SPEECH
SVERIGES RIKSBANK
DATE:
4 June 2018
SE-103 37 Stockholm
SPEAKER: (Brunkebergstorg 11)
Stefan Ingves
VENUE:
Stockholm School of Economics
Tel +46 8 787 00 00
Fax +46 8 21 05 31
registratorn@riksbank.se
www.riksbank.se
Money and payments - where are we
heading?
Today, I am going to talk about money. This is a subject that concerns us all -
most of us use money practically every day. But we probably don't give much
thought to how important it is that our daily purchases can be carried out
smoothly. It's more or less the same as not giving so much thought to your health
as long as you're healthy. But once you get sick, it becomes almost the only thing
you can think about. Our system for payments is similar; as long as it works
securely and efficiently, we don't think about it. And, to continue the analogy: It is
the Riksbank's task to ensure that the payment system remains healthy and
contributes to a well-functioning society.
Right now, we, at the Riksbank, are devoting a lot of time to issues regarding
payments and the payment system. The background to this is formed by the rapid
changes on the payment market and the rapid decrease in cash usage in Sweden -
a development that we are practically alone in, worldwide. Only a few other
countries are undergoing a similar, albeit less dramatic, development.1 This means that
we have to take the lead and prepare for the new situation faster than other
countries.
If this development continues without the Riksbank taking action, we risk finding
ourselves in a situation in which the payment market is completely dominated by
private players with no public alternative. Incorrectly handled, this could lead to
monopoly situations, which are difficult to manage, and socio-economic
inefficiency.
When we talk about money, it can be helpful to bear in mind that it was our need
for a well-functioning payment system that led, once upon a time, to the
formation of the Riksbank and other central banks and that explains why we still
have the tasks we do, namely safeguarding price stability and promoting an
efficient and safe payment system. Today, I shall explain why I think it is important
that central government - in the form of the central bank - also continues to play
an active role on the payment market in the future.
What is money and what is required for it to function?
When the human race moved from subsistence to conducting trade, the need for
some kind of instrument of payment soon arose. Barter is inefficient, as it is not
easy to find a counterpart who not only wants the goods or services you can offer
but is also willing to give you what you want in exchange. Possibilities for trade
are thereby highly restricted.2 This problem has been solved by various cultures
around the world with the use of various forms of money. For example, some
island cultures used seashells as money.
History tells us that money can be absolutely anything that a group of people in a
region have decided will act as money. It is, quite simply, a social convention,
more or less in the same way as an alphabet is an agreement over how a language
should be written.3 Money works, therefore, because everybody accepts the
convention.
So which conditions need to be met for the convention of money to be accepted
by everybody? Many people have pondered this question over the ages, leading
to a definition of money that goes all the way back to Aristotle.4 Put simply, it
could be said that the conditions are met when you can trust that you will be able
to pay with money to purchase what you want and that money's value or
purchasing power will not be undermined if you want to use it later on. It involves all
prices being expressed in the same unit, usually called a unit of value, in exactly
the same way as we need a standardised way of measuring distance. Money also
has to have a stable value (money must be a "store of value"), as this makes it
possible to postpone consumption. It also needs to be accepted by everybody. It
must be easily accessible and easy to use (it must act as a general means of
payment).
For a long time, the most common form of money was coinage issued on royal
authority, with its value being determined by its metal content. In Sweden, the
copper standard was introduced at the start of the 17th century, in addition to the
silver and gold standards that already existed.5 But handling the copper coins
proved to be clumsy, which contributed towards King Charles X Gustav granting
permission, in 1656, for the formation of Sweden's first bank, Stockholms Banco,
which was allowed to accept coins in exchange for promissory notes. These
promissory notes soon started to be used as money, as they were much easier to carry
than several kilos of metal. This is how Europe's first modern paper money to use
printing technology came to be. Unfortunately, the bank issued more money than
it had cover for, leading to bankruptcy. But the need for a bank remained and, a
few years later, the Riksbank was founded and was eventually able to issue
banknotes on behalf of the government under more controlled forms.6
However, it was not just the government that was allowed to issue banknotes at
that time. For example, in Sweden, private banks were allowed to issue their own
banknotes into the 20th century. The Riksbank did not gain a monopoly on issuing
money in the form of banknotes and coins until 1904. The problem with the
private issue of banknotes was the risk of the bank issuing the money entering
bankruptcy, in which case this money could fall in value. In the United States and
United Kingdom, it happened that banknotes issued by private banks were traded
at a lower value than was printed on them. The advantage of government issue is
that government banknotes are usually considered to be completely safe. This is
the main reason why the government, via the central bank, is granted a monopoly
on issuing banknotes. Quite simply, it has turned out to be easier for central
banks, which are run in the national interest, by what is also best for society in the
long term, to build the required confidence than it is for private companies that
have profit motives.
Substantial costs arise if confidence in the value of money disappears
Right up until modern times, the value of banknotes and coins was linked to the
value of a precious metal, such as silver or gold. But this link could be problematic
as it meant that the supply of money was determined by access to precious
metals and not by activity in the economy.7 When production increased at the same
time as the money supply was fixed, deflationary pressures arose. The
bestknown example of this is the depression of the 1930s, when the restrictions under
the gold standard led to serious deflation. Research has revealed the existence of
a relationship between how quickly a land chose to abandon the gold standard
and how quickly its economy started to recover.8
The decision to restrict the issue of money in this way, despite the disadvantages,
had, of course, to do with the strong temptation to issue too much money.9 And,
as we all know, this results in their value being undermined due to high inflation.
There are many historical examples showing what happens when central
government mismanages its assignment in this area. For example, we have the
hyperinflation in Germany in the 1920s, which led to an economic collapse and political
instability.10 More recent examples include Zimbabwe in 2008 and Venezuela
today. What history clearly shows is that when the citizens of a country lose
confidence in the value of money, this also has major negative effects on the real
economy. When nobody knows how to price goods and services, the risks become too
large and economic activity comes to a halt.
The importance of confidence for payments and the payment system was, as I
mentioned earlier, what actually led to the creation of central banks, and it
explains why central banks around the world have a mandate to "promote a safe
and efficient payment system" or the like. But other parts of the central bank's
mandate also originate from the need for a well-functioning system for payments:
monetary policy ensures that money (the means of payment) keeps its value, and
financial stability means that payments and the financial system function.
Together, this contributes towards confidence in the monetary system being
maintained.
More account-based money in the 20th century
The payment market has constantly developed. At some point in the second half
of the 20th century, the general public started increasingly to use funds from bank
accounts to pay in transactions where cash was not considered appropriate, for
example for paying at a distance. Initially, these payments consisted of cheques
and paper-based giro payments from account to account. In the 1920s, a system
for giro payments was created in Sweden in the form of Postgirot. Later on,
payment instruments issued by the private banks took ever greater market shares
and the use of cash has declined steadily since the 1950s as a proportion of GDP.
During the 1990s, electronic alternatives such as card payments also gradually
started to replace cash for purchases in shops.
Money is now electronic and is created by banks
When we talk about money, many people probably envisage a banknote in one
currency or another. But in today's digital society, cash forms a very small part of
the total amount of money, only about 2 per cent.11 The overwhelming majority is
completely electronic.
Neither is it the case that the Riksbank or other central banks are normally the
ones who create new money these days.12 Many of us have been taught that,
when banks get new deposits, they can create new loans, but it actually works the
other way around. At present, it is the banks that create new money when they
issue new loans. If I approach my bank with a request for a new loan for a home
and the bank grants me credit, I will receive a liability in my account with the
bank. At the same time, the money I have borrowed is transferred to the seller of
the property, who deposits the money in his or her bank account. So new loans
actually create new deposits. In the same way, money is destroyed if I repay a
loan to the bank. The new money created is thus private, electronic bank money
and the amount of money is governed by lending. The Riksbank thereby indirectly
influences demand for new money via the interest rate, but monetary policy does
not attempt to steer the money supply directly.13
Private bank money (sometimes called "inside money" in the sense it is inside the
private sector) is a claim on the issuing bank. In the same way, money created by
the Riksbank, for example Swedish banknotes and coins, is a claim on the
Riksbank or Swedish government (known as "outside money"). It is thus possible to
regard a 100-krona banknote as a kind of IOU with an eternal maturity that does
not pay any interest. There is also another kind of central bank money in Sweden,
namely the banks' balances in the Riksbank. Liabilities on the Riksbank's balance
sheet are usually considered to be completely safe, as the Swedish government
stands as guarantor. Debts on the banks' balance sheets, which is what private
bank money is, are usually considered less safe as they could lose value if the bank
were to enter bankruptcy. However, deposits in bank accounts are protected by a
government guarantee, known as the deposit guarantee, up to a certain
amount.14
As the banking sector fulfils a central function in society for credits and payments
and as it also receives government insurances such as the deposit guarantee,
there are many regulations aimed at making the banking system secure. With the
help of these regulations and the deposit guarantee, the public authorities have
attempted to ensure that, for the general public, it should be more or less as
secure to use private money as central bank money. This has been done because
society gains when there is confidence in the payment system.
The special characteristics of the market for payment infrastructure
suggest an active role for central government
As payments and a well-functioning monetary system form the basis on which
economic activity rests, they are also fundamental to growth and welfare. In this
regard, the payment system can be seen as a part of the basic infrastructure in a
country. And, just as with other parts of it, such as military defence or our
national parks, for example, the payment system has the characteristics of a public
good. For the payment system, it is confidence in the currency that constitutes
the public good that other aspects of the payment system then build upon.
Economic theory says that such goods will not be offered to a sufficient extent or
sufficiently efficiently by the private market. Tobin (1987)15 argued that this aspect of
the monetary system means that central government should have a central role
on the payment market and I am inclined to agree with him.
The implementation of payments involves the exchange of a large amount of
information, demanding large IT systems which are expensive to obtain but with
which the marginal cost for executing a further payment is small. In other words,
there are economies of scale, which, in theory, leads to natural monopolies. This
means that, if the market is left unregulated, the dominant company will have an
incentive to supply too little of the product for too high a price. Monopolies can
also create worsened conditions for innovation as these are often driven by
competition. In addition, the system can be vulnerable when one company, and thus
one technical platform, dominates. On such markets, central government
therefore usually applies regulations, such as those concerning the electricity network,
for example, or actively runs the system, such as for the rail network, for example.
Another characteristic of the payment market is the existence of positive network
externalities. This means that when new users join a system, the utility increases
for all participants, even those already in the system. Another example of a
product with positive network effects is the telephone: the utility of having a
telephone increases as more people join the telephone network, allowing you to call
them. This means that coordinating different players on the market may lead to
economic gains for society. Since utility increases with the number of users this
means that the market has a tendency to eventually end up being dominated by a
monopoly that takes over (a situation of natural monopoly, just as with
economies of scale). The combination of economies of scale and network effects thus
creates tendencies towards heavy concentration. Monopolies that maximise their
returns will give rise to efficiency losses in the economy in general.16 All in all, this
suggests that it may be justifiable for central government to undertake the task of
regulating the market, to reduce the power of monopolies, and as coordinator, to
ensure that network externalities are internalised, which is exactly how it works in
Sweden today.
We can thus observe that, as money provides the necessary lubrication for all
economic activity, efficient and secure forms of money are important for economic
growth. The most recent estimate we have for Sweden puts the total cost of
executing payments at just below 1 per cent of GDP per year.17
Account-based payments require a network of intermediaries and
technical systems
Unlike when we use cash, using the money we have in our accounts as a means of
payment requires a relatively advanced technical infrastructure. This is because
the purchaser's money or credit needs to be verified, payment instructions need
to be sent and so on. A transfer must also be arranged between the banks of the
purchaser and the seller. At present, this usually takes time, often a day and
sometimes more. This means that risks arise for the parties involved in the
transaction. As consumers, however, we do not normally notice that payments take
time and that risks arise.
As I mentioned previously, positive network externalities are something that
characterises the payment market. This means that there are efficiency gains to be
made by using coordination. In Sweden, we have several historical examples of
successful coordination on the payment market. In 1925, the public-owned
Postgirot was formed to answer the need for more efficient mediation of payments
via cashless payments by giro transfer. As this was a social need, a publicly owned
solution was created to facilitate the required coordination. In the 1950s, the
banks then formed their own version in the form of Bankgirot, in which
standardised paper forms facilitated the management of payments between banks. In
more modern times, the Swedish banks have also collaborated over withdrawals
from ATMs and purchases with debit cards, to give two examples. They have also
established a joint system for Bank ID and, a few years ago, the mobile application
Swish18, to which the largest Swedish banks are connected.
The Swedish banks have been able to take continual advantage of the benefits of
coordination to which economies of scale give rise. Again, this is something that
we perhaps do not give too much thought to, but in many other countries these
activities do not work anything like as smoothly. There, for example, it can be
difficult or expensive to withdraw money from another bank's ATM.
In Sweden, the Riksbank provides, like the central banks of other countries, a
central payment system so that the banks can exchange money with each other.
Allow me to explain in a little more detail what this means, before going on to
discuss the challenges we must consider for the future. All major Swedish banks,
clearing organisations, the Swedish National Debt Office and the Riksbank are
participants in the Riksbank's RIX system where weekly turnover corresponds to a
little less than Sweden's GDP. In practice, this means that participants have
accounts in the Riksbank's system in which they regulate debts to each other via
transfers between their RIX accounts. A bank's balance in its RIX account forms a
risk-free claim on the Riksbank. At some point during the day, the money thus
ends up on the Riksbank's balance sheet, which is the meaning of the term
'central bank money', as I explained previously. The system has been constructed to
manage major payments between the dominant players in the market in a secure
manner. Private persons' payments are lumped together into larger amounts
before they pass through the system. It has been optimised to manage a smaller
amount of payments of larger amounts with a very high level of security. The
mean value of a payment sent through the system is about 35 million kronor.19
The Riksbank also has regular contact with all participants, who also participate in
training sessions, crisis exercises and so on. As the Riksbank and the banks must
have personnel on site, opening hours are currently restricted to normal office
hours.
It is conceivable that the banks would have their own system to regulate
payments with each other. But this would increase the counterparty risks in the
financial system. If a private player were to run such a system, all participating banks
would have large claims on that player, just as they have on the Riksbank at
present. If such a private player were to enter bankruptcy, this money would be lost.
That risk does not exist when the central bank runs the system. In addition, the
central bank can supply the necessary liquidity that allows payments to function
without friction. The central bank can thus function as 'the banks' bank'. It is
therefore common for the settlement system to be placed at the central bank. It
is also a service demanded by the banks themselves. Settlement in the RIX system
also involves finality, which is to say that the payment is legally executed when it
arrives in our system.
The payment market is changing
The arrival of the Internet in the late 1990s and early 2000s boosted the
digitalisation of society and the payment market. New participants entered the market and
many digital services linked to payments are presently offered, such as mobile
solutions, electronic identification and so on. Changed consumption patterns such
as increased on-line shopping are also generating demand for digital payments.
The availability of goods and services around the clock on-line raises the question
of why it should take longer to make a payment than it does to send a text
message or private message via Facebook.
All of this leads to demand for real-time payments. Instant payments, meaning
the possibility of paying person to person in real time around the clock, have been
made possible by digitalisation and new technology. In other words, this is a
matter of small payments between private persons and is thus something other than
what the Riksbank's system has traditionally handled. Previously, verification,
clearing and settlement has taken time to implement, but, at present, using new
technology, it takes a few seconds instead of a few days.
In Sweden, the number of users of the mobile application Swish has increased to
over 6 million since its launch in 2012.20 Swish is a system that makes it possible to
execute instant payments between private persons. This means that I can enter a
payment into my mobile phone and, a few seconds later, show you that it has
been executed without having to wait a few banking days for account transfers. In
addition, we can make payments with the system around the clock. In this way, it
is reminiscent of cash. When banknotes change hands, the payment is completed,
at the same time as the possibility of paying does not depend on the opening
hours of the system or the banks. It could be said that Swish has replicated the
advantages of cash, adapted to today's technology. However, one difference is that
cash is central bank money, while Swish mediates payments in private bank
money.
Swish's rapid growth has contributed to the further marginalisation of cash. Since
2008, cash usage has fallen by about 50 per cent in Sweden. In surveys, only about
10 per cent of people in Sweden report having used cash for their latest purchase.
At the same time, 20 per cent report that they use their mobile telephone to
make payments at least once per week.21 Half of traders expect that they will stop
accepting cash as a means of payment within seven years.22
There is reason to believe that instant payments will be an increasingly dominant
form of payment in the future. Declining cash usage is leading to increasing
demand for electronic alternatives that enable instant payments and account
transfers.23 Another reason is that risks for the players on the payment market
decrease when electronic payments are instant.
At the same time, we are seeing interest in payment solutions increasing among
major internet companies. One of the reasons for this is new EU regulations
aimed at increasing competition and making it possible for new players, including
Fintech24 companies, to enter into the market and offer innovative services on
equal and non-discriminatory terms. The entrance of other types of company than
banks on the retail payment market25 may result in major changes. These
companies have large customer bases in several countries, giving them a platform for
offering both domestic and cross-border payment services, which could provide
them with a competitive advantage in on-line shopping, for example.26
Even if we welcome the increased competition on the payment market, there is a
risk that the development on the market will be too fast. When many players are
moving rapidly in different directions, we risk losing the economies of scale of the
old model of cooperation that has worked well in Sweden. This argues in favour of
some type of central coordination, similar to the role adopted by the ECB. In
Sweden, the Riksbank has a very important task, namely ensuring that coordination
continues to work for payments in Swedish kronor in the future.
Centralisation of payment systems
At the Riksbank, we are therefore investigating how our systems can be adapted
to better meet the increased demand for instant payments. However, if the
Riksbank offers a system, this does not necessarily mean that the actual technical
platform for settlement needs to be present within the Riksbank's premises or
even within Sweden's borders.
The European Central Bank (ECB) is currently extending its infrastructure for
payments. In the field of instant payments, it is in the process of developing a new
technical platform called "Target Instant Payment Settlement" (TIPS). This will
make it possible to make instant payments 24 hours a day, seven days a week,
and is expected to be ready at the end of 2018. It will also be prepared to be able
to handle other currencies than the euro. One alternative could therefore be for
the Riksbank to open a central bank account in Swedish kronor in the European
system for instant payments. The ECB's menu of systems for creating a single
market for payments will mean that economies of scale can be utilised even more and
is thus basically a positive development.
There are also plans among some Nordic banks to create a pan-Nordic payment
infrastructure with joint products. However, at present, we have too few details
around these plans to be able to express an opinion on it.
What we see here is the ongoing centralisation of payment systems generated by
globalisation. There has been a movement within the euro area from national
systems and a fundamentally fragmented market to centralised, cross-border
systems. Deregulation in the 1990s and 2000s contributed towards the integration of
the banking market in the EU. And now the same thing is happening to the
payments-infrastructure side.
The European Commission intends to propose an amendment of the EC regulation
on cross-border payments in euro to reduce fees for cross-border transactions in
all member states and thereby facilitate trade and contribute towards increased
competition. Other initiatives are also taking place on the EU level to develop the
market for electronic payments and create better conditions for secure and
efficient payments. The new regulations will entail a gradual adaptation of Swedish
payment services to EU standards.
Crypto-currencies are not money
Another new trend is the new crypto-currencies such as Bitcoin, Ethereum and
Ripple, to name a few. Bitcoin was launched in 2009 and is still the most
commonly-used crypto-currency. Bitcoin was created by networks of users.
Participants who pool their hardware resources to verify the payments made are
rewarded with newly-created Bitcoins. The size of the rewards declines over time in
a way that means there cannot be more than 21 million Bitcoins. The situation of
a supply that is not adjusted to demand is reminiscent, in its way, of the situation
with the gold standard that I mentioned earlier. However, there is nothing to
prevent the supply of other crypto-currencies, which are close substitutes to Bitcoin,
from increasing. At present, there are over 1500 different kinds of virtual currency
and, if prices rise, there will probably be more.
We have also seen how the value of Bitcoin, for example, varies heavily due to
fluctuations in demand. This alone makes it difficult to use them as a means of
payment. Even if Bitcoin is used for payments between certain private persons
over the Internet and in a few on-line shops, it is likely that most owners of
Bitcoins do not use them as a means of payment, but rather as an asset that is
expected to increase in value. The situation remains that few shops accept them -
27
for example, only three of the world's largest on-line shops.
Even though they are called currencies, the crypto-currencies do not fulfil the
criteria for what we usually call money that I mentioned earlier; at present they do
not work well as units of value, stores of value or means of payment as few shops
accept them and their value fluctuates heavily over time.
The e-krona, a new kind of money for the general public?
We have thus been able to establish that cash is disappearing at a rapid rate,
while, at the same time, new electronic 'currencies', issued by other players than
central banks, are appearing. In general, technological developments are
proceeding rapidly and digitalisation is placing higher demands on payment services that
are available round the clock. In this environment, it is natural to ask whether
central banks should offer the general public a secure electronic alternative that
could work in approximately the same way as cash. It is for this reason and others
that we, at the Riksbank, have opened an analysis of the possibilities for issuing a
so-called e-krona.28
The analysis is founded in the question of which problems may arise if cash were
to disappear. We can note that this means that banks are continuing to have
access to central bank money, while the general public in Sweden is losing the
access to central bank money it has had since the 17th century.29 But is this a
problem? Has there been a weakening of the arguments that have existed for
providing the general public with an asset and a means of payment that is completely
free from risk? Is it a fact that the Swedish people generally no longer have a need
for central bank money? Or is it rather that they do not want physical banknotes
and coins? If this second statement is correct, I see it as the Riksbank's obligation
to investigate the possibilities of issuing an e-krona that can fulfil approximately
the same role as cash previously did. If the Riksbank does not offer an electronic
alternative, this also means, in practice, that all of our payments will have to go
through banks or other financial institutions.
Since the payment market has the imperfections it does, as I have described
earlier, it is likely that monopoly situations, inefficient for the economy as a whole,
would arise if the private market was allowed to act freely with no central
government involvement. This problem could possibly be managed with the use of
regulations, but it can be difficult to effectively regulate a monopoly. As long as a
public alternative exists, this puts certain natural restrictions on the private players.
Historically, cash has been this alternative.
There are various possibilities for creating a technical platform for the e-krona.
One possibility is to connect it to the existing infrastructure. Another alternative
could be to develop a new system that could act as backup for other payment
systems. This would give us an alternative independent platform that can build upon
other technology, which would reduce vulnerability in comparison with only
having one system. This could be particularly important if we decide to utilise the
ECB's system so that the main payment infrastructure becomes located beyond
Sweden's borders.
An e-krona system could work for the instant settlement of payments around the
clock. We are also analysing the possibility of getting certain parts of it to work
off-line. This could turn out to be important, not least in a crisis situation. In
addition, there exists a risk for cyberattacks, which may increase in the future. I
consider that Sweden's preparedness will be weakened if, in a serious crisis or the
event of war, we have not decided in advance how households and companies
will pay for fuel, food and other necessities. Making it possible to make payments
off-line may also be necessary to ensure that payments can be executed in all
parts of the country.
Any e-krona would also have to be designed bearing in mind that there are certain
groups in society that presently experience problems with the disappearance of
cash as, for various reasons, they find it difficult to use digital solutions. This may
include older people, disabled people or people without access to bank cards for
economic or other reasons. As cash becomes increasingly marginalised, it
becomes central government's task to help these people as we cannot expect the
private market to do so. Under the framework of the e-krona, we can work with
alternative solutions for these groups, such as some kind of prepaid card for
example.
In addition, it is important to consider whether legislation needs to be updated.
Under the Sveriges Riksbank Act, Swedish kronor (SEK), in the form of banknotes
and coins issued by the Riksbank, are legal tender. The Swedish Riksdag has
thereby given cash a unique position as a means of payment. This provision
means, for example, that traders and companies are obliged, in principle, to
acce