Namoniuk, Taranenko, THE DIGITAL TRANSFORMATION OF FINANCE: IMPACTS ON MARKETS, BANKING AND GOVERNANCE

V. Namoniuk, Assoc. Prof. in International Finance
K. Taranenko, student
Taras Shevchenko National University of Kyiv

THE DIGITAL TRANSFORMATION OF FINANCE: IMPACTS ON MARKETS, BANKING AND GOVERNANCE

In recent years, the financial services industry has witnessed a significant digital transformation catalyzed by the adoption of advanced technologies including artificial intelligence, machine learning, big data analytics, and blockchain. This has led to the emergence of a concept known as "digital finance", which refers to the utilization of these new technologies across financial services. According to the European Commission, digital finance encapsulates the impacts of technologies such as APIs, cloud computing, and digital identity systems on the financial sector [8].
Digitalization has resulted in innovative new financial products, processes, business models and market structures. Tasks that were previously manual have been automated, improving efficiency. New mobile and web applications have also increased accessibility and transparency for consumers. For instance, digital payments like Apple Pay and Google Pay have gained mainstream adoption [7].
One area experiencing profound changes is capital markets and trading activities. Algorithmic high-frequency trading (HFT) now accounts for over half of all transactions in equity markets in the United States and Europe [4]. HFT relies on sophisticated algorithms and automation to execute millions of orders per second and capitalize on minute price discrepancies. While providing benefits such as enhanced liquidity and price discovery, HFT also raises regulatory concerns regarding risks of flash crashes, unfair advantages, and potential market manipulation. Events such as the 2010 Flash Crash, where the Dow Jones Industrial Average plummeted over 1,000 points within minutes due to HFT systems gone awry, highlight the need for safeguards and oversight [5].
In addition, digital platforms have enabled commission-free retail investing and trading by individual investors. For instance, Robinhood pioneered user-friendly mobile applications that made investing more accessible to millennials and first-time investors. However, practices like gamification have also elicited criticism for encouraging excessive trading and addiction-like behaviors [6].
The rise of cryptocurrencies and decentralized finance (DeFi) represents another major digital transformation of finance. In DeFi, transactions like borrowing, lending, and trading are executed directly between peers using blockchains and smart contracts without intermediaries. Over $100 billion is now locked in DeFi applications across lending, exchanges, derivatives and more. The overall crypto asset market cap recently exceeded $2 trillion, underlining the exponential growth [2].
While expanding access, DeFi also raises concerns around volatility, security breaches, governance, and the use of cryptocurrencies for nefarious activities due to their pseudo-anonymity. Recent crashes in major coins like Bitcoin and Luna highlight risks from the lack of oversight and regulation around cryptocurrencies. Governments are grappling with the challenges of regulating these rapidly evolving digital asset markets.
In addition to markets, the banking industry has undergone a sea change towards digital channels and interfaces. According to surveys, over 58% of bank customers in Europe regularly utilize mobile banking applications for their transactions, rather than bank branches [1]. Digital banking provides customers the ability to access accounts, check balances, transfer funds, deposit checks, and apply for loans anytime through their smartphones.
New entrants known as neo banks like Revolut and N26 have also emerged - fully digital banks providing mobile app-based financial services without physical branches. While primarily targeting tech-savvy, younger demographics, neobanks are making significant inroads. In the United States, neobanks such as Chime and Varo have rapidly grown their customer bases and valuations [1]. Open banking regulations like PSD2 have also enabled third-party financial applications to aggregate and analyze customer data across accounts with consent.
For incumbent banks, the digital transformation has centred around modernizing legacy IT systems, shifting services online, and leveraging data analytics for personalization. Key benefits include substantial cost savings and higher customer satisfaction from digitalization. However, increased reliance on websites and applications also exposes the sector to heightened cybersecurity risks, IT failures, and service outages. Critical challenges remain around data privacy, lack of digital skills among some customers, and responsible usage of artificial intelligence as finance becomes digitalized.
Governments too are accelerating the digitalization of their financial systems, regulations, and public financial services. India's Unified Payments Interface processed over 4 trillion rupees in transactions since its launch in 2016 [7]. The adoption of mobile-based real-time payments has boosted financial inclusion. Ukraine's Diia app provides digital IDs and enables citizens to access financial and other public services online safely and easily.
Tax administrations are leveraging technologies like cloud, AI, and analytics to uncover fraud and errors in filings through automated reviews and risk scoring. Customs and border agencies are using blockchain and the Internet of Things to track cross-border trade faster and more transparently [7]. The emergence of cryptocurrencies poses major challenges related to taxation, consumer protection, monetary control, and illicit activities.
In response, the Financial Stability Board has formulated global crypto asset regulations [3]. However, the lack of harmonization across jurisdictions persists. Moreover, increased partnerships between governments and digital payments providers also raise concerns about surveillance, commercialization of public services and vendor dependencies.
Thus, the financial industry has undergone significant digital transformation through adopting new technologies like AI and blockchain. This has enabled innovations ranging from high-frequency trading algorithms to mobile banking apps and cryptocurrency growth. While digital finance has increased efficiency, accessibility, and convenience, it has also created concerns around volatility, cyber risks, and ethics. Policymakers face challenges regulating rapidly evolving decentralized finance ecosystems and managing stability. Overall, realizing the full potential of digital finance requires prudent governance to balance benefits versus risks across markets, banking, and public systems.

Sources:
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