1 Shaping digitalisation: Opportunities and challenges for the G20
The issue of digitalisation is one of the priorities of the German G20 presidency in the Finance Track. Digitalisation has already been taking place in the financial sector for many years. However, innovations in potential uses for the internet and new technologies are leading to an increasingly fast-growing range of possible applications. Globally, this creates enormous opportunities for the financial system, the real economy and societies. The G20 can, and should, help to responsibly shape the trend towards an increasingly networked world; only in this way can the potential of digitalisation be fully exploited and its risks limited. The goal of the G20 digitalisation conference, which was organised by the Deutsche Bundesbank and the Federal Ministry of Finance and held in Schloss Biebrich in the German city of Wiesbaden, was to achieve a better understanding of the multiple facets of this issue, including how they interact with each other, and to support the work of the German G20 presidency through input from experts.
The title of the conference – “Digitising finance, financial inclusion and financial literacy” – already indicated the broad scope of this issue. In his introductory remarks, Bundesbank President Jens Weidmann highlighted the connections between the individual areas of focus and emphasised the responsibility of politicians, regulators and supervisory authorities to create an appropriate regulatory environment for digital technologies in the financial sector and for digital financial service providers. The opening speech was given by Her Majesty Queen Máxima of the Netherlands, the UN Secretary-General’s Special Advocate for Inclusive Finance for Development and the Honorary Patron of the Global Partnership for Financial Inclusion. More than 250 participants from Germany and abroad discussed the opportunities and challenges of digitalisation in business and society. Featured speakers included Australian Treasurer Scott Morrison, Deputy Prime Minister of Singapore Tharman Shanmugaratnam, Bank of England Governor Mark Carney, Swiss National Bank Chairman Thomas Jordan and German Interior Minister Thomas de Maizière. German Finance Minister Wolfgang Schäuble took part in a moderated discussion with Hasso Plattner, co-founder of SAP and chairman of its supervisory board. The specialist audience was able to participate interactively in the intensive debates using tablet computers. The event, which was held on 26 January 2017, also featured eight workshops and discussions with representatives of the business and academic communities.
2 Financial innovation through fintech: What’s new?
Enormous progress in the area of information and communication technology is opening up new possibilities for developing and distributing financial services.
Digital financial services and, in particular, the fintech sector have experienced very fast growth in recent years, which has been driven by factors on both the supply and demand side. On the supply side, technological developments are playing a key role, as are efforts to reduce the costs of financial services. These factors are being reinforced by the increasing availability of information and communication technology infrastructure, the availability of new means of accessing financial services, such as mobile phones, and the increasing number of “digital natives” who have grown up with digital technology.
On the demand side, more and more customers are continuously online and increasingly expect to be able to carry out their banking transactions anywhere, at any time, with minimal effort. These types of customers, and their expectations and behaviour, were regarded by many of the conference participants as a key force driving developments in the digitalisation of the financial sector.
Some people at the conference expressed the opinion that digitalisation had the potential to “revolutionise” the financial services sector and its infrastructure. For example, many participants in the workshops felt that blockchain or distributed ledger technologies could have large potential effects on international financial market infrastructure. Indeed, distributed ledger technology, which is well known as the technology on which the virtual currency bitcoin is based, is turning out to be a tool which seems to have a wide range of possible uses. Many market participants, not to mention supervisory bodies and central banks, are currently examining its potential in research projects, which are still, however, in the experimental phase.
There is still no generally accepted definition of the term “fintech”, a portmanteau of “financial” and “technology”. Fintech firms are usually young, innovative companies offering services in the financial sector based on technological innovations. Fintech companies compete with conventional financial service providers to a certain extent, but they can also cooperate with established players and complement their product ranges.
Blockchain and distributed ledgers
A distributed ledger is a decentralised public account book. The technological basis for virtual currencies, it is designed to record digital payment and commercial transactions between users without the need for a centralised authority which legitimises each individual transaction. A blockchain is a type of distributed ledger which forms the basis for the virtual currency bitcoin.
3 Technology as an opportunity for the financial system and the real economy
The digitalisation of the financial sector opens up a wide range of opportunities. From the economic perspective alone, the digitalisation of financial markets offers great potential benefits. Firstly, digital financial services can lead to significant increases in efficiency. In addition, digitalisation can increase competition within the financial system. Digitalisation offers newcomers the chance of asserting themselves in relation to established players, by leveraging their technical know-how. Ultimately, technology can, in many cases, make it significantly easier to access financial services, both for private customers and companies in the real economy. For example, just possessing a mobile telephone is already sufficient to be able to access financial services.
Data-based technologies can also increase the transparency of the financial system and reduce information asymmetries. For example, analysis of “big data” makes it possible to better estimate the risks of default, even in cases where a long-term relationship between the commercial bank and customer does not exist.
Online platforms for crowdfunding or peer-to-peer lending can help to enable planned investments which traditional banks would find too risky or too small. At a discussion held at the conference entitled “Crowdfunding and peer-to-peer lending – potential benefits and risks”, examples were given of an increasing number of projects for which funding had been achieved, or could be achieved, in this way. In order to obtain the greatest possible benefits from digital innovations, their opportunities must be realised and the associated risks must be contained.
4 Improved access to financial services (financial inclusion)
Innovative technologies and forms of financing can facilitate access to payment services (e.g.-- for example mobile payments), loans (e.g. peer-to-peer lending) and capital (e.g. equity crowdfunding), particularly for consumers and small and medium-sized enterprises. Especially in developing countries and emerging economies, these developments make it possible to extend access to financial services to segments of the population that were previously excluded from the financial system; one example is the ability to make payments and bank transfers via a mobile phone. Even if access to a mobile phone or the internet at home is still not universal (figure 1), these technologies are now spreading very rapidly. Particularly in areas that are underserved by traditional financial service providers, these technologies help a broad segment of the population to share the benefits of economic development.
In her opening speech to the conference, Queen Máxima of the Netherlands emphasised the particular importance of access to financial services for small and medium-sized enterprises, which comprise 90% of all companies worldwide and which are responsible for 50% of all jobs. During his conversation with Hasso Plattner, Finance Minister Wolfgang Schäuble stressed that the main opportunity offered by digitalisation consists of providing people in Africa with access to financial services and hence to new opportunities for economic development. Digitalisation could help to boost development and strengthen social cohesion, he said. It is not only about educating people to use technology, he said, but also about the general ability of our societies to deal constructively with new situations which at first sight appear strange and complex. This too is part of the international cooperation within the framework of the G20, Minister Schäuble said. Hasso Plattner emphasised that digitalisation gives developing countries the opportunity to leapfrog certain stages of development.
A conference workshop on digitising finance and financial inclusion focussed on the “High Level Principles for Digital Financial Inclusion” which were adopted under China’s G20 presidency. Participants concluded that digital technologies could make a decisive contribution to improving access to financial services in the coming years. However, uncontrolled expansion of access to financial services, particularly to loans, could also have a destabilising effect. This danger is particularly high if supervisors, regulators and consumers do not keep up with identifying and addressing the financial risks that are also connected with the development of new financial services. Participants discussed successful examples of digital access to financial services, taking these aspects into account. They also discussed options for establishing peer-to-peer exchange by means of innovative digital media technology.
5 Financial literacy as a key factor in financial inclusion
A workshop on digitising finance and financial literacy focussed on the challenges of the digitalisation of financial services for consumers and investors. Additional qualifications and skills are necessary in order to be able to use these services effectively and responsibly. At the same time, digitalisation offers options for developing new instruments to improve specific financial knowledge. Against this background, it is important to have sufficient data so that the effectiveness and impact of financial literacy programmes can be evaluated. The results of the OECD/International Network on Financial Education survey on general financial literacy among adults provides the necessary basis in terms of data. The standardised questionnaire has already been used in more than 50 countries. The questionnaire provides comparable data on the three components of general financial literacy: knowledge, attitude and behaviour. During the German G20 presidency, the OECD, in coordination with the Deutsche Bundesbank, will prepare and publish a report on general financial literacy in the G20 countries on the basis of this questionnaire. Data has also been collected for Germany.
The survey sample comprises at least 1,000 adults aged between 18 and 79 per country. The 30 questions relate to behaviour, attitude and knowledge in the area of finance, the selection and use of financial products, long-term financial planning (including retirement provision), the financial situation and socio-economic information. Normally the survey is performed by means of a telephone interview or a face-to-face interview, but it can also be carried out as an internet survey. The standardised questions and the toolkit’s precise description of the methods and procedures involved mean that the data collected on the national level can be used to perform a comparative study of the state of financial literacy in the participating G20 countries.
Financial literary was also one of the focal points of the speech given by Tharman Shanmugaratnam, Singapore’s Deputy Prime Minister and Co-ordinating Minister for Economic & Social Policies. Not only does Singapore perform extremely well in international rankings of school education, but it is also one of the more progressive countries in terms of financial literacy. In Singapore, financial literacy is even part of the curriculum in primary schools.
6 Risks of digital innovation – challenges for users and supervisors
The opportunities of digitalisation are also offset by risks. There is universal agreement that these risks must be adequately addressed. This was the focus in a workshop on the regulatory challenges of digital finance, where researchers and representatives of supervisory authorities, central banks and fintech companies discussed the regulatory treatment of risks arising from digital innovation in the field of finance.
Despite the diverse nature of the fintech landscape, the different stakeholders were able to agree on some points. For example, there was consensus that regulatory approaches must not be allowed to hinder the development of digital technology or impede its chances. At the same time, it must be ensured that the associated risks do not grow and get out of control. However opinions were divided as to which conclusions to draw from these conflicting goals. Some participants considered “regulatory sandboxes” to be useful, for example in testing the impact of new regulations on financial innovations. Others felt these were only suitable in certain cases (e.g. computerised investment advice) or were totally opposed to the idea. However, vigilant monitoring and an ongoing discussion about new developments were generally considered to be cornerstones of an appropriate regulatory strategy. Moreover, all the speakers felt it was necessary to have a process which helps stakeholders learn from each other, given the heterogeneous development of markets and regulatory approaches.
Regarding the question of whether it was necessary to have active government influence on technological innovations, German representatives argued that the government’s role should be neutral overall with regard to technological development. In Germany, it was pointed out, regulation and supervision are based on the principle of “same business, same risks, same rules”. So far there has been no need to change the German regulatory approach in the short term, participants said. The issues of whether fintech companies are able to cope with cyclical downturns or if risks could arise from excessive interconnections between fintech firms are currently being examined, however. Some of the participating researchers argued that public bodies should play a more active role in the development of technologies. Cooperation between supervisors and businesses in developing new technology was nothing new, researchers said, pointing to the example of the creation of infrastructure for payment systems.
Further discussions focussed on possible wrong incentives, parallels to risky products in the past, and the danger of regulatory discrimination:
Lending via “auctions” (peer-to-peer lending) was mentioned as an example of a significant wrong incentive in the case of online lending platforms. If investors outbid each other for the chance to lend money to a borrower, this could lead to the situation where those investors who have a particularly optimistic view of the default risk, and who therefore demand the lowest interest rate, always win (“winner’s curse”). However, some peer-to-peer lending companies provide their customers with an assessment of the risk of default for precisely these reasons and also advise customers to diversify their investments.
Another possible risk that was mentioned was the similarity of some crowdfunding business models to the structures for securitisation of real estate loans, so-called asset-backed securities. In the case of asset-backed securities, the issuing bank demands that the purchaser bear part of the risk; this is currently not (yet) the case with crowdfunding. Some participants considered it possible that risks could swiftly grow as a result. In general, too, the pace of growth of risks has increased significantly, participants said, particularly on the Asian markets. The transition from “too small to matter” to “too big to fail” can now happen within just a few months, as can be seen from the rapid rise of Asian fintech companies.
Participants in the discussion felt there was a risk caused by regulatory discrimination in the context of digital investment advisers, known as robo-advisors. In many cases, robo-advisors, in contrast to conventional investment advisers, are not subject to any licensing rules, even though this could make a lot of sense. Regarding future supervision requirements, there was unanimity that in the future supervisors will need greater expertise in the area of IT and programming in order to be able to evaluate the risks of robo-advisors. Participants warned, however, against having overly high expectations, given that there are many different ways to influence algorithms and these can be hard to detect, even for supervisors with advanced IT skills.
An expert group from the Financial Stability Board (FSB) is currently examining potential systemically important risks arising from the fintech sector. With regard to universal banks, potential risks to financial stability could include the following:
- in the area of payment services, new concentrations of risks due to digital wallets, electronic money and international payments,
- in the area of customer relations (deposit-taking activities), higher volatility and liquidity risks due to aggregators, comparison websites and robo-advice,
- in retail banking and commercial banking, greater pro-cyclicality due to peer-to-peer lending,
- in the commercial banking business, impaired market function due to high-frequency trading and the use of algorithms,
- and with regard to clearing and settlement by distributed ledgers, risks with regard to infrastructure providers, operational risks and cyber risks (see figure 2).
Fintech innovations must therefore satisfy the highest requirements in terms of reliability, data protection and scaling, participants said.
One of the conclusions that some participants came to is that there is a need to adapt regulatory approaches. “Regulatory sandboxes” could make it possible to carry out tests of innovations and business models in a realistic environment and carry out approval procedures while avoiding obstacles. Systemic risks caused by fintech firms must be countered with regulatory parameters, the dynamic adaptation of supervisory requirements, clear insolvency regimes and disciplined risk management, participants said.
A relatively new third kind of money in addition to central bank money and commercial bank money.
Virtual currencies are encrypted alternative currencies which can be used to pay for goods, services and IT applications via the internet.
Crowdfunding is a type of financing which generally takes place via websites and is basically divided into four market segments:
Donation-based crowdfunding: Members of the general public donate money to a specific project during a defined period of time without receiving anything in return.
Reward-based crowdfunding: The funders receive a symbolic, non-monetary reward, such as being mentioned by name in the credits of the film they helped to finance or personal items from the artist whose work was funded.
Equity crowdfunding: The investor receives part of the future profits from the financed project, or shares or debt instruments if the investment is linked to securities.
Debt-based crowdfunding (crowdlending): The funders receive the promise that their money will be repaid, either with or without interest.
The first two market segments are often grouped together under the term “crowdsponsoring”.
Robo-advice and auto-trading platforms
Robo-advice refers to automated systems for advising customers, while auto-trading platforms offer a corresponding trading service. With robo-advice, customers complete an online questionnaire where they give the provider details about their personal situation, their investment goals, their investment-related knowledge, and trading experience. On the basis of the information provided, an algorithm then creates an investment proposal, a model portfolio or an investment recommendation. The degree of standardisation can vary significantly between different platforms. In some cases, the investment proposal can also be realised on the platform, after the user has registered and opened a securities account.
7 Cybersecurity in the financial sector
Cybersecurity was also discussed at the conference. As the digitalisation of financial services proceeds, threats from increasingly professional cyberattacks on institutions and systems in the financial sector have also greatly increased in recent years. German Interior Minister Thomas de Maizière pointed out that the vulnerability of IT systems is continually growing due to ever more intelligent types of attack. He called for greater investments in cybersecurity.
The financial sector is characterised by its international network of markets and institutions. Large-scale cyberattacks on a single institution could therefore have effects on other institutions, including foreign institutions, meaning that cyberattacks on the financial sector could well lead to risks for the global financial system. In order to increase the resilience of the financial sector, it is therefore necessary for all G20 countries to increase their efforts in this area. The Governor of the Bank of England, Mark Carney, welcomed the initiative of the German G20 presidency for the G20 to call on the FSB to stock-take existing cybersecurity regulations in the financial sector, as a basis for developing best practices in the medium term.
The discussion of the topic concluded with an academic dialogue. Here, too, speakers agreed that the financial sector is a particularly attractive target for cybercriminals. So-called “ransomware” is being used more and more often – malicious software which restricts or blocks access to data and systems and only releases them again if a ransom is paid. Increasingly, criminals are also threatening to release sensitive customer data on the internet if a payment is not made. But it’s not just these increasingly sophisticated attacks on established financial institutions that pose new challenges for the financial sector. Players with new business models, such as fintech companies, are being identified as potential targets, particularly because these firms are subject to much lower regulatory requirements in terms of security. On a positive note, it should be emphasised that international cooperation in the area of cybersecurity has improved in recent years.
8 Conclusion and outlook
The topic of digitalisation will be discussed further during the German G20 presidency. At the same time, the FSB will carry out analysis of the potential impact of fintech firms and digital technologies in the financial sector. A stock-take of existing regulatory approaches will also help to identify possible global regulatory issues in the fintech sector that can help to ensure a stable financial system.
One important goal of the German presidency is to promote effective processes to enhance financial literacy, in particular by creating comparable data sets across the G20 to evaluate the effectiveness of support programmes. Equally important is dialogue between G20 and non-G20 countries on the topic of digital financial inclusion.
Another focus of the digitalisation debate will be the use of associated opportunities for improving financing for small and medium-sized enterprises (for example at the workshop “Helping SMEs Go Global – Moving Forward in SME Finance” in Frankfurt on 23-24 February). Furthermore, the Federal Ministry of Finance would like to use the opportunities that digitalisation provides to foster international cooperation among students within the framework of the “Global Classroom” project, developed jointly with the Hamburg-based Joachim Herz Foundation (further information on the Global Classroom is available at www.global-classroom.de).