Remarks by Francois Groepe,
Deputy Governor of the South African Reserve Bank,
at the Finovate Conference
The Westin Cape Town, Cape Town
27 November 2018
Fintech: reflections on the phenomenon and its future potential
Good afternoon, ladies and gentlemen.
There is no doubt that we are facing a period of rapid technological advancement and
innovative disruption, not least in the area of financial services, with financial
technology (fintech) likely to disrupt and redefine both payments and banking value
chains.
Given these rapid advancements of fintech, I would like to focus my remarks on two
areas.
The first is an appraisal, from a central banking perspective, on the fintech
phenomenon, given that we as the South African Reserve Bank (SARB) have been
closely observing what has been happening in this space.
Second, I would like to reflect on fintech's potential to advance our South African
migration towards a digital economy by reviewing some select examples from a few
countries. I firmly believe that fintech has the potential to meaningfully contribute to
the growth of our economy.
Fintech: 10 years on
It has been 10 years since Satoshi Nakomoto published his famous paper titled
'Bitcoin: a peer-to-peer electronic cash system'. The paper was both timely and ironic,
in that we had just begun to experience the impact and unintended consequences of
innovation in financial services that had largely escaped the regulatory radar.
Over-the-counter derivatives such as credit default swaps exposed the impact of the
types of innovation where there are information asymmetries, misaligned incentives
and opportunistic behaviour, highlighting what can go wrong systemically when
financial engineering and innovation is not subjected to appropriate regulatory
oversight.
The results included failure by lenders to robustly assess whether borrowers had the
ability to meet their obligations. Furthermore, risk transfer through the so-called
originate-to-distribute models resulted in severe consequences, amplified by the
interconnectedness of our financial system. Yet, the solutions that are so often touted
by proponents of an alternative to the 'traditional' financial system suggest that
peer-to-peer exchange largely outside of the regulatory purview is the way to prevent
future financial crises.
So, what have we observed as central bankers as we critically reflect on what's
happened over the last decade? And how can these insights assist us as we move
towards an efficient and safe digital economy?
The three defining fintech trends: teaming up, new threats, and trials by central
banks
I have three observations from the perspective of central bankers related to fintech
trends. I position these as 'the 3 Ts': teaming up among authorities, the new threats
trials
arising from fintech, and lastly by central banks.
Teaming up
First, the fintech phenomenon has brought central banking and the larger regulatory
community closer in working together on analysing and appraising new innovations.
We have a long history of working together. This collaboration is strengthened as a
result of the nature of the technology-inspired innovations not bound by physical
topographies. This is the age of platforms. These can be centralised, as in the case of
online peer-to-peer lending or some mobile payment platforms. Platforms can also be
decentralised and distributed, as in the case of crypto-assets and initial coin offerings.
They can scale with ease using technology such as cloud-computing, and adoption
across geographies can happen rapidly. Some can on-board customers due to their
digital on-boarding in a matter of minutes. Download an app, upload your payment
details, and you could be hailing a taxi anywhere in the world.
Collaborating and working together to understand the impact of innovations that can
scale services across borders is important to ensure that there are harmonised
approaches and that a regulatory 'race to the bottom' is prevented. This collaboration
by central bankers through bodies such as the Bank for International Settlements
(BIS), the Financial Stability Board, the International Monetary Fund (IMF) and the
World Bank has produced significant analysis in the fields of crypto-tokens,
central-bank-issued digital currencies (CBDCs), artificial intelligence and distributed
ledger technologies, to name a few. There have also been contributions on fintech
more broadly, raising awareness of the fact that fintech is not just crypto-assets. Such
work has also drawn out both the monetary policy and the financial stability
implications of fintech innovation and the issues that merit regulatory attention.
So, as central banks, we have not been sitting idle in the face of these technological
advancements. Whereas in the past regulators often played catch-up, this time around
it is noticeable that regulators have adopted a far more collaborative and proactive
approach. We see partnerships like Project Stella between the Bank of Japan and the
European Central Bank exploring the impact of distributed ledgers. Just recently, the
Bank of Canada, the Monetary Authority of Singapore and the Bank of England
released a report on alternative models that could enhance cross-border payments
and settlements.1 This teaming up and collaboration will stand us collectively in good
stead as robust analysis is conducted on complex issues, not least due to the
cross-border implications of many of these developments.
In South Africa, a FinTech Unit has been established within the SARB. National
Treasury, along with the SARB, the Financial Sector Conduct Authority and the
Financial Intelligence Centre (FIC), have jointly established an Intergovernmental
Fintech Working Group. These are evidence of the importance being attached to
staying close to and leveraging the fintech phenomenon.
And this will continue to happen in a responsible and proactive manner. We will
continue to strive to keep abreast of fintech developments and endeavour to apply a
balanced analysis to the fintech phenomenon, thus contributing towards a conducive
environment in which fintech, regtech and suptech can thrive in support of our
country's progress and economic development for the benefit of all South Africans.
New threats
My second observation is that it has become clear to central bankers that the fintech
phenomenon is not a passing fad and that it does hold significant transformational
potential.
However, while there may be benefits, new risks may also manifest. On the positive
side, fintech firms are often obsessed with being customer-centric, focusing on the
needs and pains of the customer, and providing simplified, convenient, on-demand
digital services. As has been noted by Professors Chuen and Teo, given their
'legacy-free and asset-lite' operating models, fintech firms can innovate speedily
through agile approaches.2 And while there are inefficiencies in any financial service
value chain, fintech firms can address these by applying exponential technologies and
finding new and innovative ways of providing services.
On the other hand, new threats can be introduced through fintech-inspired innovations.
Loans can be issued in a matter of minutes using, for example, new scoring techniques
by fintech platforms. They leverage social media and apply new techniques such as
network analysis, sentiment analysis and natural language processing to unstructured
data sources to assess default risks differently.
However, in applying new artificial intelligence and machine-learning techniques,
concerns arise about the reliability, validity and transparency of the decision-making
process. What goes on inside the so-called 'black box' of new computational learning
algorithms? We have all heard about the significant failures of Internet finance
companies such as Ezubao in China. Ezubao had been set up as an online
peer-to-peer lending scheme in July 2014. It attracted funds of about 50 billion yuan
(US$7.6 billion) from 900 000 investors. It ceased to trade in December 2015, just a
year and a half later.3 We have to be vigilant of the new threats that may arise as a
result of the application of novel technologies.
Turning to other innovations such as crypto-assets, there are numerous examples
over the last few years of exchanges being hacked and invested funds being lost. As
has been reported to the Japanese regulator, 5 966 bitcoins were stolen and hackers
managed to steal 5 billion yen (about US$44.5 million) of crypto-tokens.4 We have
recently seen increased attention by South Korean and Japanese regulators to this
domain as a result of these ever-increasing cyber-incidents. With initial coin offerings,
the lack of clarity and transparency, with numerous White Papers attempting to raise
funds quickly through token sales, is another area of concern.
So while these new business models may bring benefits, their longevity may be
challenged if financial, business and/or operational risks materialise. The provision of
financial services is a heavily regulated industry. The main reason for this is not just
the protection of consumers. As services and systems evolve and become more
interconnected, the spillover effects of risks to the financial sector and ultimately to the
real economy increase. We've seen these contagion issues during the global financial
crisis. I would therefore encourage that our assessment of both the potential and the
new risks be both honest and realistic. And while innovators put forth the benefits of
their innovations, let's engage in a truthful and sober reflection on the familiar and new
threats being introduced.
Trials by central banks
My third observation is that central banks are not immune to the impact of fintech. Our
role as operator or provider of particular services, as well as how we conduct our
supervisory roles, will be affected by the advancement of exponential technologies.
On the provision of services, such as a platform for high-value payments typically
processed through a real-time gross settlement system, we have seen waves of
experimentation by central banks. Projects such as Jasper in Canada, Ubin in
Singapore, and our own Project Khokha have been initiated to understand the impact
of new technologies on such service provision. Some of these projects are in their third
phase, trialling securities and cross-border payments on a blockchain. Other central
banks, such as the Swedish Riksbank and the Bank of Uruguay, have already
experimented with CBDCs, or are considering a more retail-focused or
general-purpose CBDC.
Of course, as each of these central banks has noted, the issues are much broader
than just technological considerations. The policy considerations are weighty. As the
BIS has indicated, careful consideration needs to be given to the impact on financial
intermediation and financial stability, and to the unintended consequences of such
solutions.
To stay on the front foot, so to speak, the SARB is considering hosting a focused
workshop on CBDCs in the coming year. We aim to attract the world's leading thinkers
on the topic to inform our own policy thinking on CBDCs. Also, several stakeholders
are enquiring about Project Khokha's Phase 2, and many have submitted suggestions.
We are giving careful consideration to all of this, and hope to make a definitive
announcement early next year.
Conclusion: the fintech potential going forward (digitally)
To conclude, I'd like to share a few thoughts on the potential of fintech, looking forward.
The emergence of fintech, the Fourth Industrial Revolution and the continuing shift
from an industrial to a digital economy affords us, as a country, the opportunity to
leverage these innovations towards lifting the growth potential of our economy. There
are anecdotal estimates that such efforts could contribute 0.5 - 1.5% to gross domestic
product (GDP).
Digitisation, for example, has reshaped financial services in countries such as China,
Estonia and Singapore. Less than a decade ago, the Chinese e-commerce retail
transaction value accounted for less than 1% of the global value. This figure has risen
to nearly 40% today and, in 2016, mobile payments for goods and services in China
totalled US$790 billion - 11 times more than in the United States. Research by the
IMF shows that a 1 percentage point growth in the digitisation of China's economy is
associated with a 0.3 percentage point growth in its GDP.
Estonia is a small country, with minimal natural resources, but it is leading the charge
in embracing digital enablers across various sectors. An astounding 99% of Estonian
companies are established online, reducing the time it takes to establish a business
from 5 days to 18 minutes. In Estonia, 97% of healthcare patients have country-wide
accessible digital records, with 99% of all prescriptions issued digitally. At least 2% of
Estonia's GDP is saved due to the collective use of digital signatures.
In Singapore, citizens have the ability to store their basic identification such as their
unique identification number, name, gender, age etc. electronically on a one-stop data
repository known as MyInfo. This enables faster completion of online information
requirements such as e-Government or banking services.
The examples from China, Estonia and Singapore demonstrate the potential of
technological innovation and fintech. If South Africa had to adopt a similar technology,
it could be used to administer social grants and could potentially result in significant
cost savings. A further application could see the simplification and streamlining of
compliance with the FIC Act.
As the SARB, we have kept a close eye on fintech developments as we appreciate
the developmental potential they hold. There is, for example, sufficient evidence to
suggest that the pursuance of common infrastructure such as digital identity platforms,
or basic citizen demographics being housed digitally (such as MyInfo in Singapore),
can promote progress towards electronic transactions and financial inclusion.
In India, their unified payments interface allows one to make payments simply by
knowing a person's unique yet simple proxy address.5
All these capabilities have demonstrated that digital authentication platforms form the
foundation for other financial services. In moving towards a digital economy, identifying
new threats, including cyberspace threats, becomes increasingly important. This is
why two-factor authentication is mandatory in many jurisdictions for transactions
performed online, as is the case for transactions in South Africa. A national digital
identity platform enables multi-factor authentication and reduces the cost for each
provider doing so on their own.
In closing, fintech holds great potential which can meaningfully lift the growth potential
of our economy and significantly improve efficiencies. To nurture this technology, we
would, however, need to be alive to the new threats that it may introduce. Hence, we
need to team up and collaborate, especially given the cross-border implications of
many of these services.
Furthermore, as the SARB, we are committed to ensuring that we make a concerted
effort to understand technological changes in an effort to regulate smartly. We will
continue to conduct further trials. We will also continue to create an ever more enabling
environment by creating innovation facilitators.
As a central bank, we are therefore committed to contributing and being part of this
journey towards a more inclusive and digitally enabled economy while ensuring that
financial stability is maintained.
Thank you.