Hiroshi Nakaso: FinTech - its impacts on finance, economies and
central banking
Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the University of Tokyo
- Bank of Japan Joint Conference on "FinTech and the Future of Money", Tokyo, 18 November
2016.
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Introduction
Undoubtedly, we are living in the age of remarkable innovation in information technology. It is
fascinating to consider how it might change the future of finance and economies. In order to
address these unprecedented and intellectually-challenging issues, close communication
between academics and practitioners is essential. Accordingly, today's conference focusing on
the future of money, jointly held by the University of Tokyo and the Bank of Japan, is of great
significance.
Today's conference has been made possible due to the close relationship of trust between the
Center for Advanced Research in Finance (CARF) of the University of Tokyo and the Bank. I
would like to take this opportunity to express our deepest appreciation to Professor Ueda,
Director of CARF, Professor Yanagawa and the staff of the CARF for their support in holding this
conference. My speech today will focus on this key word of "trust".
I. Innovation in information technology and FinTech
Information technology and financial service
After the rapid economic expansion in the second half of the 20th century, developed countries all
over the world are now facing the common challenge of how to raise their growth potential.
Looking back at history, many major companies that supported the economic growth of the 20th
century, such as those in the iron and steel, automobile and petrochemical industries, were
established after 1900. For example, U. S. Steel was established in 1901, Ford in 1903, Royal
Dutch Shell in 1907, and GM in 1908, and they quickly grew to lead the economy. This suggests
that, when new technologies reach a take-off stage at which they can be used for business, they
have the potential to completely and rapidly change the economic landscape far beyond what
could have been expected at the infancy stage of innovation.
Compared to those manufacturing industries, financial industry has a relatively old history: some
banks' history can trace their history back to the Renaissance period. This is because,
infrastructures such as "money" and "ledgers," which constitute the basis for financial services,
have been around far longer than the basic technologies of the recent manufacturing industries
such as automobiles.
Nonetheless, many people now expect that rapid innovation in information technology will have a
substantial impact particularly on financial services. In my view, there are two reasons behind
such possible linkages between recent information technology and financial services.
First, the financial service industry can be regarded as "information industry," since financial
services such as payment and settlement, investment decisions and risk management are
based on wide-ranging information processing.
Second, some of recent inventions in information technology such as blockchain and distributed
ledger technology (DLT) have the potential to significantly affect "money" and "ledgers," which
are the basic infrastructure for financial activities. Such possible impacts of information
technology on money and ledgers raise many interesting issues from the perspective of
economic theory, as illustrated by the theme of today's conference.
Technological backgrounds of FinTech
Next, I would like to focus on the context of technological innovations behind "FinTech." In my
view, these innovations can be categorized into three types.
The first category includes "blockchain" and DLT, which were invented in 2008 with the concept
of "bitcoin."
In the second category, there are artificial intelligence, or AI, and big data analytics, which are
evolving in line with dramatic increases in computing power.
The third type of technological innovation includes the cellphone and smartphone, which have
become new means of accessing financial services. Indeed, the appearance of "iPhone" in 2007
triggered new wave of devices for accessing various financial services and influenced business
models of the financial industry.
These technologies differ in terms of the degree of application to business. Although blockchain
and DLT, which were born in 2008, are attracting attention as a flagship technology in FinTech,
most of the efforts toward putting the technology into practice are still at the experimental stage.
In contrast, many firms are now competing with each other to provide financial services through
smartphones and apps.
II. Impacts of FinTech on financial services
Next, I would like to focus on the possible impacts of FinTech on financial services.
Unbundling and restructuring of financial services
First of all, FinTech would have the potential to "unbundle" and "restructure" the existing financial
services.
Most commercial banks take deposits, and engage in both processing payments and making
loans. The consequent "fractional-reserve" banking accompanied by "maturity transformation"
can be a cause of bank-runs, which sometimes triggered crises in the past. This is why central
banks serve as a "lender of last resort (LoLR)" mainly for banks in order to prevent financial
crises.
On the contrary, non-bank FinTech companies do not take deposits. Some of them focus solely
on payment services, while others provide fund intermediation services such as P2P lending
without using their own balance sheets. Moreover, many FinTech companies are trying to realize
"economies of scope" through combining financial services with other activities related to
ecommerce, sharing-economy businesses and big data analytics in order to deliver new
addedvalue.
"Globalizing" financial services
Moreover, FinTech has the potential to "globalize" basic financial services through enhancing
"financial inclusion." Not only in advanced economies but also in developing and emerging
economies where financial services are not yet widespread, cellphones and smartphones are
now spreading rapidly, and FinTech has opened up the possibility of providing basic financial
services through these new instruments.
"Personalizing" financial services
Furthermore, FinTech may facilitate "personalized" financial services. Cellphones and
smartphones have characteristics of "personalized" tools, and FinTech now makes it possible to
analyze individual customers by utilizing big data. By combining such new tools with analytics
methodology, FinTech may make it easier for the industry to provide more customized services.
Also, new technologies of FinTech can be used to explore the frontiers of financial services
through "dynamic" customization. For example, buying insurance policy can impair the
policyholders' incentives to be sufficiently cautious, and such "moral hazard" is an inherent
problem of insurance. In this regards, blockchain technology is expected to enable "smart
contracts" for various purposes, such as continuously adjusting automobile insurance fees in
accordance with driving behavior of each policyholder. As this case illustrates, smart contracts
might have the potential to overcome "moral hazard" by leveraging new information technology.
"Virtualizing" financial services
In accordance with the development of information technology, hard infrastructure such as brick
& mortar branches and ATM machines may not be prerequisites for providing financial services.
In this regard, I have found similar characteristics between such changes in business models
and the recent "Pokémon GO" boom. Game companies used to focus on popularizing the
necessary hardware such as DS, X-BOX and PlayStation before releasing game software. In
contrast, "Pokémon GO" suddenly became popular worldwide because people can start playing
it simply by downloading the app to their own smartphones.
It is technically possible to imagine a "virtual bank," which owns no tangible infrastructure and
instead uses the internet, smartphones, cloud computing, AI, and DLT to provide access to
financial services, to make investment decisions and to manage risks.
New issues
Although FinTech has many upsides, it brings new issues regarding payment, settlement and
financial stability.
First of all, we need to consider whether and how FinTech will change the structure of settlement
and other financial services. At the Pittsburgh Summit in 2009, the G20 leaders agreed that all
standardized OTC derivatives contracts should be cleared through central counterparties
(CCPs). With the introduction of new technologies such as DLT, how might these new
"decentralization-oriented" technologies affect the "tiered" settlement structure with centralized
bookkeepers?
Also, regulatory and supervisory authorities obtain much information through the balance sheets
of financial institutions, and many regulatory frameworks such as capital requirement, leverage
ratio and liquidity standards impose constraints on these balance sheets in order to achieve and
maintain financial stability. In the case of nonbank P2P lending firms, it is difficult to obtain
sufficient information regarding financial intermediation from their balance sheets. Moreover,
imposing constraints on these balance sheets may not be very effective for influencing their P2P
lending activities. Accordingly, financial authorities need to consider how they can obtain the
necessary information for maintaining financial stability.
Ironically, innovation in information technology has simultaneously brought about various new
tactics for cyber threats. In addition, financial networks are becoming increasingly accessible
through open gateways such as the internet and smartphones. This makes it more and more
important to take appropriate measures against cyber threats in order to ensure the stability of
the payment, settlement and financial systems.
III. Economic implications of FinTech
Next, I would like to examine the possible impacts of FinTech on the economy.
Obviously, finance is a great creation by humans. By using very sophisticated information
processing systems bundled as finance, human beings can continuously allocate a finite
resource to productive areas with potential. This, in turn, has served as a dynamic driving force
for humans' building of economic society. Therefore, if innovation in information technology and
FinTech enhance the efficiency of finance, it will and should eventually contribute to economic
development.
"Financial inclusion" stimulated by FinTech clearly illustrates the positive feedback between
finance and the economy. If people in developing countries gain new access to financial services
through FinTech, they will gain opportunities to expand business such as e-commerce and
elearning, which are currently hampered by constrained access to payment services. In this
manner, FinTech is expected to contribute to economic development.
However, in developed countries where basic financial services are already widespread, it would
not be easy to quantitatively assess the impacts of FinTech on the economy through existing
economic statistics.
For instance, if banks, while reducing the cost of maintaining their bricks & mortar branches,
improve services through free apps downloaded to each customer's smartphone, it would not be
very certain how existing economic statistics reflect the economic impacts (i.e., the decrease in
fixed investments and the improvement of free apps). Also, if FinTech stimulates the
development of sharing-economy businesses, how to reflect the consequent increases in
utilization rates of various idle assets, such as unused rooms in individual houses and parked
cars in front yards, in economic statistics will be another interesting issue. These examples give
rise to the challenging issue of how economic statistics can grasp the increases in economic
welfare caused by innovations in information technology.
Moreover, if FinTech stimulates economic transactions through the internet and smartphones as
well as business applications of DLT, it might become increasingly difficult to identify the physical
"location" where transactions take place and the relevant ledgers are kept. This could lead to a
variety of issues including those related to regulation and taxation.
IV. Central banking and FinTech
As stated in the theme of today's conference, FinTech encourages us to think about the future of
money and central banking.
"Information" and "Trust"
Most central banks were born after the establishment of modern nation-states and have been
serving as the single issuer of sovereign currency as their liabilities. These historical facts
illustrate that central banks inherently have characteristics as "centralized bookkeepers." In view
of such "centralized" attributes of central banks, people are interested in the issue of how the
new "decentralization-oriented" technologies such as blockchain and DLT will influence the future
of currency and central banking. Such interest is linked to the specific question of: what happens
if virtual currencies such as bitcoin reach a significant circulation?
Indeed, if virtual currencies such as bitcoin are to be widely used to purchase goods and
services directly, there should of course be influences on monetary policy. At present, however,
the consensus view in various international forums is that virtual currencies are unlikely to
overwhelm sovereign currencies. This issue is deeply related to "trust," which is indispensable to
all financial activities.
Needless to say, finance is an activity of creating added value through making links among
multiple entities such as "payer" and "payee" or "lender" and "borrower." Those financial activities
always have to be supported by "trust" among such entities.
In order for any asset to be used and accepted as currency, it must have sufficient "trust" among
a wide range of users. In this respect, "bitcoin" attempts to create a "chain of trust" from scratch,
but this requires substantial costs for the electric power needed to verify transactions called
"mining" and to manage encryption keys. Therefore, if we already have an entity with sufficient
trust, it is rational and efficient to make that entity issue the currency as the single issuer as its
liabilities. Because of this economic rationality, in most countries today central banks issue
sovereign currencies in a centralized manner, even though they are newcomers in the history of
finance.
Co-existence of "Centralized" and "Decentralized" Frameworks
Although the information processing capacity of humans is limited, "trust" dramatically enhances
the efficiency of information processing. If we cannot trust others, we must always carry
hundreds of keys with us and manage them. This would make life very difficult!
Finance has supported economic society by enabling advanced information processing through
making effective use of "trust," such as trust in payment instruments and trust in information
managed through ledgers. If such "trust" in financial activities is lost, the efficiency of information
processing will be severely damaged, causing huge turmoil in financial markets and the
economy. Also, if it is necessary to pay huge costs to maintain trust such as by keeping all the
ledgers closely and continuously monitored by all the relevant entities in order to ensure they are
not altered, then economic and financial activities would be substantially hindered.
In a similar vein, if people have to worry about possible fluctuations of the value of the payment
instruments received as settlement of past transactions, it becomes difficult for them to allocate
their limited resources to forward-looking activities. In this respect, central banks are legally and
institutionally destined to maintain the stability of the value of the currency, and by using the
central bank currency people can save their limited resources from being ineffectively spent.
Also, in the practice of bitcoin transactions, encryption keys have sometimes been entrusted to a
third party in a centralized manner, but there have been some incidents such as the failure of Mt.
Gox in 2014. In this case, people tried to avoid the cost of managing keys accompanying
decentralized-type information processing by entrusting their keys to a third party, Mt. Gox. But
their trust was destroyed by the misconduct of the third party. In this regard, the problem of the
Mt. Gox case did not stem from DLT itself but was similar to classic cases of misconduct in the
financial industry. As this case illustrates, decentralization-oriented technologies will not eliminate
centralized frameworks due to the limited information-processing capacity of financial service
users. Furthermore, this incident clearly showed that maintaining "trust" is critically important in
any financial services, regardless of the types of applied technologies.
I believe that it is entirely possible and desirable to realize the co-existence of "trusted centralized
systems" and "decentralized systems," used as and when necessary. We need to make a great
effort to design the optimum framework for economic society through utilizing the available
technologies. These frameworks should take into consideration the various incentives of
economic entities to ensure people's "trust," which is indispensable to financial activities.
Information technology and central banking
The central bank is the only entity that can provide "central bank money" without constraints.
Central bank money has "finality" in the sense that people no longer have to worry about
"payment unwinding" or "the issuer's credit risk." Formerly, the central bank provided central
bank money solely through paper-based and printing-related technologies such as banknotes
and paper-based ledgers. With the development of the economy, the central bank has adopted
newer technologies, improved its own infrastructure and continuously provided advanced
infrastructure such as electronic-based wholesale RTGS systems. If the central bank had
rejected digital technologies and only provided banknotes as payment instruments with finality,
then economic development would have been substantially constrained.
As this fact illustrates, the central bank must appropriately adopt available technologies so as to
provide the optimal core infrastructure for economic society. That means the central bank itself
must keep abreast of technological innovation.
Banknotes are payment instruments with finality and can be used at any time, by any one, and in
this regard some have recently argued that the central bank should issue its own digital currency
as a substitute for banknotes. Their argument for central bank digital currency seems to be
based on the increased awareness of the costs of processing and storing paper-based
banknotes, and they ask the central bank to adopt the newest information technology in order to
satisfy the needs of the economy. I guess that this issue will be one of the topics discussed in
today's conference.
The Bank of Japan has no specific plan at present to issue digital currencies as a substitute for
banknotes. Nonetheless, the Bank will make utmost efforts to deeply understand new
technologies including blockchain and DLT. The Bank will also continue to conduct various
research and analyses of these new technologies, while seeking the possibility of improving its
own infrastructure through applying them in future.
The issue of central bank digital currency raises diverse topics that are attracting attention from
academics. For example, to whom should the central bank provide its account, as technological
innovation changes the financial structure and the list of financial service providers? To what
extent should the central bank provide "finality" to economic society? How should the information
linked to payment transactions be handled? The Bank, in close cooperation with academics, will
make its best effort to deepen its understanding of such issues.
Conclusion
Looking back at the history of human beings, technological progress has fundamentally helped to
increase people's welfare and develop the economy, though it has sometimes been
accompanied by negative aspects such as the use of technologies in wars and environmental
pollution.
Thus, policymakers should strive to maximize the benefits of technological progress while
minimizing its negative aspects. Since recent innovations in information technology have the
potential to cause impacts particularly on financial services, how to deal with recent financial
innovation symbolized by the word "FinTech" will be the key to designing the economic
landscape in the 21st century.
In dealing with financial innovation and FinTech, there are many new and challenging issues. In
order to overcome those issues, we need to cooperate with a wide-range of entities, including
private businesses and academics in particular.
Today's conference, co-hosted by CARF of the University of Tokyo and the Bank, clearly
illustrates that new information technology is raising many issues for economic theories and
central bank practices. I firmly believe that this conference provides an important opportunity for
academics, practitioners and central bankers to tackle the new challenges.
I sincerely hope that today's conference will be a fruitful opportunity for all of you.
Thank you for your attention.
References
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