The Moral Imperatives For Banks to Adopt Digital Currencies
By: Gökçe Güven
Tags: Financial Inclusion, Covid 19, Cryptocurrency, Blockchain, Banking

The Moral Imperatives For Banks to Adopt Digital Currencies

Investigating the set of questions on how banks should act and build towards financial inclusion

In October 2018, the World Bank launched Universal Financial Access by 2020 — an initiative committed to banking the ~2 billion globally unbanked.

Now, we are in 2020.

The change towards financial inclusion is too slow to achieve the World Bank’s goal.

Under the current COVID-19 isolation, financial accessibility is needed more than ever — low income households will be disproportionately affected by this pandemic.

This crisis can be turned into an opportunity of adoption for innovative solution, especially for the traditional institutions resistant to change. Global Findex outlined the importance of leveraging “mobile phone ownership and access to the internet” for financial inclusion in 2017. Currently, platforms like Celo and Facebook’s Libra tap into this potential for accessibility.

However, these innovations need cooperation from legacy institutions and current system. Banks still control the majority of opportunities to transact value and get loans. Banks are still the preferred choice whenever accessible. That is why COVID-19 recession discerns the pressing need for banks to be part of the change.

To produce the greatest good for the greatest number and fulfill their ethical duty, banks have a moral imperative to adopt digital currencies — shifting from charitable giving to empowering the unbanked.

Currently, the Federal Reserve envisions introducing digital dollars for COVID-19 Relief Plan. However, it is important to consider the design of these digital systems. With the current proposition of FedAccounts, digital currencies can merely be equivalent to digital cash, centralizing data. Decentralized Ledger Technologies can be a solution for banks to create robust, interoperable and secure systems.

With the guidance of normative ethics, this article investigates the set of questions that arise when considering how banks should act and build towards financial inclusion:

Beneficence, Making Financial Inclusion part of the Business Model: How might digital currencies enable banks to build services for the unbanked? Utilitarianism, CDFI Partnerships vs. Digital Wallets: How might banks reach the unbanked communities more effectively and efficiently? Justice, Role of Digital Identities for Universal Accessibility: How might digital identities help banks to break barriers to entry into financial systems? Autonomy, Potential Issues in Data Privacy: How might distributed ledgers help banks to design secure systems and ensure privacy?

1. Beneficence: Making Financial Inclusion Part of the Business Model:

Based on the Federal Deposit Insurance Corporation of United States, a household with $20,000 net income pays $1,200 for banking service fees. This means a family needs to sacrifice 6% of their income only to gain access to financial tools. These high costs of providing financial systems produce the main challenge for banking the unbanked because banks set high services fees and asset requirements to cover their costs.

According to deontological ethics, banks have an imperative to act towards maximizing accessibility. Principles of Beneficence calls that an institution has a moral obligation to support its community by helping citizens to further their interests. For banks, this community consists of the unbanked groups.

Currently, banks fulfill beneficence mainly with a top-down approach of giving– such as donation to a foundation. These forms of charitable giving or corporate social responsibility do not fulfill banks’ moral obligation, as the motives are short-term and minimally beneficiary.

In order to break out from the poverty cycle, the unbanked groups need to be able to save money, grow their business and earn additional income.

For true beneficence, the unbanked need an uplifting financial infrastructure that consistently serves their needs. Banks can embody these motives by making financial inclusion part of their business model. With distributed ledgers, serving for unbanked groups’ financial needs is made more feasible.

Under current banking models, the centralized infrastructure interbank and cross-border exchanges are costly, and an average settlement of a transaction takes 3 days. Distributed ledgers can allow transactions to be settled cheaper and faster, also keeping track of transactions better than existing protocols.

Visualization of interbank payment process and fees through SWIFT

In correspondent banking, the payer’s bank searches the SWIFT network to find the payee’s bank to settle a transaction, which requires a fee. With distributed ledgers, banks can settle these interbank transactions without intermediaries or relying on a network of custodial services.

An interbank blockchain can keep track of all transactions without a fee and settle the payment when it is made. That is why, digital currencies can enable banks to both propel growth cutting costs and meet societal needs.

Useful application of digital currencies towards financial inclusion include micro-loan/payment services, lower cost remittances, lending circles and more. Compared to the same options using fiat, digital currency micro-loans enable a lower minimum borrowing amount, and lower transaction fees allow for micropayments.

For example, a digital currency backed loan can let consumers borrow more conveniently as consumers tokenize their assets, increasing liquidity, instead of providing an asset like a home or business.

Globally, there are 200+ million Micro-Enterprises and 700 million people living on less than $2 a day. These groups are unable to pay the high fees associated with transactions or provide the assets to back up traditional loans. That is why distributed ledger use cases can remove the high barriers to entry into financial systems.

Building on decentralized ledgers, banks can re-model their business to serve the unbanked as consumers instead of donation receivers — sustaining long-term growth and impact together.

2. Utilitarianism: CDFI Partnership vs. Digital Wallets

How do banks give back to society currently?

Various regulations and policies incentivize banks to give back to their community. One of these regulations is the Community Reinvestment Act (CRA) federal law in the United States. Under this law, “banks are encouraged to meet the credit needs of low income neighborhoods.”

Banks mainly partner with Community Development Financial Institutions (CDFI), private institutions like banks or loan funds dedicated to serving society, to fulfill these obligations. Banks invest to CDFIs, get issued a score by agencies, and CDFIs serve as mediators to reach low-income neighborhoods.

Problem with CDFI partnerships:

Community Reinvestment Act can be interpreted as a regulation for banks to adhere to the moral imperative to care. However, these partnerships neither maximize the beneficence to the unbanked or utility of banks’ investments.

Across the United States, access to CDFIs is uneven — of these CDFIs, the six states that need the support the most, with the lowest personal income per capita, have the least number of locations. These distributions and past CDFI corruption cases raises a number of questions:

How do CDFIs determine location? How effectively and efficiently do CDFIs serve and grant access to target populations? How does the Federal Reserve track and measure CDFIs impact?

From a utilitarian perspective, a bank’s action is morally right if it results in the greatest amount of good for the greatest amount of people affected by the action. Considering the current process of giving, CDFI partnerships are slow in implementation, restricted in accessibility and hard to measure or track outcomes.

Giving better: Digital Wallets

Banks need a direct-to-consumer way of giving through which they can identify, track and measure their reach. This change is possible through digital wallets, providing scalable, peer-to-peer and secure ways of supporting communities.

Leveraging digital ledgers and identification mechanisms to track receivers of aid, digital wallets can help banks’ investments be more targeted. Digital wallets can help banks distribute investments fast and frictionless, ensuring allocated funds reach the individuals in need.

Adding a mediator to support disadvantaged groups creates inefficiency and incompetence in the system. Aligning CRA resources with community needs, banks can use digital wallets to better serve the unbanked.

3. Justice: Role of Digital Identities for Universal Accessibility

In 2017, 1.1 out of 2 billion of the globally unbanked couldn’t open a bank account because they didn’t have the required identification documents. Of these 1.1 unbanked, the majority consists of systematically oppressed populations including immigrants, minorities, women, and people from low income neighborhoods. This is because current bank onboarding mechanisms create interdependence between documentation and financial accessibility.

Considering the denial of specific groups from financial services, banks have a moral imperative to remodel their onboarding and identity verification. The Principle of Justice calls for businesses to provide equal opportunities, treating all people in the society fairly regardless of race, gender, or class rank. To fulfill this obligation, banks can build digital and inclusive ID systems.

Leveraging cryptographic keys and unique biometric authentication systems, banks can build applications on distributed ledgers to securely verify digital identities. These identities, which can be stored and managed by consumers, can empower the unbanked to access financial systems anywhere with a mobile device.

Re-thinking fundamentals of documentation requirements, digital identities can diminish onboarding compliance and enable the unbanked beneficiaries to transact, deposit and receive money locally and globally.

4. Autonomy: Potential Issues in Data Privacy without Decentralization

As banks build new systems for governance, potential dangers of these designs must be acknowledged. Various adoptions of digital payments and currencies can increase privacy concerns given the higher traceability relative to cash transactions.

With guidance of the ethical principle of autonomy, banks need to respect the decisions made by consumers concerning their own lives.

There are numerous ways digital currencies can violate privacy of users if its applications comprise security and anonymity. If digital currencies are implemented as mere digitalization of cash, the unbanked and all consumers would be forced to make a trade-off between gaining access to much needed financial services and their privacy.

Currently, banks are already centralized authorities of consumers’ information with access to personal and financial data. In order to use a digital bank account or ID system built on the same infrastructure, the unbanked would be directly providing their information, like phone numbers or fingerprints.

With centralized digitalization, banks would be able to aggregate more consumer data and could potentially exploit this information to segregate consumers even more.

Banks can require consent to extract value from consumer data to avoid potential legal issues. However, this agreement would be a contract of adhesion as consumers would not have bargaining power.

Decentralized ledgers with cryptographic protocols can bring a solution to this problem by integrating innovations to mitigate privacy risks more successfully than current databases. The core capabilities of decentralized ledgers are that there is no central storer of transaction data, and user-ids can be encrypted, preventing banks from becoming controllers of consumers’ information.

In distributed ledgers, the tension of who is the controller of the ledger and which data sharing is publicly shared can be addressed with emerging methods like zero-knowledge proofs. These protocols enable validation of data by distributed nodes without visibility over the underlying data itself, preserving the ledger’s immutability and transparency while protecting sensitive information.

Techniques like ZK-proofs can be beneficial to help banks be compliant with Anti-money laundering and Know your customer regulations. This way banks can operate public ledgers while preserving privacy.

With a privacy-by-default systems design approach that is possible with decentralized ledgers, regulatory agencies and banks can protect consumers and create verifiable, self-sovereign platforms — respecting autonomy and ensuring privacy.

Conclusion:

Hand in hand with a clear and supportive policy framework for financial stability, technology-led innovation can offer the greatest benefit and utility for both institutions and all segments of consumers.

A world where everyone can send remittances in minutes, deposit money from their phones and open savings accounts with one-click biometric verification securely is not the distant future, it can be the tomorrow.

To make this potential present a world-wide reality, we need to build it — together.