Hiroshi Nakaso: Central bank policy on financial market infrastructure
Remarks by Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan, at the Conference
on Retail Payments, Tokyo, 12 May 2016.
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Introduction
It is a great pleasure to welcome you all today to this Conference on Retail Payments.
Today, I would like to say a few words on the Bank of Japan's views on policies related to
financial market infrastructures (FMIs), including payment and settlement systems, in light of
innovations in information technology that have brought about various innovations in
payments.
For every central bank, payment and settlement are its primary functions. Many central
banks, including the Bank, were established to stabilize payment and settlement systems as
a single issuer of the currency. Compared to such history of central banks' deep involvement
with payments and settlements, history of monetary policy for macro-management of
aggregate demand is fairly new.
After the recent global financial crisis, various initiatives have been introduced at international
forums over FMIs including payment and settlement systems. Moreover, in line with
development of information technology and various financial innovations, which are often
referred to as "FinTech", the frontier of the policies related to FMIs is rapidly expanding, and
has become a major policy field that could be called "financial market infrastructure policy
(FMI policy)" for central banks around the world.
In order to ensure the stability and enhance the efficiency of FMIs as a whole, it is important
not only to ensure stability of individual players including financial institutions, but also to
understand complicated interactions and market dynamics among these players as well as
the impacts of technological innovations, and to fully mobilize available policy toolkits of the
central bank. For central banks, FMI policy is deemed as "the oldest and the newest" policy
field, which is also intellectually challenging.
I. Origin and evolution of central bank policy on FMIs
The role of money in the economy
"Money", like "language", is undoubtedly one of the greatest of human inventions. Language
has enabled human beings to share knowledge among others and wisdom across
generations and has played a critical role in developing civilizations. Similarly, money has
enabled human beings to exchange goods and services "across space" and "over time", and
has served as a foundation for the development of an economic society. The transmission
mechanism of monetary policy, too, is ultimately dependent on the fact that money has
enabled us to exchange expenditures over time.
The exchanges via money is build upon a "chain of trust" among human beings The reason
why I can purchase goods with money is because the recipient believes that it can be used
for its own payments and will be accepted by unknown others. As such, the fact that human
beings were able to create a chain of trust among many others, including among those with
no personal acquaintance, was the key to the development of an economic society. This
shows how important "trust" is for the payment system and the economy.
Central banks and payments infrastructure
To put it in another way, one break in the chain of trust could have a catastrophic impact on
the payment system and the overall economy. Indeed, many central banks, including the
Bank, were founded with the aim of restoring and maintaining confidence in payment
systems when people's trust in them were about to be lost or damaged, which also shows
that payments and settlements are inherently the primary function of central banks. The
central banks' other core functions - such as the lender of last resort and monetary policy -
are also ultimately based on the ability of central banks to provide, without constraints,
central bank money, which provides "finality" to payments and settlements in a sense that
receivers of central bank money do not have to worry about payment unwinding or its credit
risks any more. Such power also gives central banks the ability to influence real interest
rates, which are regarded as the "rate of exchange" on expenditures exchanged over time,
as a foundation of monetary policy.
Most central banks around the world, including the Bank, support economic activities by
issuing banknotes and operating large-value payment and settlement systems, which
constitute basic infrastructures of the economy. Following the emergence of money in the
form of banknotes and coins, various types of payment instruments, including checks, bank
transfers, credit cards, debit cards, and e-money, have emerged to meet people's evolving
needs. At the same time, the role of central bank payment and settlement infrastructure is
playing a more important role in light of economic developments and innovations in
information technology, since the central bank is the only entity to be able to settle more
diverse and complex transactions with finality.
Payment infrastructures intrinsically have the characteristics of a "network". The value of
participating in a network increases as more participants use it. At the same time, a single
payment failure could spill over across the network, potentially leading to systemic crisis.
Moreover, participation in the network by a high risk profile member could increase the risk
for all others. Given such characteristics, central banks, including the Bank, determine the
range of participants to be granted access to its payment infrastructures, ensure the
soundness of those participants through on-site examinations and off-site monitoring, and,
where necessary, serve as the lender of last resort to avoid negative spill-overs and systemic
crisis.
Another important contribution to the economy by central banks is to enhance the safety and
efficiency of the payment and settlement systems they operate. The Bank has made
continuous efforts also in this regard. Indeed, a number of improvements have been made to
the BOJ-NET over time, including the adoption of delivery-versus-payment (DVP) and
realtime gross settlement (RTGS). Liquidity-saving features have also been introduced with the
aim of enhancing efficiency while avoiding payment delays. Furthermore, in October 2015,
the new BOJ-NET was fully launched, with its operating hours extended to 9 p.m. in
February 2016.
II. Frontiers of FMI policy
The financial crisis and FMI policy - the importance of interactions and market
dynamics
The global financial crisis, triggered by the Lehman Crisis in 2008, put payment and
settlement systems under the spotlight of international debates, and frontiers of FMI policy
have been expanding. The FMIs as a whole could be regarded as an "eco-system", since
they have similar interconnectedness, complexities and interactions as biological
ecosystem. Policymakers including central banks are increasingly asked to grasp those
complicated interactions and market dynamics among various players as well as the impacts
of technological innovation, and to maintain not only the soundness of individual players but
also the stability of whole FMIs as an eco-system, with making full use of all the available
policy tools.
At the Pittsburgh Summit in 2009, G-20 leaders agreed that all standardized over-the-counter
derivatives contracts should be centrally cleared at central counterparties (CCPs). This
agreement was one example of the expanding frontier in that the policymakers took a step
forward to consider the "structure" of post-trade processing of financial transactions, in
addition to the risks in individual transactions or counterparties.
Stepping into unexplored policy areas raises a number of intellectually challenging issues.
For example, central clearing might accompany the accumulation of risks in CCPs and make
CCPs "too-big-to-fail." There are also issues of "trade-off", in a sense that a CCP's call for its
participants to provide additional capital or liquidity in times of market-wide stress could
weaken the capital and liquidity positions of those participants. Similarly, terminating
membership of a financially troubled participant would make the recovery of the participant
difficult, while maintaining its membership could increase risks for other participants and the
CCP itself. Moreover, a CCP's efforts to enhance its stability by collecting an extra layer of
margin could undermine the incentives of participants to make use of CCPs, possibly
increasing aggregate risks in the overall market.
Adding on to such complex challenges is the perspective of globalization. Also on this front,
there emerge many issues, such as what should be the appropriate framework for
international oversight of CCPs operating across borders, how liquidity shortages at
crossborder CCPs dealing with multiple currencies should be addressed, and how central banks
should contribute to the resolution of those issues.
Various international forums also recognize the importance of good understanding of
complex interactions and market dynamics by central banks and policymakers in enhancing
stability and efficiency of FMIs as an eco-system. In 2012, the Committee on Payment and
Settlement Systems (CPSS) - which is now the Committee on Payments and Market
Infrastructures (CPMI) - of the Bank for International Settlements and the Technical
Committee of the International Organization of Securities Commissions (IOSCO) published
the "Principles for Financial Market Infrastructures (PFMIs)." Since then, effective framework
has been developed for central banks and other authorities to ensure, through their oversight
and international peer reviews, that FMIs including payment and settlement systems meet
the PFMIs. The Bank is actively engaged in this initiative as an overseer of FMIs in Japan.
Innovations in information technology and FMI policy
Continuous efforts are being made to develop, enhance and sophisticate FMI policy. In
recent years, in accordance with innovation in information technology and rapid
popularization of internet, mobile phones and other digital outlets, wide-ranging financial
innovations, which are often referred to as "FinTech", have been taking place. In such an
environment, central banks and other policymakers need to grasp the impacts of those
technological innovations on financial architecture and FMIs, and to make full use of the
benefits of those innovations while effectively addressing any new risks.
The safety and efficiency of FMIs including payment and settlement systems have always
been closely linked to the information technology of the time. For example, many of the
operational practices and security features of traditional financial instruments, such as
banknotes, paper securities and ledgers, have been to a large extent based on paper-based
and printing-related technologies. For example, the security of banknotes is reliant on
paperbased anti-counterfeit features such as watermarks and holograms, and bill and check
clearing houses were established to facilitate and reduce the burden of their physical
delivery.
Given that the financial service industry has strong characteristics as an "information
industry," it is not surprising that innovations in information technology have a particularly
large impact on financial services and infrastructures. FMIs including payment and
settlement systems have been all the more characterized as "information infrastructures" for
recent developments in information technology. With "FinTech" developments, which
combine finance and information technology, financial services are expanding their frontiers,
while new players are venturing into the financial services market. Such dynamics are also
evidenced by the rich variety of participants attending today's conference.
Innovations in financial services and FinTech have significant potential to bring wide-ranging
benefits to the overall economy by expanding also the frontier of economic activities,
including e-commerce, sharing economies, big data processing, smart contracts and IoT
(internet of things). At the same time, FinTech may also have the potential of drastically
reshaping the forms of financial services and financial architecture.
Traditional financial infrastructure is built around "centralized ledgers," where banks have
managed ledgers of deposits and other financial products. On the other hand, "blockchain"
and "distributed ledger" - technologies underpinning digital currencies such as "Bitcoin" - are
considered as enabling to keep ledgers in a de-centralized manner without relying on a
trusted third parties to manage ledgers. Owing to such characteristics, blockchain and
distributed ledger have attracted considerable attention, since international forums are
focusing on their potential to be applied to wide-ranging businesses and practices. The
application of those technologies would also change the structure of the financial
infrastructure that has been built around centralized ledgers managed by trusted third
parties. Thus, central banks will and have to follow these issues closely and with great
interest.
FinTech has also the potential to unbundle and reconstruct various financial services. For
example, there may be payment-related services having substantial synergies with services
provided by non-financial businesses such as e-commerce and big data processing. As a
result of exploitation of "economies of scale" under technological innovations, new players
may become the providers of new services that incorporate financial solutions.
Moreover, it could be considered that such changes in financial architecture may change the
risk profiles of financial systems and infrastructures.
Commercial banks have long been the main provider of payment services. Commercial
banks, based on their deposit-taking as the core of their services, have kept on providing
both financial intermediations such as lending through maturity transformation and payments
services. Various financial infrastructures were built around such structure of commercial
banking. For example, access to the current account at central banks, including the Bank,
have been provided primarily to commercial banks and other depository institutions. The risk
of "bank-runs," which stems from maturity transformation by commercial banks, has been
considered as the main trigger of systemic crisis. Reflecting the above, central banks have
traditionally been assumed to provide its "lender of last resort" function mainly to commercial
banks and other depository institutions.
Since more and more non-financial institutions are providing payment services under
"FinTech" developments and there seem to be structural changes in the supply-side of
financial services, however, risk profiles might also change from those originally assumed.
For example, it is hard to assume the risk of bank-runs in "crowd-funding", which directly
matches demand and supply of funds through the internet, and in remittance services that
are fully covered by deposits. Deputy Governor Ben Broadbent of the Bank of England
pointed out in his speech in March the possible shift towards a risk profile that traditional
debates on "narrow banking" or "free banking" suggested due to the application of
technological innovation to finance.1 On the other hand, with the expansion of access points
to financial services through the popularization of internet, mobile phones and other digital
outlets, there are risks that would require higher attention, such as cyber attacks and hacking
against vulnerabilities on information security.
III. Bank of Japan's FMI policy
Taking into account the above-mentioned technological innovation, the Bank has been
actively enhancing the stability and the efficiency of Japan's FMIs by utilizing various policy
tools. They include providing banknotes and BOJ-NET as basic infrastructures to the
economy, conducting on-site examination and off-site monitoring of financial institutions,
oversight against FMIs including payment and settlement systems, and playing a "catalyst"
role to facilitate communication among wide-ranging players involved in FMIs.
Under globalization of the economy and technological innovations, more and more
transactions and payments are being made across borders and time zones, and more
diverse players are now providing payment-related services. One of the challenges for
private-sector entities to provide payment services related to global cash management and
e-commerce is how to deal with unsettled exposures that arise from time-zone differences
and payment operations at night hours and on weekends. Central bank money is the solution
that would ultimately erase these unsettled exposures through settlement with finality, but
providing central bank infrastructure also involves costs. In taking both possible benefits and
costs in account, the Bank will continue to consider the most appropriate way to provide its
central bank accounts and BOJ-NET from both "time" (i.e. operation hours of the BOJ-NET)
and "space" (i.e. eligibility criteria of the Bank's accounts), so as to contribute to the overall
economy.
Besides, banknotes are payment instruments that all the people can use 24/7, and under the
innovation in information technology, there emerges an issue about whether central banks
themselves should provide, in the future, digitalized payment tools that would substitute
paper-based banknotes. Indeed, some central banks have recently mentioned the possibility
of central banks' issuing digital currencies, and there are arguments that central banks'
digital currencies would be similar to the provision of central bank accounts not only to
financial institutions but also to the general public.2 The Bank does not have a specific plan to
issue digital currencies at this stage, but will deepen its research and analytical activities so
as to understand the impact of technological innovations, FinTech and distributed ledger on
financial architectures and FMIs while keeping all options open, including the possibility of
the Bank's utilizing such advanced technologies in its own operations in future.
Moreover, taking into account the importance of the people's "trust" towards financial
services and FMIs, the fact that the Japanese financial system has maintained its stability
during the recent global financial crisis could be a great advantage in developing innovative
financial services in Japan. On the other hand, as access to financial services expands
through internet and mobile devices, new types of threats to financial systems and
infrastructures, such as hacking and cyber-attacks, are gaining prominence. In order to
maintain people's trust towards financial infrastructures and innovative financial services,
relevant entities are strongly encouraged to take effective countermeasures against these
new risks also by utilizing new technologies such as digitalized encryption and biometrics
authentication. Furthermore, it is important to establish business continuity plans (BCPs) for
FMIs with sufficiently conservative stress scenarios such as natural disasters and acts of
terrorism. The Bank will work to deal with these important tail risks on FMIs. At the recent
earthquake in Kumamoto, the Bank's Kumamoto Branch, other area branches and Tokyo
Head Office took immediate and coordinated actions to firmly maintain the functions of
financial infrastructures in the region through various efforts such as ensuring smooth supply
of banknotes and funds settlement. The Bank will make use of those experiences so as to
strengthen overall BCP strategy.
In addition, in order to ensure the stability and enhance the efficiency of FMIs as a whole,
including those operated by the private sector, it is important to cooperate with the private
sector and encourage their efforts. Through the oversight of private-sector payment and
settlement systems, the Bank will conduct monitoring and dialogues with these
infrastructures, and when necessary, will strongly urge them to take actions to ensure the
stability and enhance the functionality of these infrastructures.
Furthermore, while more players with wider backgrounds have entered in the market of
providing payment-related services, it has become important to facilitate interactive dialogue
among wide-ranging entities beyond traditional financial industry, in order to make the
expansion of the financial service frontiers under the technological innovations fruitful for the
customers and the overall economy, and to enhance the stability and efficiency of FMIs. The
Bank, as the nation's central bank, is firmly committed to being a "catalyst" in fostering such
developments, and the establishment of the Bank's "FinTech Center" on April 1 is a part of
such commitment.
The Bank is ready to mobilize all the policy tools available while paying attention to
interactions among various players involved in FMIs, market dynamics and impacts of
technological innovations, and make maximum efforts as a central bank to enhance the
stability and the efficiency of Japan's financial infrastructure.
I would like to close my remarks by wishing that today's Conference on Retail Payments will
generate fruitful discussions.
Thank you for your attention.