The financial industry is going hand in hand with technological progress

(Tech in Asia,, CC BY)

The International Monetary Fund (IMF) and the World Bank (WB) have published an agenda devoted to the fintechs, and call for the extensive cooperation between the regulators.

In light of the ongoing technological revolution, central banks are currently facing new challenges. It’s enough to look at the example of Sweden, where, due to the development of technology, the value of cash in circulation, as a share of GDP, is now only 1.2 per cent. It is therefore no wonder that the Swedish central bank is considering the possibility of introducing electronically issued money.

However, the question arises if the central bank has the right to withdraw cash from use? And what might happen to the electronically issued money and to the financial stability when there is a failure or a hacking attack? These are the questions addressed in the document prepared by the IMF and the WB, officially known as The Bali Fintech Agenda.

The agenda would be very superficial, if it was only limited to the above-stated questions. The document addresses the risks, dangers, and challenges associated with the technological revolution in the world of finance. It contains 68 recommendations, which should be mandatory reading not only for economists, but also for politicians and, above all, for the lawyers.

The ATM – a useful invention

In the economy, we distinguish between the so-called real sector of the economy and the financial sector. The latter hasn’t always been open to technological novelties, unlike the real sector. It’s enough to look at the course of the industrial revolution. The novelties invented by the British rapidly spread to other areas of what was considered the then civilized world. In 1825, George Stephenson built the first railway line and a little more than half a century later there were over 160,000 kilometers of railway tracks in Europe, and traveling by train became an almost universal activity. Later on, the rate of popularization of automobiles was even faster, not to even mention aviation. The first flight on an airplane took place in 1903, and after less than forty years later airplanes determined the course of history due to the role they played in the Second World War.

Meanwhile, when it comes to, for example, payment checks, at least two centuries had to pass before they became widely used. The evolution leading to the emergence of the credit card in a form that we know today lasted almost a hundred years. The debit card needed more than a quarter of a century to become similar to the object that many of us use today. It even took about fifteen years for online payments to become widespread. It is believed that they were first introduced in 1983, when the Bank of Scotland, together with the Nottingham Building Society, made it possible for clients to pay bills using a television set and a telephone. Meanwhile, the Stanford Credit Union was the first institution to launch a banking website in 1994, but online payments only started to become increasingly common at the turn of the century.

Most likely, the only exception to this rule was the automated teller machine (ATM) launched in 1967 by the British Barclays Bank. Perhaps that is why the banking guru and the former president of the Federal Reserve Bank, Paul Volcker determined in 2009 that this device had been the only useful invention in the preceding twenty years.

The lag in the application of technological progress in the world of finance can be explained in at least two ways. First of all, the above-mentioned conservatism, which characterized the banking industry for many decades, certainly played a role. Secondly, the development of the financial world was greatly influenced by the huge crash on the New York Stock Exchange in 1929, and the resulting Great Depression. Over time, foreign exchange restrictions relating to capital transactions would become increasingly common, which had to have a bearing on the development of finance. Of course, financial markets have never been a museum of technology. Nonetheless, for a good part of the second half of the 20th century, the development of technology was mainly related to one issue: circumventing the above-mentioned foreign exchange restrictions. This is best demonstrated by the development of the Euromarkets. However, this kind of activity could not enjoy the support of the authorities.

The financial world was revolutionized by the emergence of Margaret Thatcher and Ronald Reagan on the political scene. Between June and October 1979, the Chancellor of the Exchequer in the British Prime Minister’s government abolished all the foreign exchange controls that the United Kingdom had introduced from 1939. In October 1986, the famous “Big Bang” reform started and initiated a new era in the functioning of the British financial system. The world of finance not only gained the freedom to cross borders in an unrestricted manner, but also started making use of the latest technological solutions.

A challenge for the monetary authorities

However, the monetary authorities quickly came to understand that technical novelties carry certain risks. New products derived from the advances in technology quickly started undermining the previous definition of money supply. As a result, it became increasingly difficult to determine the boundary between individual monetary aggregates. And when there is a problem with defining the money supply, it is easy to upset the monetary equilibrium, as the Bank of England found out in the late 1980s.

The 21st century brings an acceleration of the transfer of technological innovations into the world of international finance. This is best demonstrated by the development of contactless payment cards. These cards, which were introduced into circulation at the beginning of the previous decade, have become very popular already at the beginning of the present decade.

In the era of foreign exchange controls, the supervisors of the banking system did not have to hurry too much. The first credit card was issued in 1950, and the regulations concerning the circulation of these cards were only fully developed in the 1970s.

Today nobody can afford such delays

Therefore, it is difficult to imagine a better time for the publication of a document such as the one published by the IMF and WB. We are most likely witnessing a reduction of the time lag between the introduction of technological innovations and their application in the world of finance, which has until recently been very rigid and conservative in this regard. That is why the IMF is tackling this challenge head-on and is drawing the attention of the decision makers (i.e. the monetary authorities) to what it believes are the most pressing issues in this area.

This includes, among other things, the extensive cooperation between the regulators, also involving the sharing of relevant information and the strengthening of joint supervision over what is happening in the broadly defined international monetary system. Despite the process of globalization, we are still dealing with legal regulations at the national level. The regulators should therefore think about a greater harmonization of the existing legislation.

Who is the donor and who is the recipient

One issue that seems particularly difficult to control is the trade in crypto-assets. The authors of the report are pointing out another challenge for the supervisors — the blurring of the boundary between the recipient and the donor of a given transaction. Let’s take the example of bitcoin. A person can acquire bitcoins by buying them at a cryptocurrency exchange or by mining them. From the point of view of the supervisor, this is a very complex arrangement. While it is relatively easy to identify the buyer of the bitcoin, it is much more difficult to locate its supplier. If there is still some room for maneuver when bitcoins are purchased on the exchange, this is not the case in the process of “mining” bitcoins. Can the process of mining bitcoins undermine the central bank’s control of the money supply?

It is not surprising that in the face of such dilemmas, the authors of the discussed agenda devoted an entire subsection to the topic of maintaining monetary and financial stability. The question of what it means to lose control over the money supply can be answered by the experience of the Bank of England from the second half of the 20th century.

However, central banks are not only responsible for the money transmission mechanism. They also control the functioning of the payment system and serve as the lender of last resort. The authors of the document published by the IMF and the World Bank cover each of these roles.

The article presents the private views of the authors and does not express the official position of Poland’s central bank, NBP.

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