasing insurance.
Monitor and Review Risks.
Companies should continuously monitor and review risks to ensure that their risk management strategies are effective. This includes regularly reviewing and updating risk management plans and conducting periodic risk assessments.
Effective risk management is crucial for any company, especially in the fintech industry, where risks can be significant and potentially devastating. Creating a culture of risk management and readiness involves identifying potential risks, developing strategies to mitigate those risks, and regularly reviewing and updating those strategies. It also involves ensuring that all employees understand the importance of risk management and are trained to identify and report potential risks.
With DeshDevs, you can be confident that all potential risks in fintech will be carefully considered and managed. Our experienced team has a proven track record of effective risk management in the industry, and we prioritize staying up-to-date with the latest regulations and industry best practices. Don’t miss your company’s success to chance — partner with DeshDevs for expert risk management solutions.
What are some common risks in fintech?
Common risks in fintech include regulatory and compliance risks, operational risks, liability risks, communication risks, cybersecurity risks, financial risks, vendor choice and vendor lock risks, as well as maintenance, support, client-facing, architecture, and development risks. It is essential to identify and mitigate these risks to ensure the success of fintech operations.
How can fintech companies manage cybersecurity risks?
Fintech companies can manage cybersecurity risks by implementing robust security protocols and ensuring that their employees and customers are aware of best security practices. Regular security audits and penetration testing can also help to identify vulnerabilities and strengthen security measures.
How can fintech companies manage operational risks?
Fintech companies can manage risk, especially of that kind, by implementing effective internal controls and monitoring systems. They can also conduct regular stress testing and scenario analysis to identify potential risks and develop contingency plans.
How can fintech companies manage regulatory risks?
Fintech companies can manage regulatory risks by staying up-to-date with the latest regulations and compliance requirements, and ensuring that their operations are in line with these requirements. They can also engage with regulators and seek guidance and feedback to ensure compliance.