Burkhard Balz: Payment services at a crossroads
Speech by Mr Burkhard Balz, Member of the Executive Board of the Deutsche Bundesbank, at
the 6th Annual FinTech and Regulation Conference Afore Consulting, virtual, 8 February 2022.
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1 Payments (r)evolution
Ladies and gentlemen,
Some might think that there are huge "walls" dividing the worlds of fintech - or even broader -
financial innovation and regulation. Yet Santiago Calatrava, the renowned SpanishSwiss
architect, preferred to build bridges rather than walls. Therefore, I will take a closer look at the
roads bridging these topics and also where they lead.
For more than a decade now, we have been observing and increasingly using financial
innovations. New entrants in the payment markets - bigtech and fintech firms alike - have
started making the initiation of transactions faster and more intuitive, but without changing the
fundamentals of payment processing.
Let me elaborate with a small example. Whether payers use an e-commerce solution or their
smart device at the point of sale, or they send money peer-to-peer to another person: the transfer
of money takes place via familiar credit transfers, including instant ones, direct debits or card
payment rails.
What has dramatically changed, though, is the number and kind of actors involved. For example,
if a consumer presents her smart phone at the point of sale, she could use her Google Pay app
to initiate a payment. This may be funded by her PayPal account which, in turn, is funded by a
payment card. Instead of just initiating a regular card transaction, two bigtech players, in this
case, are added to the payment chain.
Such arrangements are becoming more and more popular and might be considered convenient
by users, because they fit seamlessly into their day-to-day digital lives. But they add significantly
to the complexity of payment processing.
Often, technical service providers, as they are known, such as firms providing the wallet app, are
part of this payment chain, but they are not as firmly regulated as payment service providers or
clearing and settlement mechanisms, for example.
Up till now, payments have been built around centralised hub-and-spoke models, like at card
organisations or in clearing and settlement mechanisms. That means transactions flow via a
central processing entity either directly to the payee's account or after passing a number of
additional processing entities, depending on the number of actors involved. Basically, the central
organisation establishes trust among the participants that funds can be exchanged safely.
But more than ten years ago, a new idea came onto the scene challenging the established model
with a decentralised approach: distributed ledger technology. This allows crypto-assets or
crypto-tokens to be transferred without a central organisation. Instead, trust between the asset
holder and the beneficiary is established via a cryptographic consensus mechanism.
Bitcoin was the first of these crypto-tokens and is the most prominent example. Since it first
emerged, a whole zoo of crypto-assets based on different consensus mechanisms and transfer
protocols has been invented.
There is a lot of creativity, IT brilliance and entrepreneurial spirit. But there is also a kind of "Wild
West mentality", which is still a far cry from the initial idea of replacing traditional payment
instruments. Instead, crypto-token values fluctuate like blades of grass in a hurricane, inhibiting a
wider uptake for payment purposes.
Consequently, stablecoins were introduced to address this. Essentially, these are crypto-tokens
that claim to be backed by fiat currency. Prominent examples that already exist are USD Coin
and PAX Dollar. While payers and payees trust fiat money because central banks take
responsibility for its stability, stablecoins merely borrow trust from the currency they are pegged
to. Yet, the substance of this pledge has so far neither been regulated nor put to the test.
2 Different regulatory approaches
Nevertheless, tremendous progress has been made in payments overall. The market has been
moving away from a fairly simple structure. There used to be a limited number of regulated
participants domiciled within a certain area. Now we are seeing a plethora of arrangements with
a wide variety of different parties from all over the world, and developments are sometimes hard
to keep track of.
That is why I see "Payment services at a crossroads". And now, it's time for regulators - not only
in Europe, but worldwide, too - to review the existing regulatory approaches in order to ensure
the safety and efficiency of payments.
This responsibility is also enshrined in the mandate of the Bundesbank and of the other central
banks around the world in their capacity as overseers. And it has led not only to a review and
amendment of existing regulations and frameworks, but also to the development of new ones.
In the following, I will set out three different pieces of regulation to offer you an interesting glimpse
into the diversity of regulatory action. First, I will turn to the international Principles for Financial
Market Infrastructures, or PFMI. Second, I will take a look at the prospective European Regulation
on Markets in Crypto-Assets, or MiCA. And lastly, I will present the Eurosystem oversight
framework for electronic payment instruments, schemes and arrangements - or PISA for short.
So, let me start with the Principles for Financial Market Infrastructures, or PFMI. Ten years ago,
the Committee on Payment and Settlement Systems (CPSS) and the International Organization
of Securities Commissions (IOSCO) issued these standards. Since then, many - if not most -
countries around the world have been implementing them.
These principles are intended to enhance the robustness of the infrastructure supporting global
finance markets and to improve their ability to withstand financial shocks. The approach is
technology-agnostic. Consequently, it became evident that systemically important stablecoins
should also fall within the scope of the PFMI.
As analysis showed, the transfer function of a stablecoin arrangement can be compared with
that of other types of payment infrastructures.
It is still based on participants, common rules and a transfer of value - neither central nor
commercial bank money is involved, but there is a high degree of decentralisation of operations
or even governance.
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Hence, the responsible BIS Committee on Payments and Market Infrastructures and the
technical committee of IOSCO decided not to develop new standards for stablecoins. Instead,
they proposed practical guidance on the interpretation and application of the existing rules for
systemically important stablecoin arrangements and the relevant authorities. After a public
consultation of the draft report last autumn, the comments are currently being analysed and the
final report is being drafted.
My second example is the regulatory approach pursued by the European Commission in the
context of its Digital Finance Strategy for the EU.
The Commission's proposal for a Regulation on Markets in Crypto-Assets, called MiCA, is a new
legislative act that focuses on the issuance of stablecoins as well as utility tokens, and, more
generally, on the provision of services related to crypto-assets. MiCA is intended to support
innovation and at the same time preserve financial stability and protect investors.
Thus, it aims to provide a harmonised general framework that will offer legal certainty for the
treatment of cryptoassets in all EU Member States. Furthermore, MiCA is designed to improve
competition by reducing regulatory fragmentation and the scope for regulatory arbitrage in the
case of cross-border activities.
The Council and the European Parliament have concluded their in-depth internal discussions,
adopted its respective negotiating mandate, and trilogue negotiations with the Commission are
about to start.
This will culminate in a version of the regulation that both institutions can formally adopt.
I sincerely hope that MiCA might also serve as a blueprint for similar regulations in other
jurisdictions. Because cryptoassets are a global phenomenon that operate beyond geographical
borders, we need a harmonised approach.
My final example concerns an even more specific area of regulation - Eurosystem oversight of
payment instruments. Over the course of the last years, the existing oversight framework has
been revised and modernised. The outcome is PISA, the new oversight framework for electronic
payment instruments, schemes and arrangements.
The PISA framework is based on the PFMI that I mentioned earlier. It is technologically neutral.
And, it replaces the different frameworks for individual payment instruments and offers a "one for
all" modular approach.
In future, it will apply not only to traditional payment instruments, but also to innovations, mainly
payment arrangements. This comes in response to the developments I referred to at the
beginning of my talk.
The decision-making bodies of the Eurosystem approved the PISA framework last autumn. Now,
its implementation is progressing and it will be used for oversight assessments as of November
2022.
So what can we learn from these three rather different examples? Regulators need to be aware
of the dynamics in the payment market. The prospect of new arrangements, as well as new
services and their providers, altering the market needs to be assessed early enough to design
appropriate regulatory answers. While much has changed in the past decades, there is one rule
- a golden one, perhaps - that still holds true: same business equals same risks equals same
requirements.
Moreover, the regulatory response needs to be technologyneutral and principle-based in order to
be future-proof. Last but not least, the complex structure of payment arrangements calls for
cooperative approaches between banking supervision and oversight when assessing
compliance with the rules. Regulators are aware that there is a fine line between safeguarding
security and hindering innovation through unsuitable regulation. Thus, applying proportionality and
a risk-based approach seem to be a good basis.
3 Alternative approach: CBDC
So far, I've talked about payment arrangements, stablecoins and the response from regulation
and oversight. But is this the road that leads to security and efficiency in tomorrow's payments?
Or are there already new roads under construction that link previously distinct areas of the
payment market?
One of the first and most prominent examples was the announcement by Facebook - or Meta,
as it is now known - to issue a stablecoin called Libra, later renamed Diem. Although, this
specific project has been abandoned; Meta only recently launched a pilot with Paxos to allow
stablecoin payments with its dedicated Novi app from the United States to Guatemala. PayPal is
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also aiming to issue its own stablecoin. Visa and Mastercard have both announced plans to
offer stablecoins as part of their payment services.
In short, governments and central banks worldwide are concerned about the prospect of billions
of platform users exchanging fiat currency into private money that may become locked into
private ecosystems of global players, calling monetary sovereignty into question.
As Agustín Carstens, General Manager at the BIS, said only recently: "Let me be clear: it is
undesirable to rely solely on private money. Users may initially find great convenience in paying
with a big tech global stablecoin. But in doing so they may be handing the keys to our monetary
system over to private entities, driven by profits and accountable only to their shareholders and
other insiders. Such an arrangement could erode trust. A public good like money needs oversight
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with the public interest in mind."
Yet, besides proper regulation and oversight, central banks around the world have been initiating
projects with the ultimate destination of issuing their own digital currencies. While Nigeria and the
Bahamas have already launched their eNaira and Sand Dollar currencies, a dozen other central
banks are piloting central bank digital currencies of their own, most prominently China.
So far, the digital yuan has been distributed to a limited number of citizens to test its functioning.
But, in the course of the 2022 Winter Olympics in Beijing, which started on 4 February, locals as
well as athletes and visitors from abroad should be able to try out the e-CNY, presumably via
fancy smart payment cards.
Last summer, the Eurosystem, too, decided to explore the benefits and downsides of introducing
a central bank digital currency, the digital euro, in greater depth. Until mid-2023, the Eurosystem
will be investigating use cases, the potential design and the features of a digital euro.
It will also engage with stakeholders before deciding whether or not to implement the digital euro.
It would have to meet the needs of citizens and enterprises. And it shouldn't crowd out private
sector solutions or pose risks to intermediaries. The key is to leverage payment industry
expertise to develop new products and services that carry a "digital euro inside".
A digital euro of this kind would not only represent a stateof-the-art means of payment for the
digital age, but also support the universality of money in open digital ecosystems.
Payments are well and truly at a crossroads. Many new arrangements for digital payments are
complex, involve a large number of different actors, and tend to be absorbed by global players
that are looking to become increasingly important in the payment landscape. In addition,
decentralised approaches to transferring cryptoassets have been invented and are now making
inroads into regular payments by pegging themselves to fiat money.
While there is no perfect answer to these challenges, I introduced you to three current regulatory
approaches - PFMI, MiCA and PISA - and to the efforts around central bank digital currency,
especially the digital euro. Overall, these seem to be arterial roads that add safety and efficiency
to payments that are the backbone of our economy - in the euro area and beyond. There may be
several roads leading to the same destinations, but whatever happens we will have to choose the
right ones.
1
Committee on Payments and Market Infrastructures.
2
www.bloomberg.com/news/articles/2022-01-07/paypal-is-exploring-launch-of-own-stablecoin-incrypto-push
3
www.bis.org/speeches/sp220118.htm