Denis Beau: What role should banks play in the twin digital and
climate revolution?
Speech by Mr Denis Beau, First Deputy Governor of the Bank of France, at the conference at the
Jean Monnet University, Saint-Etienne, 15 April 2022.
* * *
Accompanying slides can be found on the Bank of France website.
[SLIDE 1] Students, faculty, ladies and gentlemen,
We now have sufficient distance to say that, if the health crisis unleashed by Covid-19
was not compounded by a financial crisis, this was in part because our prudential
framework has made banks considerably more resilient. The new framework, coupled with
the exceptional support measures introduced by governments and the European Central Bank
(ECB), enabled banks to continue financing businesses during the health crisis. Today, it is
enabling them to cope with the economic and financial impacts linked to the war in Ukraine. That
being said, for this new architecture to be consolidated, the Basel III Accord still needs to be fully
implemented in a manner that is fair, reasonable and definitive.
Yet this strengthened abilities to withstand shocks cyclical crises must not blind us to
more structural vulnerabilities, which the health crisis has helped to amplify, I am thinking
in particular of digitalisation and the transition to a sustainable economy. These two
transformations present banks with a twofold challenge: on the one hand, they are exposed to
and must protect themselves against the intrinsic risks associated with these developments; on
the other, they have to act, because they have a role to play in these transitions, particularly on
the financing side, with government backing.
1. The banking sector and the transition to a digital future and a sustainable economy
The banking sector is currently facing the twin
Let us begin by diagnosing the situation.
challenges represented by the digital and green transition. These have the potential to weaken
banks but also the wider financial system, and could ultimately impact the real economy.
1.1 Vulnerabilities in relation to the digital transition [SLIDE 2]
From blockchain and artificial intelligence to electronic payments, the cloud and big data,
the growing digitalisation of banking and finance represents a multi-faceted evolution
that is changing how banking has traditionally been done. We can pick out three broad
shifts that characterise banking's digital transformation and that are impacting the industry's
business model. First, customers have new expectations in terms of digital services. I am
thinking here in particular of greater accessibility to tools to manage accounts remotely and
obtain remote banking services, faster - even instant - payments, and more flexible customer
relations. As the chart shows, more and more Europeans are using the internet for online
banking, in a clear sign of how the sector is going digital [SLIDE 2]. Customers also have new
product needs. They want customised products that match their own profiles and habits. Some
are showing interest in crypto-assets as investment products. Second, banks are facing
stiffer competition from agile and opportunistic fintechs and bigtechs. These firms follow a
model based on breaking up traditional universal banking activities into a series of distinct core
functions, such as payment routing, finance provision, risk sharing and capital allocation, which
are reassembled on an online platform that acts as a user interface. Bigtechs, in particular, enjoy
numerous comparative advantages, including deep financial resources, a strong brand image, a
global customer base and, critically, preferred access to data that can support the sale of
customised products. This makes them extremely serious competitors for banks. Third, the
intermediation role between borrowers and lenders played by banks is threatened by the
rise of decentralised finance, or DeFi. At this stage, the banking sector's future path could
follow different scenarios, not all of which are equally likely, namely (i) continuation of the
traditional bank intermediation model, (ii) a non-bank financial intermediation model, (iii) a
reintermediation model in which bigtechs and fintechs act as intermediaries for banks, and (iv) a
decentralised model.
Besides changing the business model, digitalisation is increasing banks' exposure to
operational risks that were already present, including cyber risk, naturally, but also third-party
risk linked to the outsourcing of services as well as risk in relation to money laundering and
terrorist financing. Digitalisation is an ambivalent process in that it also offers banks tools to
control these risks. For example, artificial intelligence is a valuable tool in the prevention of money
laundering and terrorist financing, as it can be used to analyse large volumes of data quickly in
order to spot unusual transactions more swiftly.
1.2 Vulnerabilities in relation to the transition to a sustainable economy [SLIDE 3]
The other structural challenge, namely the green transition, exposes banks to a number
of vulnerabilities.
The exposure of banks to climate-related risks is now well established, in part thanks to
work by the Network of Central Banks and Supervisors for Greening the Financial
System, or NGFS. In particular, banks may be exposed to physical risks and transition risks.
Physical risks stem from the rise of extreme weather events such as droughts, flooding and
storms. These events can weaken the businesses and households to which banks are exposed,
potentially generating losses. Transition risks are related to the measures that are taken by public
authorities or the private sector to support the move to a low-carbon production model, which
oblige economic participants to restructure their activities and cause some assets to become
impaired. Coal mines, for instance, are destined to become stranded assets. Since transition
risks materialise over a longer time horizon and are less visible, they are challenging to identify
and model. In addition to climate risk, the financial system is also affected by the risks linked to
ecosystem disruption, such as biodiversity loss.
The quantitative measurement of these risks over time represents a major
challenge. Whereas standards of supervision have traditionally been based on statistical
analyses of historical, backward-looking data, there are few, if any, past climate risk events that
resemble what scientists are predicting for the 21st century. This is why, to borrow an image
from Banque de France Governor François Villeroy de Galhau, the snapshot of risks that I just
provided is being supplemented by a video, as it were, of the long-term risks, created through
forward-looking climate stress tests. In 2020, France's Prudential Supervision and Resolution
Authority, the ACPR, conducted a pilot climate exercise to measure losses by 2050 connected
with the climate transition to net zero by that date. The assessment found that French banks are
"moderately" exposed to climate risk. However, our analysis points to a greater probability of
default for business loans in the event of a disorderly transition, albeit with variations across
sectors, calling for us to work together to organise the financial system's climate
transition [SLIDE 3]. The ECB, meanwhile, is assessing banks' resilience to climate-related risk
at the level of the euro area for the first time through a climate stress test that kicked off in late
January. The findings are to be published in July. The ECB also recently conducted
supplementary work. After assessing reporting requirements, it found that, overall, European
banks have significant room for improvement if they are to meet in full its expectations on climate
and environmental risk disclosures. French banks have a head start in this regard, owing to the
statutory disclosure requirements applicable to institutional investors since 2015 and the ongoing
dialogue in recent years with the ACPR, notably aimed at measuring action on climate
commitments.
1.3 These vulnerabilities are a source of risk for financial stability [SLIDE 4]
The vulnerabilities that I have just outlined could affect financial stability. If the public
and private responses to these structural developments fall short, banks could be
weakened, which in turn could adversely impact the real economy.
competition from new intermediaries, such as fintechs,
In terms of the digital transition,
bigtechs and DeFi players, along with the rise of private digital assets like stablecoins and
cryptoassets could (i) lead to fragmentation of financial and payment services, making them less safe
and efficient, and (ii) cause banks to be crowded out of the value chain by the "platformisation" of
financial services. DeFi especially is seeing pronounced growth, although the amounts in play
remain small in absolute terms, as the chart illustrates [SLIDE 4]. Moreover, these new
participants and products are not currently subject to regulations and supervision comparable to
those applicable to banks. This situation could eventually impact financial stability, notably if it is
accompanied by decreased regulation of critical financial and payment services providers and a
reduction in the security associated with regulation.
As regards the challenge of moving to a more sustainable economy, the financial sector
and the wider economy could be hurt by an inadequate or delayed response to the accelerated
transition to a carbon-neutral economy. Allow me to illustrate my point with an example: the
Banque de France conducted simulations based on macrofinancial scenarios prepared by the
NGFS, which found that a delayed and disorderly transition would be far more damaging, costing
up to 5.5% of French GDP by 2050.
Given their lynchpin role in financing the economy, banks must continue to be resilient
amid the twin transition. This is especially necessary in Europe where, unlike in the UK and US
economies for example, bank loans are the main source of financing, accounting for
approximately 70% of financing for euro area businesses, compared with around 40% in the
United States. In saying this, I do not want to give the impression that banks are alone in
providing financing to the economy. On the contrary, they need to harness the complementarities
offered by market financing. The digital and green transition that lie ahead will require huge
investment but also, and most importantly, innovation. On this front, the European Union (EU)
lags Asia and the United States. Take the example of research and development (R&D)
spending: in 2018, total public and private R&D expenditures in the EU were equivalent to 2.2% of
GDP, compared with 4.5% for South Korea and 2.8% in the United States. However, the
European Union holds a trump card as it boasts the world's largest pool of savings, with the
annual surplus of domestic savings over investment regularly exceeding EUR 300 billion. For this
reason, we see a critical need to foster equity financing, as it is ideally suited to innovative
projects, which entail higher risk-taking. This is also why, on a broader note, we support
implementation of the Capital Markets Union which, through a series of technical
[SLIDE 5],
reforms, will enable Europe's plentiful savings reserves to be allocated efficiently to companies
through market financing. Efforts to strengthen the Capital Markets Union must be conducted in
concert with steps to deepen the Banking Union, which remains an absolute priority. These two
initiatives are crucial to the continued financial integration of the EU and will ultimately pave the
way for investment and innovation to be funded more effectively.
That is the diagnosis that I wanted to share: the twin transition to a digital future and a
sustainable economy has the potential to weaken not only banks, but also financial stability and
the real economy. Yet this is merely a diagnosis, not a prognosis. This same risk could also be a
source of beneficial changes.
2. The banking sector: a participant in the digital and green transition
And so I come to what could and should be done to turn these challenges into
opportunities. I will talk about three courses of action. First, the regulatory response that will
enable the operating framework for finance and payments to adapt to the new challenges.
Second, the adjustments that banks must make. Third, initiatives by the Banque de France to
lead by example and support participants as they engage in the necessary transformations.
2.1 The regulatory responses to these challenges seek to ensure that risks are better
controlled and to create a change-friendly framework [SLIDE 6]
For starters, let's talk about the regulatory responses being initiated by lawmakers
alongside regulatory and supervisory authorities.
In terms of the digital transition, the regulations are intended to nurture innovation while
ensuring that it is subject to the "same activities, same risks, same rules" principle. In the
case of DeFi, this principle is applied via a square of guarantees designed to
ensure equal security, compliance, responsibility and accessibility relative to the situation for
traditional financial services. [SLIDE 6]
Accordingly, the Banque de France supports the adoption of several key pieces of legislation that
are currently being discussed by the European Parliament and the Council. First, the draft Digital
Operational Resilience Act (DORA) is set to improve the financial sector's digital operational
resilience by harmonising the applicable requirements and by making certain critical IT services
providers, including cloud services providers, subject to direct regulation. Second, in 2020, the
European Commission presented a proposal for a Markets in Crypto-Assets (MiCA) regulation
that we hope to see adopted during France's presidency of the EU Council. These two pieces of
legislation will usefully supplement the Second Payment Services Directive adopted in 2015,
which paved the way for the creation of payment institutions, i.e. regulated entities that do not
have to be registered as credit institutions.
As you are well aware, however, the challenges linked to better regulation of digital
finance are not confined to Europe. Globally, several major initiatives are under
way. Because of time constraints, I will mention only two. First, the Financial Action Task Force,
an intergovernmental body that works to prevent money laundering and terrorist financing,
recently extended the scope of transfer transparency requirements, also known as the "travel
rule", to include virtual assets. Second, the Basel Committee on Banking Supervision is currently
doing work on the question of setting prudential requirements for banks' crypto-asset holdings.
In a fast-changing world, there are a number of issues that regulatory authorities have
yet to get to grips with. For example, we need to develop an adequate approach to regulate
bigtech activity in finance.
I would now like to talk about regulatory responses in the area of sustainable finance.
A major step forward was taken with the
The EU leads the field in this regard [SLIDE 6].
adoption on 18 June 2020 of the European Taxonomy Regulation, which seeks to promote
sustainable investment through a common classification of economic activities (not of financing
or businesses). Furthermore, several European reforms currently under discussion have the
same end goal of increasing transparency and data disclosure in order to improve market
discipline and ensure that capital is allocated more efficiently. Thus, the Corporate Sustainability
Reporting Directive (CSRD) will require large companies to publicly report on the alignment of
their activities with the taxonomy from 2024 onwards. Likewise, we hope that a European
regulation establishing a label for green bonds (EuGB) will be adopted by next summer. This
voluntary label is expected to have stringent requirements, which will help to build confidence:
proceeds from the bonds will go towards funding activities designed to achieve six environmental
goals; ex ante and ex post transparency requirements will make it possible to assess the
environmental impact of the funds raised; and most importantly of all, an external reviewer must
check that bond issues are compliant with environmental requirements. This reviewer must be a
legal person that is registered with the European Securities and Markets Authority and, as such,
subject to supervision modelled on that of credit rating agencies.
In addition, the proposed CRD6 Directive provides supervisors with new means to
through the
integrate environmental, social and governance (ESG) risks in supervision,
harmonised development of stress testing methodologies. The European Banking Authority
(EBA) has also been tasked with exploring the question of including ESG risks in regulatory
requirements, although persistent conceptual difficulties make calibrating these tools a tricky
business.
2.2 Banks are adapting to the digital and green transition [SLIDE 7]
Beyond the regulatory response, banks themselves will be in charge of another course of action:
far from being merely a source of risk, the digital and green transition offers growth
opportunities for the banking sector, which has already found ways to adapt.
Efforts to adapt to the digital challenge are already under way, as illustrated by three
examples. First, the ACPR study on the digital transformation of the banking sector published in
January, shows the wide array of initiatives taken. Strategies aimed at acquiring fintechs or
developing partnerships with them point to the emergence of a new rationale of "coopetition".
This kind of cooperation by competitors is proof that banks and fintechs can grow together and
that the digital transition can be a boon for all participants. Next, banks are increasingly
harnessing new technologies. Artificial intelligence, as I mentioned earlier, is being built into new
operational systems, where it is helping to improve aspects ranging from customer relations to
risk management. Banks are also experimenting with blockchain technologies. And they are
collaborating on an initiative that has our strong backing: the European Payment Initiative, more
widely referred to as EPI, seeks to provide Europeans with an everyday payment solution that
combines card and mobile components and addresses all use cases.
Banks are also adapting to ensure the transition to a sustainable economy. For example,
they are making public commitments in different areas that can have a positive impact in terms
of mitigating and adapting to climate change, such as their carbon footprint, fossil fuel exit
strategies, shareholder engagement and greenhouse gas emissions reductions. The ACPR and
France's securities regulator, the AMF, which have been monitoring these commitments for the
last two years, stress that significant headway has been accomplished in a short time, but also
warn that progress still needs to be made if banks are to communicate more clearly and
transparently about their objectives and especially about the means of action likely to ensure that
these collective commitments are kept. Banks could also contribute to the transition to a
sustainable economy by playing their part in the emerging green bonds market. This market
doubled in size in 2021 to reach EUR 460 billion globally, of which half is denominated in euros
[SLIDE 7]. But it still has lots of room to grow, judging by the fact that green bonds made up a
mere 0.4% of the total volume of bonds issued during the same year worldwide and 2.6% in
Europe. In this setting, the new label will help to support a fast-growing market while also
preventing greenwashing risks.
2.3 Central banks are also helping to steer these transformations as they lead by example
[SLIDE 8]
To conclude, I would like to say a few words about what we at the central bank are doing. I will
offer two illustrations for each challenge.
Central banks are playing an active role in digital innovation. To support innovation while
safeguarding the vital anchoring role of central bank money, the Banque de France is exploring
the question of issuing a central bank digital currency, or CBDC. We carried out nine trials
between September 2020 and December 2021 on the issuance of a "wholesale" or interbank
CBDC, acting in partnership with a diverse line-up of participants, including commercial banks.
These trials showed that a CBDC could significantly improve cross-border payments and
interbank processes, such as securities settlement, more generally. On the question of a retail
digital euro, the Banque de France is making a full contribution to efforts by the Eurosystem,
which, following preliminary work, began an investigation phase on 14 July 2021 aimed at
analysing the pros and cons of such a currency. A final decision on whether to launch a digital
euro will be taken in the final quarter of 2023 To preserve the strong complementarity
[SLIDE 8].
between central bank money and commercial bank money that lies at the heart of our monetary
system, the intermediation role of banks must be maintained and banks must be fully involved in
this project. A CBDC will be created with banks, not in opposition to or in spite of them.
On the climate front, the ECB has adopted an ambitious action plan [SLIDE 8] to which
the Banque de France made a decisive contribution. Running through to 2024, the plan
aims to integrate climate-related risk into the ECB's monetary policy strategy, not just in
asset purchases but also in the framework governing the collateral eligible for central bank
refinancing. Central banks themselves also have a role to play in steering investment flows
towards the green transition, in particular by greening their own funds. The Banque de France
was the first Eurosystem central bank to adopt and implement a Responsible Investment
Charter, which it did in 2018 for its own funds portfolios. It aims to limit the exposure of its assets
to climate-related risk while also taking account of the impact of its investments on the
environment, in keeping with the double materiality principle promoted by the EU.
In conclusion, there is certainly no shortage of challenges for banks. However, I hope I have
shown that these challenges are also opportunities. Accordingly, we should neither overstate nor
underestimate their significance. Thank you for your attention.