Paving the Way for Fintech

May 16, 2019

Good morning, ladies and gentlemen. Thank you for the opportunity to offer some reflections on financial technologies — or “fintech ” — and the serious policy issues they raise.

Rapid advances in financial technology in recent years are transforming the economic and financial landscape. They’re already offering wide-ranging opportunities — and raising potential new challenges — for consumers, financial and nonfinancial firms, service providers, and regulators alike.

Fintech can support economic growth and poverty reduction, by strengthening financial development, inclusion and efficiency. Yet they may also pose risks to financial stability and integrity, as well as to consumer and investor protection.

National authorities around the globe, and in the Caribbean region, are eager to promote the benefits, and avoid the potential risks, of fintech.

In my remarks today, I’ll begin by offering an overview of the Bali Fintech Agenda — which offers an important framework for how countries could approach fintech issues. Then I’ll focus on three topics that are of particular relevance to policymakers and private-sector leaders in the Caribbean region: financial inclusion, interoperability, and Central Bank Digital Currencies (CBDC).

The Bali Fintech Agenda (BFA) was launched last October, at the IMF and World Bank Group Annual Meetings, which we held in Bali, Indonesia.

The BFA has been inspired by the need to deepen understanding — among financial-industry leaders, policymakers and regulators, and the general public — about how technological innovation is changing the nature of providing financial services, for both incumbent firms and new players.

As a framework of concepts, for policymakers and for the international community, the BFA has broad relevance to all of the member countries of the IMF and World Bank. It will surely help all of our member countries, as they shape their domestic fintech policy discussions — deciding how to tailor their technology platforms and regulatory approaches to fit each country’s particular circumstances.

The BFA is composed of 12 elements, which are grouped into four objectives:

• Building an enabling environment for fintech innovation;
• Ensuring an adequate financial sector policy framework;
• Addressing risks and resilience; and
• Encouraging international collaboration.

The challenge is how to strike the right balance between (on the one hand) enabling financial innovation and (on the other hand) addressing challenges to market and financial integrity, consumer protection, and financial stability. Arriving at an appropriate balance is critical to maximizing the social benefits of financial innovation.

Despite the challenge of achieving the right balance, every country — including the countries of the Caribbean — would be wise to prepare for and embrace the fintech revolution, in the hope of realizing its far-reaching social and economic benefits.

Financial Inclusion

Financial inclusion is one of the areas where fintech solutions have been identified as potentially transformative. Those solutions can help address several chronic financial frictions:

• the cost barriers for delivering financial services — especially in remote, rural locations and among groups that have long been marginalized (such as women and the urban poor);
• information asymmetries between service providers and consumers — especially among the unbanked, who lack the information they need to adequately assess risk;
• the lack of verifiable identification, and the difficulty in meeting “Know Your Customer” and “customer due diligence” requirements; and
• the lack of suitable financial products for lower-income portions of the population.

To encourage the adoption of fintech solutions to promote financial inclusion and develop financial markets, policymakers and private-sector leaders should consider a number of practical steps.

One of the most important considerations is embedding fintech topics in each country’s inclusion and financial-literacy strategies.

Several countries are now focusing on the development of digital financial services as part of their National Financial Inclusion Strategies. Indonesia, Malaysia, Myanmar, the Philippines, and Thailand, for example, have implemented such frameworks — with data-gathering mandates, and, in some cases, with mechanisms for monitoring and evaluation.

Within the Caribbean region, countries now vary widely in their levels of financial inclusion and development. This creates significant opportunities for fintech growth, which could lead to positive economic and social impact.

Around the world, mobile payment and lending services have had profound impacts on financial inclusion. Mobile phone operators in many countries have set up highly successful payment services that have broadened the access to financial services broadly. This has had a particularly strong impact in several African countries, in China, and in ASEAN countries. In some of those countries, the mobile payment services have also morphed into mobile lending services, based on novel technologies.

Despite the opportunities created by fintech, we should also be mindful that fintech comes with important risks to financial inclusion. Those risks arise from such fintech factors as the high speed of transactions; remote interactions; automated decision-making; the extensive use of data; and the involvement of unregulated or non-financial entities and intermediaries.

Policymakers and private-sector leaders should be vigilant as they watch for a number of risks — including:

• Exclusion: Unequal access to infrastructure and technology — including affordable data plans and access to the internet — limits fintech’s potential and increases the digital divide. Women and the poor are usually disproportionately disadvantaged.
• Discrimination: The record is mixed, at best, on how successful fintech analytical decision-making tools are in removing biases. Such tools often reflect the biases in the underlying data, and in the mindsets of the people who are designing them. They also can reflect existing social preferences or prejudices, such as social views regarding borrowers who are members of minority groups.
• Consumer protection: Important factors in this area include risks related to transparency and electronic disclosure; product suitability and over-indebtedness; agent liability; data privacy; effective recourse mechanisms; safety of funds; cybersecurity; and digital illiteracy.
• Data-protection related risks. The potential for this type of risk (such as the compromise of individuals’ privacy, identity theft, and fraud) is greater where consumers have low levels of financial and digital capability, and where there is a lack of alternatives (particularly in previously unbanked populations).

Interoperability

Another significant element of the BFA calls for reinforcing competition—and upholding the commitment to open, free, and contestable markets.

That commitment is critical to achieving several priorities:

• harnessing fintech capacity, in order to reduce barriers to entry for new business models, products and services — and, in the process, deepening and transforming financial markets;
• enhancing efficiencies, by reducing information asymmetries and reduce operational and compliance costs; and
• improving the customer experience by driving competition, market contestability, and innovation. That priority would promote consumer choice and would improve access to high-quality financial services—which is especially important for underserved households and firms.

The BFA highlights a number of considerations for promoting fair competition and open markets. Those priorities include fostering standardization, interoperability, and fair and transparent access to key infrastructures.

Among those priorities, interoperability stands out as a critical component in building up the backbone of the fintech ecosystem.

What is “interoperability”? There are many definitions — but, broadly, it means the ability of systems and applications to communicate and share data in a seamless manner, without an effort from the end user.

Interoperability is a transformative concept, and its successful application has the potential to improve, fundamentally, the landscape for many industries — including, in particular, financial services.

Let me offer an example from beyond the financial sector. For a very long time, different communications systems and media operated their own separate systems — producing services and content with limited distribution channels; with significant inefficiencies; and at relatively high costs to the consumer. Over the past 10 or 15 years, a push toward interoperability — through many steps, including public policy actions — have completely transformed the communications and media landscape. Telecom firms are now distributing media content, and media companies are offering telecom services, with new players entering and transforming the market. All of that activity leads to much broader choice for consumers, at a lower cost.

Consider that experience when you weigh the potential for interoperability in the financial sector. Interoperability is critically needed, among financial-service providers, for sharing data and for designing effective payments systems.

Interoperability includes concerns that go beyond technical concerns. Yet its effective application also requires having in place robust and supportive data frameworks. They’re pivotal to providing operational resilience and in preserving confidence — as well as to protecting individual and institutional data.

Data, after all, is the fuel of fintech innovation. The collection, processing, and sharing of data amount to the bedrock of the fintech revolution. Without the interoperability of the various data systems, many fintech applications would simply not be able deliver on many of their promises — including their potential for enhanced efficiencies and better customer experience.

Significant aspects of fintech innovations do not involve building new systems. Instead, they take advantage of existing systems and technologies to create new products and services — as well as adding new functionality to existing technology. The lack of interoperability would effectively limit the scope of fintech innovations.

Interoperable and fast systems for payments and settlement provide the critical infrastructure for innovative fintech payments solutions. Such solutions can enhance payments efficiencies and reduce costs — including the costs of cross-border transactions.

Fintech has stimulated competition, innovation and diversity in the payments space with the direct access to payment systems by non-bank payment service providers (PSPs). Recent developments have included the granting of direct access to central bank settlement accounts with adequate safeguards by a new generation of non-bank PSPs. In the United Kingdom, these new players have included authorized electronic money institutions and payment institutions. As these non-bank PSPs do not undertake maturity transformation activities, they are not eligible for reserves accounts and intraday liquidity. These new players are subject to supervisory assessments to ensure regulatory compliance on governance arrangements, safeguarding of customer funds, and financial crime. Also, they are required to periodically commission independent audits covering key risk areas.

Interoperability also holds promise for greater efficiency, operational resiliency, and fraud detection. Many countries have adopted, or are in the process of implementing, the new open and global messaging standard called ISO 20022. These new standards establish a common set of rules for exchanging relevant payment information to enable efficient communication between participants and infrastructures. ISO 20022 would support the exchange of content in both large-value and retail payments, and could enable the rerouting of payments across different platforms in the event of an operational disruption. Furthermore, ISO 20022 adoption would improve fraud detection by banks and non-bank PSPs. That is, the inclusion of the Legal Identity Identifiers (LEIs) functionality would improve the information on the identities of those in payment transactions.

The private sector should take the lead in the development of interoperability standards and functionalities, based on market needs. However, there is significant room for national governments to facilitate broader dialogue among the various stakeholders — and to encourage interoperability across different types of financial data.

The bottom line is: If the private and public sectors fail to collaborate in building robust interoperable financial infrastructure, the current seal for fintech could end, instead, “interoperababble” — with many of its promising potentials unfulfilled. If needless confusion were to undermine progress toward the ideal of greater financial inclusion, it would be especially disappointing.

Central Bank Digital Currency

Another very significant area for policymakers deserves thorough consideration: the issue of Central Bank Digital Currencies (CBDC).

Many central banks have been pondering whether and how to adopt CBDC. But less than one-quarter of central banks around the world are actively exploring the possibility of issuing CBDC — and, so far, only four pilot projects have been reported.

However, wide-ranging debates are under way about the benefits and costs of issuing CBDCs. How such issues are addressed will be of critical economic importance, considering that issuing CBDCs will have a major impact on financial systems — and on monetary-policy conduct and transmission channels.

In particular, policymakers much consider such issues as these: Why should they consider issuing CBDCs, and under what circumstances should they be issued? What are their design options, and those options’ potential impact? What are the risks (if any) to central banks?

It seems clear that the case for CBDC adoption depends on country-specific circumstances. There doesn’t seem to be a “one size fits all” policy prescription.

There are surely some positive aspects of adopting CBDC.

It could reduce the costs associated with the use of cash, and it may improve financial inclusion in cases where there have been unsuccessful private-sector initiatives and unsuccessful policy efforts. It could also help central banks strengthen the security of, and trust in, the payment system — and it could protect consumers where regulation does not adequately limit private monopolies. Moreover, issuing CBDC could also facilitate the “contestability” of the payments market, and could reduce the risk of having a few large providers dominating the system.

Adoption of CBDC, and its impact on the financial sector, will hinge in part on its design. Critical features that central banks can control are the degree of anonymity (the traceability of transactions), security (the risk of theft and loss), transaction limits, and interest paid. Other features of CBDC follow from the nature of central banks. Settlement and default risk are null, and transaction costs are low. Depending on the features that central banks wish to build into CBDC, they will adopt a token- or account-based approach. Token-based CBDC involves the transfer of an object — namely, a digital token — between transacting parties. As such, CBDC would more closely resemble cash. Account-based CBDC involves the transfer of claims recorded on an account.

Yet central banks must also carefully evaluate the potential downsides to issuing CBDC. These could include:

• Concerns about integrity risks, if the CBDC is issued as an anonymous instrument that could be used for illicit activities. Almost all central banks that are researching the issuance of CBDC seem to favor a hybrid approach that allows central banks — and only central banks — to trace transactions;
• The potential impact on financial intermediation. Depending on the design of the CBDC, it is conceivable that bank deposits could migrate to CBDC, thus fundamentally changing the nature of financial intermediation; and
• The impact on monetary policy conduct and transmission channels.

In addition, issuing CBDC would come with potentially significant operational risks, which central banks must carefully assess and manage.

These concerns are all very relevant to the debate that’s occurring here in the Caribbean region. The Eastern Caribbean Central Bank (ECCB) and the central Bank of the Bahamas are conducting extensive research on all these issues in preparation for launching pilot projects within the next couple of years.

About two weeks ago, central bankers and financial authorities from throughout the Americas met in Costa Rica at a high-level conference to discuss the Bali Fintech Agenda. The two central banks — the Eastern Caribbean Central Bank (ECCB) and the central Bank of the Bahamas — delivered excellent presentations there, highlighting their careful deliberation of the prospects for issuing CBDC.

Considering the wide-ranging agenda that policymakers and private-sector leaders are now confronting: It seems clear that this is a thought-provoking and potentially creative moment in financial technology — and the Bali Fintech Agenda is helping channel our conversations along imaginative new pathways.  

Surveying the potential for progress, that accompanies so many ideas in fintech: In my summation, I’d like to reiterate the message that I opened with: We should embrace the many opportunities that fintech could bring to the Caribbean countries — while being mindful of its potential risks.

That is the surest way to capture the greatest benefits of the fintech opportunity, while steering clear of its potential downside risks. 

Thank you very much. Now, I’d be pleased to take any questions that you may have.

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