SPEECH
BY GOVERNOR LARS ROHDE AT
AARHUS SYMPOSIUM
CHECK AGAINST DELIVERY
3 November 2017
Thank you for inviting me to speak about future changes and challenges
in the financial sector.
Today, I will present you three key messages from a central bank point of
view:
Slide 2: Key messages
1. Digitisation and globalisation will increase innovation and competition
in the financial sector which is very positive. It will also create new threats
to the financial system, such as cyber-attacks. Thus, the operational risks
of yesterday are not the same as the operational risks of today and to-
morrow.
2. Another threat to our financial system is the risk of a new financial cri-
sis. We should use our fresh memory of the recent crisis and its devastat-
ing impact on our economy to strengthen our financial regulation and
prevent future crises.
3. Central banks have played a crucial and high profile role in the recov-
ery of the economies in Europe and the US after the financial crisis. Hope-
fully, we now enter more normal times in the sense that monetary policy
will not remain "the only game in town."
4. Despite an increased focus on new technologies in financial services,
such as digital currencies, Danmarks Nationalbank will not grow into a
bank for every citizen in the country. Financial intermediaries perform an
important task for society and help ensure a flexible financial system in
Denmark.
Slide 3: Increased competition and new partnerships
The future of money and finance will be marked by innovation, new tech-
nologies and increased competition across borders. Such a development
should be embraced by financial authorities just as we welcome innova-
tion and competition in other sectors of the economy.
New technologies and innovations may lead to the disappearance of
some of the financial intermediaries we know today, while new players
enter the markets for financial services. However, we can also expect to
see new partnerships between established businesses in the financial sec-
tor and new players.
One area of the financial sector that could undergo rapid changes soon is
the payments market. There are multiple reasons for this, but I would like
to mention the European Union's new payments service directive, PSD2,
which will be implemented in Danish legislation in 2018. Due to the up-
coming legislation, it will become easier for third parties to enter the
payments market. The presence of new third parties will increase compe-
tition in the payments market, which existing players must be ready to
match.
Currently, there are quite a few new players who attempt to gain a foot-
hold in the payments market by either competing with established com-
panies or engaging in partnerships. Roughly speaking, these new players
can be divided into two groups. The first group are the fintechs. These
are companies that are highly specialised in financial technology and typ-
ically small and based on an entrepreneurial culture. The other group of
new players in the payments market are multinational technology com-
panies that are already huge players in other sectors. Two examples are
Apple and Alibaba who have just launched their payments services, Apple
Pay and AliPay, in Denmark.
Whether the agents in the payments market are banks, specialised pay-
ment service providers or multinational technology companies, authori-
ties have a responsibility to safeguard against systemic stability prob-
lems. Regulating and monitoring of risks will remain as important in the
future as today.
Slide 4: Denmark is a digital front-runner
The Nordic countries are among the digital front runners and digitisation
has already affected the financial system significantly. At the beginning of
2017, less than 5 percent of the Danish money supply was made up of
banknotes and coins. Furthermore, the use of cash is rapidly diminishing.
In 2016, card payments accounted for around 80 per cent of the total re-
tail turnover in Denmark, leaving only 20 pct. of retail turnover for cash
transactions. It is thus possible for Danes to choose a cashfree living if
they wish to.
The digitisation of money and payments enable citizens and businesses
to make transactions faster at a lower cost for society. However, the dig-
itisation of money also involves a new kind of vulnerability as it relies on
complex IT systems. I am certain that we are past the point where cash is
an effective backstop should electronic payment systems break down.
This makes cyber security an extremely important task.
In general, digitisation is a double-edged sword. The digitized world has
produced a number of advantages for the financial sector and society as
a whole, but the increasing dependence on computers has also created a
new threat in the form of cyber-attacks.
Slide 6: The cyber threat today
A variety of agents are involved in cybercriminal activity, from small-time
offenders through hacktivists to nation states. The agents have different
motives: Some attack purely for financial gain, others seek to disrupt or
destabilize their target. However, they all have one thing in common:
Their level of sophistication is ever-increasing at a rapid rate.
In 2010, it took approximately five years for small-time offenders to adopt
the most advanced techniques developed by the intelligence agencies of
nation states. Today, small-time offenders seem to adopt the most so-
phisticated techniques in only 18 months. Because their attacks are much
more frequent than those of nation states, the overall impact of cyber in-
cidents has increased.
A recent example of a cyber-attack is the incident that paralyzed Maersk
Line for almost two weeks in June/July this year. The malware inflicted
serious damage on Ukraine and spread to many global companies includ-
ing Maersk.
Imagine if a critical financial institution was hit by a cyber-attack that par-
alyzes it for two weeks, while the financial markets were already volatile -
what would be the implications for financial stability? And what would
happen if the malware spread to other key financial institutions?
In a worst case scenario, cyber-attacks aimed at critical financial institu-
tions will not only have economic consequences for those institutions di-
rectly affected but also make people lose their trust in the financial sys-
tem as a whole. Cyber-attacks are therefore not just a threat for individu-
al institutions but a threat that could shake up the whole foundation of
the financial system: peoples' trust in the system.
Slide 6: Financial Sector Forum for Operational Resilience
Because of this, Danmarks Nationalbank has initiated a forum for collabo-
ration among the critical companies in the Danish financial sector - the
Financial Sector Forum for Operational Resilience (FSOR).
FSOR has three primary goals: (1) To create an overview of cyber threats
to financial stability, (2) to implement joint measures to ensure financial
sector resilience and (3) to set up a framework for collaboration and
knowledge-sharing.
We have to accept that cyberattacks are inevitable and that attackers are
persistent, but we should not succumb to fatalism: By continually improv-
ing and testing our cyber security capabilities, we can significantly miti-
gate the systemic risks of cyber threats.
The creation of FSOR is an example of how key institutions in our society
have to adapt to changing circumstances. Cyber-attacks have been
around from some decades now, but cyber security can no longer be left
to a few specialists; it has to be on the agenda of senior management in
all larger institutions. Furthermore, the growth in cyber-attacks increases
the need for cooperation between private and public institutions because
the weakest link in the chain might expose other institutions to security
threats - as in the case of the cyber-attack on Ukraine.
Slide 7: Lessons learned from the financial crises
One thing is the growing, potential cyber threat. Another, is the threat of
a financial crisis, where the confidence in the financial system disappear
overnight and the whole system freeze. This threat became a reality 10
years ago, and as it evolved it became the worst financial crisis since the
the late 1920'es.
Few of us have personal memories of the 1930'es and the huge, devastat-
ing effects of the financial crisis on the real economy, but we all got a
clear picture of this era of great depression. During the recent crisis we
once again witnessed how a banking crisis evolved and developed into a
severe macroeconomic slowdown. For Denmark you could say that we
ended up losing 7 years of output growth. Only in 2014 our level of eco-
nomic activity was restored to its level prior to the crisis.
With this fresh memory of the effects of a financial crisis in mind we now
work on bolstering our financial system to prevent such crisis to occur
again.
The crisis revealed a need to shake-up the regulation of credit institu-
tions. And in recent years we have seen a number of international regula-
tory initiatives which aims at strengthening the resilience of the financial
sector and preventing a new financial crisis.
Looking ahead the question is, whether we have truly learned our lesson
well - and what to do next?
Let me present my vision for the future financial regulation.
Slide 8: The pillars of financial regulation
Our regulatory framework should basically rest on 3 pillars, addressing
capital, liquidity and resolution.
The first pillar should ensure a solid, true and fair capital adequacy posi-
tion - based on the actual risk exposure of the bank.
Second, we need requirements to ensure healthy liquidity management
and stable financing, as included in recent Basel reforms.
Last but not least, we need a credible resolution regime. In our European
case we need a strict implementation of the EU directive on Banking Re-
covery and Resolution. This includes setting minimum requirements for
own funds and eligible liabilities to be used in the resolution of a bank in
troubles. It also includes formulating credible resolution plans for credit
institutions.
This is all about getting the incentives right. No credit institution should
be too big to fail.
If we - through the ongoing reforms with the new rules adopted in Basel
and Brussels - end up delivering on all three pillars of regulation, I think
we have learned our lesson well after the crisis. And with all these
measures in place we will be ready to take a new step: Simplify the re-
maining part of the regulation and ease the administrative burden of
banks.
Basically the three pillar system would leave it to market forces to keep
the financial sector in check. As long as banks perform on all three pa-
rameters, the credibility and soundness of the bank will ensure their ac-
cess to the necessary capital and funding. And with the resolution regime
in place we no longer need Governments to save banks with taxpayers
money.
The most important effect, however, is that we significantly reduce the
likelihood of a new financial crisis with all its detrimental effects on our
economy.
Slide 9: Unconventional monetary policy
Let me now finally turn to some future perspectives for us in the central
banks.
Since the beginning of the financial crisis many things have been far from
normal for central banks.
In response to persistently weak demand and low inflation, central banks
across the globe have reduced their monetary-policy rates to historically
low levels.
In fact, Danmarks Nationalbank was a central bank pioneer in terms of
setting the key monetary-policy rate well below zero already in 2012 in
order to offset large capital inflows.
As we have seen in Denmark, the low interest rates set by central banks
across various currency regimes are simply the result of one thing and
one thing only: Central banks are trying to fulfil their specific mandates
which have been assigned to them by elected representatives. The low
interest rates in Denmark have been nothing but a necessary conse-
quence of our fixed exchange-rate policy.
However, very low and even negative interest rates might not be pre-
ferred for an extended period. Long periods with very low interest rates
create risks of financial bubbles in specific sectors of the economy. For
example, we have seen increasing prices in the housing market here in
Aarhus and in Copenhagen. [This is something we will keep an eye on in
the coming years.]
***
Slide 10: Major global central bank balance sheet
With interest rates close to their effective lower bound central banks have
deployed a range of so-called unconventional measures to achieve the
desired amount of monetary accommodation. The most famous one has
been to engage in purchases of financial assets including government
bonds on a massive scale - known as quantitative easing, or QE.
QE has become an integral part of the set of unconventional tools central
banks use to support economic growth and increase inflation towards
target levels. [As you can see from this figure, the balance sheets of the
world's major central banks, the Fed, Bank of Japan, Bank of England and
the ECB have therefore expanded to historically high levels.]
The key question is: Do these unconventional measures work as intend-
ed?
Before answering, it is important to remember that in the heat of the cri-
sis, many national governments were paralyzed for political reasons or by
fiscal constraints. Therefore, central banks were forced to take on a large
responsibility in fighting against the crisis in order to limit its adverse
consequences.
As such, QE programmes helped the US economy to recover quickly from
the financial crisis. In the euro area, the ECB's unconventional monetary
policy and its communication to the markets have been crucial in order to
support the euro area economy and helped the euro overcome its most
severe crisis since its introduction.
Taking on a greater role in the economic policy-making in this period has
left central banks prone to criticism. However, when looking back in 20
years' time, I think history will acknowledge the responsibility they have
taken in the period of crisis management.
Hopefully, central banks can allow themselves to relax a bit more in the
future and let fiscal and structural policy do the heavy lifting.
***
Slide 11: Are cryptocurrencies a mirror of the tulip mania
But one thing we know for sure is that central banking and the idea of
money will change a lot in the future due to new innovations.
The question is how?
Looking at the recent developments in digital money and payments, this
is perhaps the most relevant question for a central banker right now.
In these days, crypto-currencies, and especially Bitcoins, are on every-
body's lips, even though their use is still relatively limited. [In fact, the
number of MobilePay payments in Denmark exceeds the total global
amount of payments conducted by Bitcoins.]
[I sometimes run into the question: Will crypto-currencies be our future
money?]
However, before making trivial comparisons, we must remember that
crypto-currencies, like Bitcoins, have no fundamental value, and therefore
their value can increase or decrease quite fast. This is completely the op-
posite of how we usually think of money.
One of the first things we learn about money is its function as a store of
value. In other words, a fundamental characteristic of money is related to
price stability. In contrast, Bitcoins have been compared with the tulip
bulbs in the Netherlands in the seventeenth century.
Looking at this figure, it is not difficult to see why crypto-currencies can-
not be mistaken for ordinary national currencies, which are under the
control of central banks.
[In my opinion,] the most interesting thing about crypto-currencies is the
underlying Blockchain technology. In the coming years, I believe we will
see a lot of interesting examples of Blockchain's huge potential.
***
Slide 12: The future of central banking
There is an ongoing debate about the fact that money creation is not
controlled by central banks, but is taking place in commercial banks as
they grant loans to households and firms.
As you know Danmarks Nationalbank issues banknotes and coins, but we
do not regulate the creation of money in connection with bank deposits
and lending.
Therefore, it is sometimes suggested that Danmarks Nationalbank should
take back control of money creation, by creating a central bank account
to every citizen in the country and provide a digital central bank curren-
cy.
However, it is important to remember that even though today's money
stock primarily consists of deposits in bank accounts, it is not possible to
create more money than households and firms want to hold. In other
words, the total amount of money in society - both banknotes and coins
in circulation as well as bank deposits - depends on demand.
And by changing interest rates - and hence the cost of holding money -
the money demand is, in the end of the day, determined by central
banks' monetary policy.
This is because monetary policy interest rates are transmitted to banks'
deposit and lending rates, which in turn have a direct impact on the de-
mand for deposits and loans - and thus economic activity.
Therefore, money supplied by banks as deposits is not any worse than
money supplied by central banks. In a well-functioning financial sector
the amount of loans and deposits should be allowed to increase or de-
crease depending on the demand for liquidity. This means that firms can
obtain the loans needed for investment purposes. At the same time,
households can plan their consumption profile over time. In this way,
banks help to secure a flexible financial system for our economy.
Given this important role in society, the banks are subject to extensive
regulation and supervision by the authorities. As I mentioned before, it is
important that we continuously ensure that there is no excessive risk tak-
ing in the financial sector and that we do not repeat yesterday's mistakes.
***
Thank you!
DANMARKS
NATIONALBANK
THE FUTURE OF MONEY AND BANKING
​Lars Rohde, Chairman of the Board of Governors - 3 November 2017
Key messages
1. Financial sector will face
more competition, and
that is good news
2. Need for strengthen the
financial regulation and
prevent future crises
3. Hopefully we enter more
normal times with a
lowkey role for central banks
in economic policy
Increased competition
and new partnerships
Facebook Google
Alibaba Fintechs
Starbucks Bigtechs
Amazon Apple
Denmark is a
digital front-runner
The Cyber Threat today
​Source: Bank of England. Generic perceptions based on central and commercial threat intelligence.
FSOR: Financial Sector Forum
for Operational Resilience
The crisis revealed
a need to shake-up
the regulation of banks
The pillars of financial regulation
Unconventional monetary policy
Major global
central bank balance sheet
Are cryptocurrencies
a mirror of the tulip mania?
Bitcoins have
skyrocketed
but have no
fundamental
value
The future of central banking
1. Money in society depends on demand
It is not possible to create more money than
household want to hold
2. CBDC - Central Bank Digital Currency
Hard to identify what CBDC can do better
3. Digital money already exist in Denmark
Deposit guarantee, full access to bank accounts
and instant transfers