Denis Beau: Digital finance, market disruption, and financial
stability
Speech by Mr Denis Beau, First Deputy Governor of the Bank of France, at the Bank of France
Toulouse School of Economics joint conference, Paris, 12 November 2018.
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Ladies and Gentlemen,
I am very pleased to welcome you all today, for the tenth edition of the Banque de France and
Toulouse School of Economics joint conference. This year, we have decided to shed light on
how digital-based financial innovations are affecting the robustness and efficiency of the financial
system.
It is a good time to talk about digital finance and market disruption for at least two reasons:
- 2018 is both the 10th anniversary of the Lehman bankruptcy and that of Nakamoto's paper
underlying Bitcoin.
- those events have unleashed regulatory and market developments and innovations that should
contribute to both strengthen and change the role and structure of financial intermediation.
As a result, we see a complex set of interactions, involving competition and cooperation, which
are developing between "old" and "new" players and which are likely to coexist in the
intermediation space going forward.
"What does that mean in terms of financial stability?" and "how does this coexistence affect
central banking?" are two questions open for discussion at today's conference. But for the time
being, let me quickly follow two leads.
I. Promises of digital finance: redefining financial intermediation?
First point: The digitalization of finance is prospering on the ground of cutting-edge technologies.
The combination of big data analytics, cloud computing, artificial intelligence and blockchain is
transforming the way financial products are designed and distributed. For its proponents, this
transformation is promising better consumer experiences, a better financing of the economy and
a better efficiency of the financial system.
Beyond those promises, cutting-edge technologies also lower the barriers to entry into
and make it possible to unbundle financial services into an
the financial sector for Tech firms
array of distinct core functions such as channeling payments and money, providing financing,
sharing risk and allocating capital.
This new competition also implies that incumbents' business model should be prepared
the unbundling of services will challenge business models built around the logic of an
to adapt:
exclusive and comprehensive customer relationship possibly involving elements of cross
subsidization; more mobile customers could limit the ability to cross-sell products; and higher
deposit volatility may unbalance the funding of maturity transformation.
That said, FinTechs are the talk of the town but BigTechs are the real deal.
On the one hand, frankly, FinTechs already had a huge and positive impact on the financial
sector by developing new solutions and proving that these solutions bring value.
However, overall, with a market capitalization of $125 bn worldwide, Fintech start-ups have been
so far more a complement to existing financial actors, through integration or partnership, than
irresistible rivals to incumbents.
On the other hand, the market capitalization of the GAFA - Google, Amazon, Facebook, Apple -
is 25 times higher than that of the whole FinTech universe. The BigTechs already have a material
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footprint in financial services and competitive advantages to expand their activities further in this
area.
On top of massive financial resources able to support investment at scale and an undeniable
digital agility, they benefit from strong brand recognition, worldwide customer base on which they
have accumulated proprietary database and privileged access to forefront technologies.
In that context, BigTechs more than FinTechs have the potential to fundamentally
redefine financial intermediation beyond the universal banking model toward integrating
financial services within a universal ecosystem.
Such a move is already gaining considerable traction in China. And it is raising very fundamental
questions to which I will come back.
To conclude my first point, digital finance may not lead to a more decentralized system as the
centripetal forces of network effects may profit most to large conglomerates. Rather than
eliminating intermediation, if left on its own, digital finance will more likely lead to
reshuffling the cards with the most digitally agile incumbents and the most financially
able challengers becoming the new dominant (and potentially systemic) intermediaries.
II. A common challenge: Rethinking old issues, investigating new ones
This leads me to my second point. The digitalization of finance forces us to revisit old regulatory
and supervisory questions and to face new ones.
Among old issues to revisit, I would like to highlight two of them.
First, the question of the financial regulation perimeter. Consider for instance ICOs and
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crypto-assets: even though they don't bring something new in terms of types of risks , the
existing regulatory framework may be inadequate to address the challenges they raise. The
classification of tokens into existing legal categories proves very challenging and the
internetbased crypto-intermediary activities facilitate regulatory arbitrage.
The same issue applies to 3rd party dependency risk. Just to pick an example, cloud computing
market is highly concentrated and Amazon Web Services has built a dominant position. As the
core financial functions lift and shift to the cloud, the risk of a single point of failure will emerge,
but yet, cloud providers are unregulated and to a large extent out of the reach of supervisors.
Second, the question of conduct. Our regulation embeds a judgment of things that are
acceptable and some that are not. Technological developments are making it possible to use
information that was previously out of reach of a financial intermediary. This would potentially
allow a more accurate assessment of risk or a more "responsive" pricing of service. But what is
possible may not be (socially) acceptable - to take one example, the current development of
"social network informed credit scores" raises privacy concerns. In that context, the regulator (in
some cases, the legislator) could have to revisit its stance on conduct issues.
Let me now turn to new risks which are non-financial in nature but highly intertwined with the
digitalization of finance. Two in particular merit scrutiny.
First, the question of If incumbents depend on
strategic independence of incumbents.
BigTechs for key infrastructure such as cloud computing, if they rely on the same BigTech to
distribute their products through their platforms and then compete with BigTechs on certain
segments, they see their strategic independence challenged in the same way as hotels and
retailers did. This process of commoditization of incumbents may lower credit standards to
compensate for higher pressure on margin and exacerbate the funding gap because of lower
customer stickiness.
Second, With greater interconnections between technologies and
the question of cyber-risk.
the financial system, cyber-risk is moving from an idiosyncratic risk to a potential source of
systemic risk.
Whether and how to address the type of issues I just mentioned is a challenging task
from a regulatory and supervisory standpoint, as it involves an assessment of both the potential
risks and benefits brought to the financial system and the economy more largely, which are by
nature uncertain. It may give rise to a significant array of alternative courses of actions to
meet two key imperatives: ensure an adequate level of protection for participants and
preserve the potential benefits brought by innovation.
Let me illustrate this with crypto-assets. Because of incomplete information, a lack of data and
the novelty of these monetary and financial objects, four options to tackle them from a public
policy standpoint can be considered and have actually been under consideration to drive action:
monitoring, isolating, regulating or banning.
Vibrant economic research is needed to help us dealing with these challenges, notably in three
key areas.
The first relates to the economics and implications of blockchain and crypto-assets, and will be
the topic of David Andolfatto's keynote lecture and of the concluding panel discussion: What are
the implications for the financial system in general, and for central banks in particular? Will
Central banks' monetary policy become less effective and, if so, are Central Bank Digital
Currencies a way to restore their effectiveness?
The second one, which will be addressed by several research papers today, relates to the
financing of the economy: Do alternative and innovative ways to finance the economy
(marketplace lending, ICOs, alternative scoring models) perform better than traditional financial
intermediation without increasing the risks? What roles can incumbent banks play if financial
services are to be driven by data?
The third one is not on the agenda for today's conference, but should be on the research agenda,
relates to the use of artificial intelligence in finance: What would be the dynamics of financial
markets if most participants were to rely on AI and machine learning techniques? How should
regulation and supervision practices adapt to ensure that AI behaves in accordance with a
financial and social optimum?
Conclusion
I would like to conclude my intervention by quoting Bill Gates himself: "We always overestimate
the change that will occur in the next two years and underestimate the change that will occur in
the next ten. Don't let yourself be lulled into inaction".
The Banque de France tries to follow this piece of advice. To do so, we have adapted our
organization and our governance structure with the creation of a Fintech hub within our
supervisory function (which has already supported more than 300 FinTechs), the appointment of
a Chief Digital Officer and the launch of a Lab to foster innovation within the Banque itself. We
are experimenting with new technologies: the Banque de France has been the first central bank
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to implement a fully-fledged project based on DLT which is now fully operational and we have
successfully ran 8 artificial intelligence projects. We are also hosting discussions between
regulators and the industry: the latest working group on artificial intelligence will deliver its
conclusion by end of this year. Finally, as we are doing with today's conference, we are seeking
insights from economic research and trying to be a platform for open debate.
I wish you fruitful discussions, and now give the floor to David Andolfatto, Vice President at the
Federal Reserve of Saint-Louis, for his keynote lecture.
1
Exemples: Ant Financial (Alibaba Group's financial services), Tencent, Amazon, Apple, Facebook. See Ztezsche,
Buckley, Arner, Barberis 2017, "From FinTech to TechFin : The regulatory challenges of data-driven finance"
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E.g.: financial conduct, price manipulation, market integrity risks or money-laundering.
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Madre