Banks, Digital Banking Initiatives And The Financial Safety Net

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BANKS, DIGITAL BANKING INITIATIVES AND THE FINANCIAL SAFETY NET OECD-ADBI Tokyo Roundtable 26-27 February 2019 ADBI, Tokyo Stephen A. Lumpkin, Ph.D. Sebastian Schich, OECD

Topic outline 1. The digital transformation Rules and regulations

2. Are banks special?

Financial resources

3. Components of the financial safety net

Functions that make banks special Information Capacity 4. Fintech initiatives (digital banking)

5. Why banks remain special

THE DIGITAL TRANSFORMATION

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The digital transformation of the economy The technological shift to digital forms of interaction has begun to alter the nature of assets that generate value, how ownership is imparted, and where value is being generated. These shifts change the structure and operation of markets, enable the formation of mini-economies or eco-systems and ultimately influence how relationships – both economic and social – are developed, maintained and located. “Technological improvements and innovations are often beneficial for an economy, but they can place strains on the incumbents in a particular industry or sector on which they are focused, and they may create challenges for public policy, especially in a heavily regulated industry”

Implications of digital innovations for banks  Focus: functions typically associated with depository institutions (i.e. banks)  Question: are banks still special and thus warrant exclusive access to all of the provisions of the financial safety net?  Question: or is it rather the case as Bill Gates once quipped that ‘banking is necessary; banks are not’?  Issue: New commercial-loan and deposit-like substitutes pose questions about the design of public policy towards the banking sector.

ARE BANKS STILL SPECIAL?

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Why were banks deemed to be special?

Taking deposits that are withdrawable on demand at par

Providing liquidity to other banks and non-banks, thus effectively engaging in maturity transformation, and Serving as conduits for monetary policy transmission

Institutions versus functions and the FSN

The literature on why banks are special implies that this mix of functions explains why banks, as institutions, are given access to all financial safety net components and why the boundaries of the FSN have tended to be focused on institutions rather than functions.

In any event, banks have been the only institutions that provide all three relevant functions.

Components of the financial safety net

Note: Traditionally, the financial safety net was defined as consisting of a lender of last resort and a deposit insurance function (which could include special bank failure resolution regimes) and, as a counterbalance for the privileges associated with these functions, a regulatory and supervisory framework. (Schich, 2013)

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The “specialness” of banks

Functions that make banks special Functions that make banks “special” under the FSN

Functions of digital banks and other FinTech initiatives

Safekeeping (deposit taking)

Safekeeping (eW); Deposit taking (DB)

Offering transactions accounts (redeemable in cash on demand)

Offering transactions accounts (DB, eW)

Liquidity provision

Liquidity provision (DB, eW)

Maturity transformation Clearing and settling payments Serving as conduits for transmission of monetary policy

Facilitating the exchange of payments DB, eW, API)

A key question

Digital banking initiatives basically unbundle selected bank functions and products and deliver them separately or rebundle them. Given the overlap in functions one might ask whether banks remain special and whether these other entities should also be covered by the financial safety net.

The short answer  The specialness of banks depends crucially on decisions of the central banking community to support a system of intermediation based largely on the provision of central bank money to and withdrawal of central bank money from commercial banks.  The sight deposits that commercial banks hold with the central bank are particularly important in this context, as they are used for the settlement of payment transactions.  the importance of banks as conduits of monetary policy should not be minimised when thinking about which types of entities should be covered by the full financial safety net.

Banks and digital initiatives and the FSN

The short answer  A key issue with the financial safety net is the appropriate pricing of its support provisions.  Hence, one should note that the financial safety net consists not only of those components that provide protection or support but also those that aim to limit moral hazard by imposing restrictions on activities of banks to limit their incentives and ability to take on excessive risk.  The common elements include the regulations on banks’ capital, which require banks to hold a buffer layer of capital relative to risk-weighted assets that is subordinate to the claims of depositors and other providers of low cost funds, which helps to protect the deposit insurance fund.  Presumably, the same or equivalent requirements would need to be applied to other service providers who receive the benefits of insured deposits.

THANK YOU! Contact: Stephen A. Lumpkin, Ph.D. [email protected] Sebastian Schich, OECD [email protected]