SPEECH
SPEECH BY GOVERNOR PER CALLESEN
AT CBS' 100 YEARS CELEBRATION EVENT
CHECK AGAINST DELIVERY
30 October 2017
CAN BANKING BE SUSTAINABLE IN THE FUTURE? A PERSPECTIVE FROM
DANMARKS NATIONALBANK
Key messages
Thank you for the invitation. Congratulations with the 100 years!
I will focus on three issues and set of conclusions:
First, banks will likely face stronger future competition from several
sources. This is to be welcomed from the perspective of consumers and
business. Such competition will drive further innovation and productivity
in both the financial and non-financial sectors. Some banks will cope well
with stronger competition. Others will fail. The most important regulatory
challenge in this respect is to enable orderly resolution of failing banks.
Second, digitisation of financial services will likely continue to grow. Pay-
ments and other financial services are already highly digitised in Denmark
and other countries. Sound digital currencies exist in the form of private
bank deposits. A couple of side issues are under debate and need clarifi-
cation. Crypto-currencies are unhealthy for consumers and business, and
potentially, down the line, for financial stability. At the other end of the
spectrum central banks - which are the banks of the banks - should not
offer digital currencies to the general public.
Third, digitisation poses new risks, not only in financial services, but also
in financial services. Risks include vulnerable or unstable equipment,
human error and outright crime, such as cyberattacks. Coping with such
risk is costly, and a continuous struggle or arms race, but is indispensable
for financial stability and the credibility of financial institutions.
Diversity and competition
Stronger competition in financial services is in part driven by technology
and new private business models. It is also being facilitated by regulatory
developments. We should welcome all these sources of competition.
Regulation should strive to underpin innovation and competition, not
seek to put a brake on them. Three potential driving forces are cross-
border competition, stronger market financing - or non-bank financing -
and the appearance of Fintech, typically start-ups, as well as Techfin
companies, typically major IT companies broadening their scope of busi-
ness.
Cross-border competition certainly prevails, but many financial activities
are still, even within the EU, predominantly national. There are historical
and cultural reasons behind. But also regulation and crisis management
has typically contributed to limiting competition across borders, not least
due to the adverse loop between banks and their sovereigns - very vis-
ibly so during the 2008 financial crisis.
The Single Supervisory Mechanism, anchored in the ECB, and the Single
Resolution Mechanism represent major progress. These institutions en-
able effective supervision of cross-border banks, they reduce barriers to
competition, such as unwarranted differences in regulatory standards
and practices, they reduce the risk of regulatory capture by local banks
and not least, they are a precondition for a competition-friendly resolu-
tion of failing institutions.
Like all institution-building this work is not complete (and probably never
will be), but Banking Union is about the single market, competition and
innovation. These are not currency issues, and Denmark would benefit
from joining the Banking Union. In the meantime we should build our
own regulation on the same principles - we are in any case all committed
to joint EU regulation - seeking close cooperation and avoiding national
peculiarities where they may unnecessarily block cross-border competi-
tion.
Market-financing and non-bank lending is rather limited in Europe com-
pared to other advanced countries. Banks have many virtues, but we miss
out in terms of diversification and competition if they are too dominant.
This is acknowledged by the EU Capital Market Union initiative. A major
change from bank-driven financing to market financing is likely to occur
slowly and gradually, but it should be encouraged. By its nature, market
financing circumvents the vulnerability of bank intermediaries. But of
course regulators should be vigilant towards bank-like risk occurring in
other forms.
New technologies may lead to shrinking or the disappearance of some of
the financial intermediary activities we have been used to expect from
banks only. Currently this is particularly the case in the market for pay-
ments. Some of this is driven by Fintech start-ups. Some is driven by
competition-enhancing regulation such as the new payment services dir-
ective, which allows for third party access to bank accounts - of course
based on explicit acceptance by the account holder. Yet another source is
large, well established world-wide IT or network institutions expanding
their range of activities based on their vast existing customer base.
Also the technology-driven competition is to be welcomed, but it comes
with challenges as well. If new institutions go beyond payment activities,
if they start taking deposits and provide lending - in other words if they
become banks, they will need to be regulated as banks. If they become
too dominant, competition may eventually suffer and any systemic im-
portance for financial activities will need to be managed carefully by
regulators.
What does this innovative and competitive environment imply for the
banks? They will continue to exist, they will all have to adjust business
models over time, some will thrive and expand in both domestic and for-
eign markets, others will shrink or disappear. This is what market eco-
nomics is about - to the benefit of society, consumers and business. The
objective is to enable the best provision of services to the market, not to
preserve specific companies.
Banks should continue to strive to be well capitalised, and we know from
history that they need a helping hand from regulators to pursue this at all
times.
But one needs to stress one particular horizontal conclusion in the con-
text of competition and increasing competition, irrespective of the driv-
ing forces. That is the need for a fully functioning and comprehensive
resolution framework, which enables market exit or restructuring of un-
viable banks without triggering financial crises and without bail-outs by
taxpayers.
We are in Europe much closer to achieving this than we were in the past.
But we are not where we should be or wish to be yet. A lot needs to be
done in terms of recovery and resolution-planning by banks and regula-
tors. Commitment needs to be stronger, avoiding exceptions which
undermine the credibility of the resolution framework. Communication
needs to be clear and transparent: losses and recapitalisation are to be
fully borne by shareholders and creditors, not taxpayers.
Bail-out was something authorities had to do, when that was the only
way to avoid standard bankruptcies of failing financial institutions.
Standard bankruptcies do not work for large financial institutions. There-
fore we now have the principle of bail-in, which will at the same time
allow the vital activities to continue while letting shareholders and cred-
itors cover those losses they would have had to cover in case of bank-
ruptcy - just like in any other failing private company.
So yes, banking can be sustainable, but it would be hazardous to predict
their future market share and business models.
Digitisation and currencies
Coming back to digitisation and payment systems, one may start from
acknowledging what a payment is. A payment is basically a transfer of
ownership for an asset from one person or entity to another person or
entity. In barter economies that could work through exchanges of physi-
cal goods or services. Cash issued by central banks made some progress
in the payment system. Modern payment systems are so much more effi-
cient. In addition, people like to be able to store financial assets.
Such virtues are combined by exchanging deposits between bank ac-
counts, and it became convenient to think about bank deposits as "mon-
ey". Bank deposits are one out of many other components of financial
assets. And bank deposits take many different forms. One should not for-
get that any financial asset is the debt of somebody else. In the case of
bank deposits they are a liability, or debt, of the banks.
The point here is that the possibly ongoing wave of new payment tech-
nologies is just one of a long historical series of innovations preventing
any perfect definition of monetary aggregates, not to mention observing
any stable correlation between such monetary (stock) aggregates and
real economic (flow) variables such as GDP and inflation.
If, say, a bond can be exchanged for another liquid asset, say a bank de-
posit, within a very short time span, why should it matter for the real
economic decisions of a person or a company if their financial assets are
held as a bond or a bank deposit? In other words, we are not able to
control what people think of as money supply at a given point in time.
And this should not worry us. As central banks we have not even con-
trolled the supply of notes and coins, they are issued according to de-
mand from the public.
What matters for the real economy is rather the entire spectrum of finan-
cial assets and liabilities and the interest rates, which offer incentives to
build up more or less of these assets.
Of course the vital factors from a central-bank perspective include finan-
cial stability, efficient payment systems and preserving the purchasing
power. We should care for the health of banks and we should vigilantly
monitor and sometimes control the development of credit, not least cred-
it provided by banks.
When it comes to payments based on bank deposits they serve the ne-
cessary characteristics for efficient digital currencies. They can be ex-
changed instantly (admittedly in most countries it will still take some
hours or days), they are sufficiently safe as enough of them are covered
by the deposit guarantee, and they retain their value because central
banks ensure price stability. Challenges still remain with respect to inter-
national payments.
Privately initiated so-called crypto-currencies do not meet these criteria.
In particular, nobody and nothing stands behind their value, which may
therefore fluctuate a lot and disappear entirely. Their existence is for a
start a consumer-protection issue. Arguably, some people fully under-
stand the products and volunteer to take upon them such risk. Other us-
ers may not understand the risk. More importantly, should the general
public and financial institutions engage in holding such risk to a very
large extent, this may pose financial stability risks. Regulators need to be
alert to such developments and act accordingly.
For very different reasons it is neither to be recommended that central
banks change their entire business model from being the banks of banks
to issuing digital currency to the general public, say by opening an ac-
count for every citizen and company (including foreigners?). For a start it
would not create something which is not already offered by private
banks. It would not be a substitute to notes and coins but to private bank
accounts. It would therefore rather open a highway to bank runs, chal-
lenging financial stability, unless the amount allowed would be limited to
an extent where it could not serve useful transactions purposes. It would
add competitive distortions at the expense of private institutions and
very substantial costs in terms of IT, staff and regulatory compliance. In
addition, piling up large deposits from the general public in central banks
would raise the question if central banks should also engage in central-
ised and perhaps politically motivated lending activities.
New sources of risk
Finally, unfortunately, all the virtues of digital financial services do not
come for free. The system is exposed to vulnerable or unstable equip-
ment, human error and outright crime, such as cyberattacks. These are
serious operational risks, which need to be managed by financial institu-
tions one by one, by authorities and in cooperation.
Of course we passed the point of no return quite a while ago. The use of
cash in this country is rapidly declining and digital payments accounted
for around 80 per cent of retail turnover last year.
Danmarks Nationalbank has initiated a forum for collaboration among
the critical companies in the Danish financial sector - the Financial Sector
Forum for Operational Resilience, FSOR. FSOR has three primary goals:
1. to create an overview of cyberthreats to financial stability,
2. to implement joint measures to ensure financial sector resilience and
3. to set up a framework for collaboration and knowledge-sharing.
Testing is one measure that has proven to be excellent at uncovering
cybersecurity weaknesses. We regularly test cross-sector crisis response
plans to manage serious operational incidents, including cyberattacks.
But we also seek to test the cyberresilience of individual institutions
through so-called Red Team Testing. In a Red Team Test, an external
team is hired to perform a series of coordinated attacks. The target insti-
tution's internal IT security then has to defend the systems to the best of
their abilities.
Once the test is over, the institution's vulnerabilities and its capability to
detect and respond to the attacks are evaluated. A remediation plan is
then put in place to eliminate weaknesses before cybercriminals are able
to take advantage of them.
Thank you for your attention. Enjoy the conference!