The Financial System of the Future: 44Th Economics Conference 2017 of the Oenb in Cooperation with SUERF

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Proceedings The financial system of the future: 44th Economics Conference 2017 of the OeNB in cooperation with SUERF

SUERF Conference Proceedings, No. 2017/3

Provided in Cooperation with: SUERF – The European Money and Finance Forum, Vienna

Suggested Citation: Oesterreichische Nationalbank (Ed.) (2017) : The financial system of the future: 44th Economics Conference 2017 of the OeNB in cooperation with SUERF, SUERF Conference Proceedings, No. 2017/3, SUERF - The European Money and Finance Forum, Vienna

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44th ECONOMICS CONFERENCE 2017 of the OeNB in cooperation with SUERF

The Financial System of the Future Contents

Contents

Ewald Nowotny Session 5 Opening remarks 4 Technological change and the future of cash Thomas Drozda Kurt Pribil Opening address: The Financial System of the Future 10 Introductory statement: Technological change and the future of cash 110 Clemens Jobst, Helmut Stix Session 1 Is cash back? Assessing the recent increase in cash demand 112 Digital money and digital banking François R. Velde Doris Ritzberger-Grünwald Money and payments in the digital age: innovations and challenges 124 Introductory remarks: Digital money and digital banking 18 Michael Kumhof Session 6 The macroeconomics of central-bank-issued digital currencies 22 FinTech: opportunities and challenges for banks and regulators Thomas Puschmann Peter Mooslechner Banking without banks: Will technology transform financial intermediation? 26 The FinTech Revolution: More important than the ATM? 136 Klaus Kumpfmüller Session 2 Financial innovation – a regulator’s perspective 144 Keynote address Andreas Ittner Session 7 Introductory remarks: Preparing banking regulation for the future 36 SUERF annual lecture Sir Paul Tucker Erkki Likkanen The political economy of central banking in the digital age 42 Is the post-crisis financial system more resilient? What remains to be done? 150

Session 3 Contributors 158 Technological change and the future of financial intermediation Martin Summer Introductory statement: Technological change and the future of financial intermediation 60 Patricia Jackson PSD2 and open banking: the policy issues 62 John Kay Technological change and the future of financial intermediation 70

Session 4 The capital markets of the future Ernest Gnan The capital markets of the future: positive versus normative aspects 80 Nikolaus Hautsch High-frequency trading: risks and benefits 84 David Yermack Smart contracts and corporate governance 94 Klaus Liebscher Award ceremony 100 Dinner speech Hans Jörg Schelling The banking sector – fit for the future? 102

2 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 3 Ewald Nowotny Opening Remarks Governor Oesterreichische Nationalbank Ladies and gentlemen, cooperation and would also like to I am very pleased to welcome you to encourage those among you who are the 44th Economics Conference of the not yet SUERF members to join this Oesterreichische Nationalbank here in network. Vienna. My particular welcome goes to Fed- Today, I want to invite you to take a eral Minister for Arts and Culture, break from our routine engagement in Constitution and Media Thomas Drozda, the daily workings of the financial sys- who will tell us what role the financial tem. Let us take a look at the future system plays in his vision for the future instead: what kind of institutions and of the Austrian economy. markets will manage our financial wealth, I am also very honored to welcome our liabilities and our payments in 10 my colleague Erkki Liikanen, Governor of or 20 years? Suomen Pankki – the Bank of Finland, To explore this issue, we have as- who will give a lecture here tomorrow. sembled a noteworthy list of distin- Erkki Liikanen is not only a dear col- guished speakers from different back- league of mine on the Governing Coun- grounds in academia, policy making cil of the European Central Bank, but and the financial sector. I am sure they he also heads the central bank of a will provide us with intriguing food for country that is very advanced with thought during our two-day confer- respect to digitalization, which seems ence. I would like to thank all of them to be a major route for the future finan- for coming to Vienna and for contribut- cial system to take all over Europe. He ing to our endeavor. I would also like to is therefore in a vanguard position to take the opportunity to thank the staff shed light on some of the challenges we members of the OeNB, and our friends are most likely to face on the road ahead. at SUERF, for their effort in organizing Thank you very much for joining us this event. today. We are very pleased to organize this year’s Economics Conference jointly with SUERF – The European Money and Finance Forum. SUERF has been in existence since 1963 and has made countless contributions to research on money and finance matters over the past half century. SUERF’s central aim is to facilitate and promote dialogue between policy makers, financial firms and practitioners as well as academia on money and finance topics. Such a dialogue is definitely also key to shaping the Financial System of the Future. Ladies and gentlemen, The OeNB has had a very special One of the key tasks central banks and good relationship with SUERF for have is to ensure stability. Regardless of over a decade. The OeNB hosts SUERF’s how stability is defined, it is inextrica- Secretariat, and a senior OeNB staff bly linked with a longer-term orienta- member acts as SUERF’s Secretary tion. Looking back at the 200-year his- General. We are very glad about this tory of our bank last year, we were re-

44th ECONOMICS CONFERENCE 2017 5 Ewald Nowotny Ewald Nowotny

minded of the many unforeseen events remembered for his referral to “known expectations in Europe is a widespread wealth, information collected in the that had unfolded during the past two knowns” as distinct from “known perception that we are about to be Eurosystem’s Household Finance and centuries. And this will become mani- unknowns” and “unknown unknowns”.1 overtaken by strongly growing emerg- Consumption Survey points to dispari- fest in an even broader perspective In economics, these distinctions are ing economies. And indeed, the EU’s ties that are even more pronounced when we celebrate the centenary of the well known, although under different share in global economic activity has than inequalities in income. Income establishment of the Republic of Aus- names – certainty, risk and uncertainty. been declining, namely from 26% in and wealth inequality may fuel social tria next year. For a central bank, committed to 2004 to 22% in 2015, and it is expected tension and harm economic growth, as representing an anchor of stability, the to fall below 20% by 2030. Similarly, pointed out by the IMF’s recent World main orientation points which guide its the EU’s share in world population, Economic Outlook. To tackle inequal- behavior in an uncertain world are of a currently at 6%, will shrink to a mere ity, the IMF reminds us that we will macroeconomic nature: economic growth 4% by 2060.4 But let us not lose sight of have to envisage policies which prospects, population trends and the the fact that neither one of these shares strengthen the position of those at the distribution of the fruits of growth. in isolation is relevant for measuring bottom of the income and wealth dis- With respect to growth, the recov- our prosperity. What really counts is tribution in the labor market, and more ery in the wake of the financial crisis per capita income. Here, the EU – substantial redistributive measures.5 has been modest by historical stan- while still slightly lagging behind the Otherwise, we risk losing public sup- dards. Strong savings, modest invest- U.S.A. – is still far ahead of any other port for policies which contribute to ment activity and a continuing debt economic region. And within the EU, our prosperity. We should not forget overhang have led some observers to Austria is among the top performers that international cooperation and expect a period of secular stagnation. I with respect to per capita income. exchange remain the key to prosperity do not share this gloomy perspective, Perceiving the world economy as an in an interconnected world economy. Times change, and time and again but I agree that we cannot expect a endeavor where the expansion of one Finally, I would like to come back we realize how flawed our efforts are at return of growth rates comparable to country results in a loss for the rest is a to the role of technology. predicting the future. Public institu- those seen in Europe during the two misperception that can become out- Let me touch on a few implications tions that are committed to maintain- decades of reconstruction after the Sec- right dangerous if it forms the basis of for the banking sector. Whatever im- ing stability are invaluable because, in a ond World War. international policy making. Economic pact digitalization will have on the long-term perspective, uncertainty Let me turn to population trends to growth in emerging markets in recent future shape of the financial sector, it is about the future seems to be one of the illustrate that unforeseen events do not decades went hand in hand with a reasonable to expect a reduction of the few constants in life. always imply a need for a downward growing world economy. In such an current labor force in the banking sec- Today, technological innovation is revision of expectations, but can instead environment, a declining share in the tor. To some degree, such downsizing an ever-present factor, but we should require an upward adjustment. A decade world economy does not imply a wel- is already an ongoing process in the be wary of drawing deterministic con- ago, Austria’s demographic projections fare loss. After all, the global economy post-crisis landscape. In Austria, we clusions from it. Structural changes in pointed toward stability, even decline.2 is not a zero-sum game. see employment in the banking sector our economic system have exhibited a Yet, recent unforeseen developments have Focusing on per capita income decline. And we must be prepared to remarkable tendency to prove unpre- transformed perspectives. Largely due might undoubtedly mask huge asym- see a continuation of this trend in the dictable. It seems that the only thing to migration, Austria’s population is ex- metries in the distribution of the gains years to come. we can be certain about is uncertainty. pected to grow by as much as 12% until from globalization within countries. The other important change that is This applies both to the future path of 2040 according to the latest forecasts.3 But also in this respect, the European likely to occur is the rising importance innovation and the future sources of The impact of migration serves as Union comprises the most equal societ- of market-based forms of finance, also financial crises. The former U.S. Secre- a reminder that we live in an age of ies in the world. Admittedly, it has not in countries like Austria, i.e. countries tary of Defense Donald Rumsfeld is well globalization. One reason for gloomy managed to escape the general trend of which are traditionally characterized declining labor income shares that had by a dominance of bank-based finance. 1 Graham D. A. 2014. Rumsfeld’s Knowns and Unknowns: The Intellectual History of a Quip. https://www. started in the 1980s. As to household The capital markets union pursued by theatlantic.com/politics/archive/2014/03/rumsfelds-knowns-and-unknowns-the-intellectual-history-of-a- quip/359719/. 4 Source: European Commission. 2017. White Paper on the Future of Europe. Reflections and scenarios 2 Scherbov et al. 2008. Probabilistic Population Projections for the 27 EU Member States Based on Eurostat Assumptions. for the EU27 by 2025. World Bank Database. https://ec.europa.eu/commission/sites/beta-political/files/ http://www.oeaw.ac.at/fileadmin/subsites/Institute/VID/PDF/Publications/EDRP/edrp_2008_02.pdf. white_paper_on_the_future_of_europe_en.pdf. 3 Statistics Austria. 2017. Population Forecasts. https://www.statistik.at/web_en/statistics/PeopleSociety/population/ 5 IMF. 2017. World Economic Outlook. April. Chapter 3. Understanding the downward trend in labor income shares. demographic_forecasts/population_forecasts/index.html. p. 140. http://www.imf.org/en/Publications/WEO/Issues/2017/04/04/world-economic-outlook-april-2017.

6 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 7 Ewald Nowotny

the European Union will foster activity and contributes to their favorable devel- and cross-border integration in this opment is certainly an important endeavor domain, promoting the development of in an era of rapid change. I hope our new forms to finance economic activity. conference will help foster our under- But the extent of economic activity standing of emerging trends and their to be undertaken and its financing needs possible impact – with all due modesty, will be shaped less by technology than given our experience in attempting to by the macroeconomic parameters and forecast the future. policies I have already referred to above. I wish all of us two days of lively Having said that, framing techno- and productive discussion, and I hope logical evolution in a way that best we will succeed in strengthening confi- adapts to macroeconomic circumstances dence in the future ahead of us.

8 OESTERREICHISCHE NATIONALBANK Thomas Drozda Opening address: The Financial System of Federal Minister for Arts and Culture, Constitution and Media the Future

Dear Governor, Then like today, we were con- Ladies and gentlemen, cerned about the efficient allocation of capital. This has always been one of the It is my pleasure to welcome you today, most important functions of the finan- also on behalf of Chancellor Kern, who cial system. Our economics textbook sends his greetings. I have started my offered a rather sketchy idea how this personal career in the central bank, so allocation would work: banks take this is kind of a homecoming for me. deposits and lend to enterprises that Today, I would like to talk about the use these credits to fund their invest- financial system and its role in the allo- ments; the investments in new machin- cation of capital. I will also briefly men- ery, or more general: in new technolo- tion what the government and the reg- gies, would then enhance the productive ulators can do to make the financial capacity of the economy and thereby system of the future more stable. drive growth. If each credit expansion But first, let me thank the central was used to finance productive invest- bank for hosting this conference for the ment, financial deepening indeed would 44th time because when you bring always contribute to growth and em- together policy makers and economists, ployment. bankers and academics, you provide us But it wasn’t, so it didn’t. with a good opportunity to exchange our views and learn from each other. Today, the production of knowledge very often is organized in strictly separated fields, sometimes even called “silos”, and even within one field, theory and practice often are not much in contact. I would like to thank my former colleagues for organizing this event where we can mingle and chat and see what views we have on the financial system of the future. When I worked as an economist in the Oesterreichische Nationalbank (OeNB) – some 25 years ago – our present finan- More and more often we see that cial system of today was still very much people take credits to buy already existing the financial system of the future. I am assets, for example houses. While build- quite sure that back then no one would ing a new house creates value added have imagined the financial system of and therefore contributes to growth the future in the way it has developed and employment as it generates profits since. In the words of Paul Krugman: for the construction firm and wages for “The old world of banking, in which the masons and plumbers, buying an institutions housed in big marble already existing home is merely a finan- buildings accepted deposits and lent the cial transaction. Sure, there might be money out to long-term clients, has some value added from the real estate largely vanished.” agent, but in comparison, it is negligible.

44th ECONOMICS CONFERENCE 2017 11 Thomas Drozda Thomas Drozda

Adair Turner analyzed this phe- more private households and once an many initiatives that can be imple- for private investments are waning, nomenon very well and called it “too asset price bubble bursts, these house- mented at the national level and we too. And in the current low interest much of the wrong sort of debt”. He holds end up being over-indebted. This have already started to do so. rate environment, public investment shows that 2/3 of bank lending in the over-indebtedness makes the recession But I would like to come back to would be cheaper than ever. Martin UK went into residential mortgages following the crisis especially painful the allocation of capital, this time at the Hellwig, one of the most eminent Ger- and another 14% into commercial real and long, because households have to international level. We know from our man economists of our time, published estate. By using a large share of credit deleverage before they can spend a textbooks that national savings minus an opinion piece in the FAZ last week, for real estate transactions, you can larger share of their income on con- national investment equals the current in which he was asking his government inflate house prices, thereby making sumption again. account balance. This is not a theoreti- exactly to do that: invest more in public the house owners richer. But this is not Now for what we know, in Austria cal conjecture but a mere accounting infrastructure to improve German the most productive use of capital one income inequality has not risen as identity, so we know it must hold. roads and rails and to reduce the exorbi- can imagine. And it also raises the ques- strongly as in other countries, but we Countries that exhibit a current account tant German current account surplus. tion of sustainability: credit-fueled a sset cannot be quite sure as we have no reli- surplus save more than they invest and inflation drives up house prices and able data. We know that wage inequal- lend their excess savings to other coun- higher house prices justify larger loans ity has not risen strongly, but informa- tries. This might be a perfectly sensible because the loan-to-value-ratio stays tion on capital income is lacking. thing to do as many countries face de- within reasonable limits. As long as credit Besides, wealth inequality is rather high mographic challenges in the form of supply is unconstrained the expectation in Austria as we know from the studies ageing populations. The financial sys- of increasing future prices itself leads to conducted by the OeNB in cooperation tem should also facilitate the allocation higher house prices and eventually to a with the Household Finance and Con- of capital over time and enable people bubble that will burst. sumption Network, for example. to manage their personal finances This is exactly what we have seen in So what is our policy response? If across their lifetimes, between genera- the U.S.A., in Ireland or Spain. To pre- we want to avoid financial turmoil and tions and across borders. In theory, vent these self-reinforcing boom-bust- strengthen the resilience of our econo- well-integrated financial markets allow cycles from happening, we have to mies, we have to strengthen the middle for international risk sharing and should equip our regulators and supervisors class. As it happens, this is exactly what stabilize the economy. with macroprudential instruments. But our chancellor aims to do. Already last There are several problems with this as useful as these instruments may be in year Chancellor Kern has presented his assumption. First, there is no empirical I would also like to comment briefly strengthening the resilience of the vision for more growth and broadly evidence that risk sharing has happened on the stability of the financial system of financial sector and the economy as a shared prosperity by strengthening in Europe to a degree that would have the future. That financial stability is dear to whole, they do not address the root cause investment and labor demand. His aim had any stabilizing impact on final central bankers goes without saying. But of the unsustainable credit demand: the is to implement practical measures that demand, even before the crisis, despite also we in government have a very strong rising inequality in our societies. improve the lives of the men and women a significant amount of financial inte- inherent interest in the stability of the Thomas Piketty, Tony Atkinson and in our country directly. gration (e. g. Moser et al., 2004). And financial system, mainly for two reasons: others have well documented the As we are here on invitation by the second, investing abroad does not really 1. The economic, social and political increasing inequality in western societ- central bank, let me quote Mario Draghi: yield high returns, if any. When Ger- consequences of financial crises can ies over the past decades. Raghuram “In a society where […] the welfare man and French savers invested in U.S. be dreadful. The Great Depression Rajan was one of the first to explain the state generously supplies education, health mortgage backed securities or Spanish that followed the financial crisis of rising financial instability of the 2000s and housing benefits, covers against the residential property, they suffered quite 1929 brought poverty and despair, by the simultaneously rising inequality risk of unemployment and protects old-age painful losses. radicalization and war. of income and wealth. His reasoning is income levels, […] holdings of wealth are At the same time, investment at 2. Even if a financial crisis does not straight forward: when a rising share of less important. When these conditions cease home is lacking. This is in particular lead to depression, the cost of fight- income goes to the people at the very to hold, […] wealth takes on a new signi true for the public sector: public investing a financial crisis or of avoiding a top of the distribution, the middle class ficance for household prosperity.“ ments have been at low levels for many meltdown of the financial system and everyone else must take credits to The plan of the chancellor, the so years but the ministers of finance are usually ends up on the government’s keep their standard of living. This leads called “Plan A”, also aims at the sustain- obsessed with the “black zero”. This is balance sheet. to growing indebtedness of more and ability of the welfare state. It includes worrisome because if domestic infra- Unfortunately, according to the work of structure is deteriorating, incentives Hyman Minsky we seem to be trapped

12 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 13 Thomas Drozda Thomas Drozda

IMF states that in response to the cash from our citizens. Unfortunately, we know them. Žižek was referring to financial crisis, major regulatory some politicians like to evoke a phan- the Freudian unconscious. When it comes reforms have been started. However, tom menace that is threating the public to the financial system and the ques- while the financial system is still vul- because they hope to gain some addition: how to avoid a financial crisis? I nerable in some respects, there are tional votes by fighting these made-up find it quite interesting how many pressures to stall or even roll back the conspiracies. Unfortunately, some sen- things that we have known were reform process. Clearly, we have to sationalist media like to propagate these unknown when we needed them. The evaluate our reforms constantly and ad- made-up threats. But I can assure you insights and findings of Keynes, Min- just shortcomings or overshooting that there are enough serious politicians sky, Tobin or Galbraith – just to name a when needed. But, for the very reasons who are focused on the financial system few – have been suppressed to establish I have just presented, we want the of the future and the real problems and a new orthodoxy in the spirit of the financial system of the future to be the real solutions. ever so efficient market. Generations of strong and stable and therefore we can- Finally, as Governor Nowotny quoted economists had to unlearn the things in a cycle: financial stability bears com- not allow ourselves to be complacent or Rumsfeld’s distinction of “known knowns”, they had known from their university placency, complacency bears crisis, cri- our regulations to be weak. “known unknowns” and “unknown un- training and when the crisis hit us, sis bears better regulation, better regu- Also the policy makers must be knowns” I would like to bring to your many policy makers and their staffs lated markets bear financial stability, strong and sincere on this point. It is attention a response by the philosopher were unprepared. I hope that this con- and so on. not sincere to agree on regulations in Slavoj Žižek who reminded Rumsfeld ference also gives us the chance to How can we break this cycle? If I Brussels and then to complain at home that next to these “knowns” and “un- uncover some of these insights and help may say so, there are some dialectic les- about the onerous EU regulations. They knowns” there is also the “unknown us to establish a more stable financial sons from the past: did not appear from nowhere, member known”: things that we don’t know that system of the future. First, we were told to avoid a finan- states’ ministers have a fair share of cial meltdown at all cost, which meant ownership for these regulations and to save banks, sometimes even bank- they have to live up to that. References rupt banks in order to prevent panic. Before I end let me just briefly men- Atkinson, A. 2015. Inequality: What Can Be Done. Harvard University Press. This was the big lesson from the 1930s. tion two more issues about the future Caballero, R., H. Takeo and A. Kashyap. 2008. Zombie Lending and Depressed Restructuring Then we learned that banks that of payment systems that you might dis- in Japan. In: American Economic Review 98/5. were almost bankrupt could delay or cuss during the conference. With Draghi, M. 2007. Household wealth in central bank policy analysis. Speech at the Luxembourg even impede the recovery when kept respect to Bitcoin and other alternative Wealth Study conference in Rome. alive artificially; the warning example forms of money: personally, I am rather Hellwig, M. 2017. Bitte nicht großdeutsch. Frankfurter Allgemeine Zeitung. May 20. has been Japan since the 1990s. So, the open to these approaches, but also IMF. 2017. Global Financial Stability Report: Getting the Policy Mix Right. Washington D.C. conclusion was to avoid “zombie banks”, skeptical about their chances. We know Krugman, P. 2008. Financial Russian Roulette. New York Times. September 14. and let bankrupt banks go belly up. that Hayek had this idea about compet- Minsky, H. 2008. Stabilizing an Unstable Economy. McGraw-Hill. (e. g. Caballero et al., 2008) ing private currencies and good money Moser, G., W. Pointner and J. Scharler. 2004. International Risk Sharing in Europe: Has So how do we square this circle? driving out bad money. However, that Anything Changed? In: Liebscher, K., P. Mooslechner and D. Ritzberger-Grünwald (eds.). The The synthesis seems to be to save the was in the 1970s. Now, in the days of Economic Potential of a Greater Europe. Edward Elgar. part of financial sector that serves a Google and Facebook, we are con- Piketty, T. 2014. Capital in the Twenty-First Century. Harvard University Press. useful economic purpose, and unwind stantly reminded of the existence of Rajan, R. 2010. Fault Lines. University Press Group. the rest. To do so, we had to create a network externalities that might also Turner, A. 2015. Between Debt and the Devil. Princeton University Press. workable and credible resolution frame work in favor of our legal tender issued Žižek, S. 2008. Rumsfeld and the bees. The Guardian. June 28. work. An appropriate EU framework by the central bank. has been enacted, now we have to live And with respect to the future of by the rules that we have agreed upon coins and banknotes, let me paraphrase in order to establish the credibility that Mark Twain: reports on the death of we need. cash are greatly exaggerated. We will In this context, I would like to echo use cash in everyday transactions for a warning by the IMF. In its recent the foreseeable future and we in gov- Global Financial Stability Report, the ernment have no intention to take away

14 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 15 Session 1 Digital money and digital banking Doris Ritzberger-Grünwald Introductory remarks: Director Oesterreichische Nationalbank Digital money and digital banking

Central banks and the banking system ments for the near or mid-term future? have been the institutional backbone of One obvious reason is that we tend to the monetary system for roughly three have a poor understanding of many centuries. Today digitalization is mak- aspects of the issues at stake. While we ing inroads into both of these domains. discuss at length particular aspects, say, While it is still unclear how transfor- cryptocurrencies and blockchain tech- mative these changes will turn out to nology, FinTech and banks, peer-to- be for money and banking as we know peer lending and payment innovations, it, the discussion, both among academics very rarely due consideration is given to as well as among practitioners, has gained the bigger picture, taking into account momentum in the past few years. how the different parts interact and We want to take up the major themes influence each other. For instance, we and issues of this debate right at the be- still know very little about how the ginning of our conference on the future digital revolution in money will interact of the financial system, which will obvi- with the digital revolution in banking. ously be a future profoundly shaped by How will monetary policy work in a digitalization. digital world? Should central banks In the debate, some have embraced actively adopt new technologies or pursue a rather utopian interpretation of the a more passive strategy? Is it necessary to recent technological advances in money develop regulatory tools now, or is it and banking. For them, digitalization better to pursue a “hands-off” approach promises a future of higher financial and not to impede financial innovation? inclusion, and unprecedented user-friend- liness by broadening the availability of financial services and by slashing the costs of providing these services. At the same time, it is argued, we can expect improvements in financial stability because thanks to their decentralized nature, the new technologies of digital money and banking, in particular the blockchain technology, will increase the resilience of the financial system. Others are more concerned with potential downsides, fearing, in particular, the retreat of the state from money and banking, monetary chaos, financial In the end, the discussion of the impli- instability and financial exclusion rather cations of digital change in money and than inclusion as well as negative labor banking forces us to rethink the foun- market implications for those in the dations of our monetary and financial financial industry who will be made system and the key economic functions redundant. it has to and should fulfill. How is it possible that the participants’ In this session, we will have two views in the debate differ so widely, papers that can help us with this task. with even contradictory interpretations Our first speaker, Michael Kumhof, of the implications of recent develop- senior research advisor at the research

44th ECONOMICS CONFERENCE 2017 19 Doris Ritzberger-Grünwald

hub of the Bank of England, will present the head of the Swiss FinTech Innovation a paper about the macroeconomics of Lab at the University of Zürich and Exec central bank-issued digital currency. utive Director of Swiss FinTech Innova- Michael and his co-author, John Barrdear, tions, an independent association of Swiss see great potential in an activist approach, financial institutions committed to driv- where central banks embrace and actively ing collaboration and digital innovation use the new technology of digital cur- in the financial service industry. Based rencies for monetary policy and macro- on this experience he will discuss the economic stabilization. Our second question whether technological change speaker, Thomas Puschmann, will shed in banking will lead to an effective end light on the digital revolution in bank- of banks as we know them and lead us ing. He can draw on rich experience as into a future of “banking without banks.”

20 OESTERREICHISCHE NATIONALBANK Michael Kumhof The macroeconomics of central-bank-issued Senior Research Advisor Bank of England digital currencies

The emergence of the distributed ledger tary policy that determines the risk- technology (DLT) and of Bitcoin was a free nominal policy interest rate, and watershed moment in the history of CBDC policy that determines either electronic monies. It may now, for the the quantity of or the interest rate on first time, be technically feasible for CBDC. Countercyclical CBDC policy central banks to offer universal elec- either withdraws CBDC from circulation tronic access to their balance sheet, to a in a boom, or makes CBDC less attractive central bank digital currency (CBDC). to hold by paying a lower interest rate The only existing form of electronic in a boom. access, centralized real-time gross settle- In this model, if liquidity becomes ment (RTGS) systems, has only been scarce, increases in tax-like monetary designed for a small number of partici- frictions increase the cost of doing busi- pants, and would not be sufficiently robust ness, leading to lower output. Liquidity to accommodate universal access. scarcity originating in the banking sector We define CBDC as a monetary in- can be partly offset through the creation strument issued by the central bank, of additional CBDC by the government. available on a 24/7 basis, electronic and probably based on DLT, universal (meaning accessible to banks, firms and households), national-currency denom- inated, issued either through public spending or against eligible assets (government debt), coexisting with the existing banking system (with banks remaining the creator of the marginal unit of domestic currency), and interest-bearing, with the interest rate managed so as to equate demand and supply for CBDC at a 1:1 exchange rate with other forms of national money. We use a state-of-the-art DSGE Our first quantitative experiment model to study the benefits and costs of studies the introduction of CBDC into introducing CBDC into an economy an economy without CBDC. The mag- that is calibrated using U.S. macroeco- nitude equals 30% of GDP, which is in- nomic data. The key ingredients of this troduced through buying back govern- model are a banking sector that creates ment debt equal to that amount. The private deposit money through the exten- result, which of course is calibration- sion of loans, a government that creates dependent (but where that dependence CBDC, and a private sector that requires can easily be studied), is a 3% increase liquidity to purchase consumption goods, in GDP, and this is shown to be due in investment goods, and inputs into pro- roughly equal measure to three factors. duction. Liquidity in turn is produced The first factor is lower real interest through an imperfectly substitutable rates, due to a 30% of GDP reduction combination of bank deposits and CBDC. in the outstanding stock of high-inter- Government policy rules cover fiscal est defaultable government debt, and its policy (including the use of revenue replacement by 30% of GDP of low- from CBDC creation), traditional mone- interest non-defaultable CBDC. The

44th ECONOMICS CONFERENCE 2017 23 Michael Kumhof Michael Kumhof

low interest rate on CBDC is explained One question concerns the compar- Another question concerns the effects CBDC, there is no way for the econ- by its non-pecuniary convenience yield ative advantages of using a quantity rule of using the CBDC interest rate counter omy as a whole to do so. The exchange due to its use in economic transactions, or an interest rate rule to manage cyclically, in combination with the con- of bank deposits between individuals while its non-defaultable nature is due CBDC issuance over the business cycle. ventional policy rate for the interest rate does not change the aggregate stock of to the fact that holders cannot ask for This choice turns out to be especially on central bank reserves. To illustrate bank deposits, while a run from bank repayment of sovereign money in some- important following shocks to the sup- this, we choose a CBDC interest rate deposits against CBDC at the aggregate thing other than sovereign money. ply of or demand for liquidity. Consider rule that, similar to the policy rate, re- level would require that the central The second factor is lower distor- a sudden increase in the demand for sponds to deviations of inflation from a bank accept bank deposits in exchange tionary tax rates on labor, capital and liquidity, either in the form of bank target, and that otherwise maintains for CBDC issuance. This however is consumption. The assumption is that deposits or of CBDC. We interpret this the CBDC interest rate at a fixed spread ruled out as part of the assumed mone- the government uses the interest savings as a flight to safety, with agents prefer- below the policy rate. Our simulations tary policy operating environment. from CBDC issuance, and the revenue ring to hold on to their liquid and safe show that, in a credit boom-bust cycle, First, under a quantity rule the central from its creation, to lower these taxes balances rather than spending them. a negative response to inflation stabi- bank allows the interest rate on CBDC while leaving the deficit target unchanged. This is represented in the model as an lizes output. In other words, during the to adjust to remove any demand in ex- The third factor is an increase in increase in the cost of doing business, boom/bust the spread between the cess of the quantity target. And second, liquidity that lowers the cost of doing and it has a contractionary effect on policy rate and the CBDC rate widens/ even under a CBDC interest rate rule business. CBDC can be produced by GDP. Going back to an argument of narrows, thereby making it less/more CBDC is only issued against eligible the central bank without the cost of the Poole (1970), under such money de- attractive to hold CBDC. The endoge- assets such as government bills, not spread and of other frictions that ac- mand shocks a quantity rule is far infe- nous withdrawal and injection of against bank deposits. A run scenario company the creation of bank deposits, rior to a price rule, because holding CBDC liquidity during the boom and therefore requires extreme assump- leading to an overall increase in liquid- liquidity fixed in the face of an in- bust periods helps to stabilize GDP, tions, such as CBDC interest rates that ity. The increase in CBDC is accompa- creased demand for liquidity forces a over and above the effects of the policy become too negative to be politically nied by a small further increase in bank much larger real adjustment. However, rate. This result holds considerable prom- acceptable, together with a market that deposits due to an increase in demand in Poole’s world the central bank con- ise for CBDC, but of course the subject runs out of eligible assets to obtain for liquidity in an improving economy. trolled the entire broad money supply, requires further study. more CBDC. It is hard to envisage such CBDC therefore need not crowd out which is true neither in the current envi- There are also some arguments that a scenario, particularly in a world where but to the contrary may crowd in bank ronment nor in a world with CBDC. advise caution with regard to CBDC. the presence of CBDC is likely to make deposits. Central banks only ever control narrow The most important of these is that the resolution of troubled banks much e asier Our remaining quantitative experi- money, with very imperfect control transition to such a system could be quite and quicker, thereby removing part of ments study the use of CBDC as a mone- over broad money due to the autono- difficult, and getting the “plumbing” the ex-ante incentive to run. tary policy tool in a post-transition econ- mous role of banks. The presence of right requires very careful homework, There are therefore many reasons omy that is operating, on average, with CBDC does not alter this significantly, including attention to legal and regula- to look at the possibility of CBDC issu- CBDC balances equal to 30% of GDP. because CBDC only represents a frac- tory issues and to questions of computer ance as a positive development, so long tion of the money supply, because its hardware, software and protocols. But as the above-mentioned technical issues substitutability with bank deposits is the good news is that many central banks can be addressed. Central banks’ stated unlikely to be extremely low, and be- are right now doing such homework. reasons for considering CBDC issuance cause banks remain the creators of the Another objection to CBDC, the furthermore go beyond what is men- marginal unit of currency. Our simula- danger of a bank run due to the greater tioned above, including improved whole- tion finds that there is a trace of the (electronic) ease of trading bank depos- sale securities settlement (Canada, Sin- Poole (1970) argument, in that a CBDC its against CBDC, seems to this author gapore), replacement of vanishing cash interest rate rule performs better than to be mostly based on a partial equilib- (Sweden), and greater financial inclu- a quantity rule in buffering the effects rium fallacy. The point is that while it sion (several developing countries). The of the shock, but it also finds that the may become possible for an individual future therefore promises to be very difference is quantitatively small. The to quickly find a counterparty to dis- interesting, and research will have an choice between a quantity rule and an pose of his bank deposit in exchange for important role to play. interest rate rule does therefore not make a great difference.

24 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 25 Thomas Puschmann Banking without banks: Will technology Head of Swiss FinTech Innovation Lab University of Zurich transform financial intermediation?

1 What we know from the past: delivered from standard core banking digitization as an enabler of solution providers such as SAP or financial (dis-)intermediation Temenos. Digitization changes the mechanisms of 3. Customer-oriented digitization (phase 3): the established financial system from a This third phase of digitization is cen- hierarchical, centralized structure tered around customers and their towards a more decentralized, networked processes redefining today’s inside- one. But digitization is not a new phe- out, product-centered to an outside- nomenon for the financial services indus- in logic. This phase is characterized try. Some major milestones of early devel- by the application of new IT-developments of digitization in the last century opments like social media, smart- are the introduction of the automated phones, cloud computing etc. teller machine (ATM) in 1959 in Arling- The first two phases have already changed ton/Ohio (the first ATM in Europe was the banking value chain and financial launched in 1967 by Barclays Bank in intermediation, defined as banks’ role as London), the transition from physical to an intermediary of taking in funds from electronic trading of NASDAQ in 1971, a depositor and then lending them out the introduction of home banking through to a borrower (http://www.businessdic- Citibank and Chase Manhattan in 1981, tionary.com/definition/financial-inter- the launch of the first internet banking mediation.html). A well known example in 1994 by Stanford Credit Union as well are the electronic stock exchanges that as the first mobile banking from the Nor- emerged as additional intermediaries wegian Fokus Bank (Arner et al. 2015, between buyers and seller of securities. pp. 9 ff.). The digital development of But with the third phase of digitization, banking can generally be split up into financial intermediation might even three phases, each of them focusing on increase in customer-related areas like a different areas of digitization (Pusch robo-advisors and thus lead to new forms mann and Weber, 2017): of financial intermediation between cus- 1. Internal digitization (phase 1): The first tomer and banks. phase of digitization concentrated on internal processes, such as advisory, payment transactions or portfolio management. Here, banks focused on the automation of financial services processes like for example cash transactions with ATMs. 2. Provider-oriented digitization (phase 2): In the second phase financial service providers focused on the integration of core banking systems. For this, they had to standardize processes and application functions which were

44th ECONOMICS CONFERENCE 2017 27 Thomas Puschmann Thomas Puschmann

2 What we know today: potential encing (advisory), robo-advisory Chart 1 changes of the financial services (investments) and online credit appli- Impact of FinTech on the banking value chain and ﬁnancial intermediation value chain towards digital cation (financing). In contrast to B2C Threat of substitute products or (+) Increased threat from subsitutes, in ecosystems services where banks are the primary particular from consumer and IT market services (e.g. FinTech start-ups) segments (e.g. Apple, Google) (+) New substitution threats, e.g. FinTech The market for so-called digital banking provider, C2C-solutions focus on innovations in payments and securities solutions or financial technology (short peer-to-peer-services and platforms. “FinTech”) solutions just recently devel- Examples are peer-to-peer-payment Bargaining power of buyers Rivalry among existing Bargaining power of suppliers oped as part of the third, customer-ori- or online customer communities. (e.g. business/end customers) competitors (e.g. retail banks) (e.g. upstream banks) ented phase of digitization in banking. 2. Non-banks: The market sector of non-

These FinTech solutions differ regarding banks covers both start-up companies (+) Improved bargaining power of (+) Standardization of product descriptions and (+) Suppliers obtain access to end customers , e.g. comparison sites, interfaces reduces possibilities for customers the provider type (bank/non-bank), and large IT companies like for exam- multi-bank functionality in PFM differentiation (–) Tends to yield all banks and non-banks (+) Reduces switching costs among (+) Market transparency leads to increased price equal access to suppliers interaction type (business-to-customer ple Apple, Google or Alibaba. In con- financial service providers competition between financial service providers (–) Fosters the standardization of products (–/+) Widens the geographic markets, thus, which reduces possibilities for (B2C), customer-to-customer (C2C), trast to banks, these FinTech solutions increases the number of competitors, but also differentiation business-to-business (B2B)) and the bank- often focus on disintermediation and the reach to new customers ing processes they support (advisory, concentrate on single activities. In (–) Reduces barriers to entry, such as the payments, investments, financing, cross- addition to the B2C and C2C interac- Barriers to entry need for branches (e.g. electronic market platforms) (–) Applications are difficult to keep proprietary process). Table 1 gives an overview on tion models, non-banks also provide from new entrants (–) Enables market entry of numerous new existing FinTech solutions and is charac- B2B services which focus on coop- financial service providers terized by the following developments eration among banks and non-banks. Source: Porter (2001), Alt und Puschmann (2012, p. 212). (Puschmann, 2017): Prominent examples are digital client 1. Banks: Although many FinTech solu- advisory (advisory), personal finance tions from the third phase were devel- management (payments), digital iden- cess areas covered. A recent study for • FinTech leads to increased rivalry among oped from start-up companies from tity or stock analysis and prediction example identified, that the most impor- existing competitors due to the entry of the non-banking sector, many banks (investments). tant sector of the emerging FinTech mar- numerous non-banks and the adop- currently start to adopt them. Among The maturity level of the different Fin- ket is financing, followed by payments, tion of FinTech solutions by banks. the B2C examples are video confer- Tech solutions differ regarding the pro- cross-processes and investments (Haddad • The increasing standardization reduces and Hornuf 2016, p. 21). the barriers to entry in the market. FinTech solutions enable both, more Examples are the Payment Services Table 1 efficient business processes among the Directive 2 (PSD2) or the Open Appli- Overview on FinTech Solutions involved parties and the change of the cation Interface Programming (Open Provider type Interaction Advisory Payments Investments Financing Cross-Process existing value chain in banking towards API) approaches of the British Finan- type new digital ecosystems1. A more in-depth cial Conduct Authority (FCA). analysis of the drivers behind this trans- • The growing number of FinTech Bank B2C Video confer- Social Media Robo-advisory Online credit Online bank encing (HVB, Payment (Com- (UBS, CH) application account opening formation can be structured along five startups and the increasing service DE) monwealth (Targobank, DE) (Fidor Bank, DE) forces (according to Porter, 2001; Alt offering of technology companies lead Bank of Australia, AU) and Puschmann, 2012, see chart 1): to a growing threat of substitute prod- C2C Online Peer-to-peer Community- Crowdlending Social network • The new digital ecosystems strengthen ucts or services. An example is Financial customer com- payment based interest (Hypothekar- (Fidor Bank, DE) munity (Bank of (Paymit, CH) rate (Fidor bank Lenzburg, the bargaining power of buyers because Innovation Now, a cooperation of Am- America, U.S.) Bank, DE) CH) of reduced switching costs and the azon, Apple, Google, Paypal und Intuit Non-bank B2C Personal finance Cryptocurrency Multi-asset Corporate Electronic data elimination of existing bilateral chan- for the development of new global management (Bitcoin) trading credits (Fin- safe (Secure- (Mint, U.S). (360t.com, DE) point, DE) Safe, CH) nel structures. financial services. C2C Community- Mobile Payment Covesting Crowdlending Loyalty points based advisory (Square, U.S.) (Covestor, U.S.) (Lendico, DE) marketplace 1 A business ecosystem is defined as an “economic community supported by a foundation of interacting organizations (Wikifolio, AT) (PointsPay, CH) and individuals – the organisms of the business world. The economic community produces goods and services of B2B Digital client Personal finance Stock analysis Crowdlending Digital identity value to customers, who are themselves members of the ecosystem. The member organisms also include suppliers, advisory (Folio- management and prediction (PostFinance & (WebID Solu- lead producers, competitors, and other stakeholders. Over time, they co-evolve their capabilities and roles, and Dynamix, U.S.) (Meniga, SE) (Stockpulse, DE) Lendico, CH) tions, DE) tend to align themselves with the directions set by one or more central companies. Those companies holding leadership roles may change over time, but the function of the ecosystem leader is valued by the community as it Source: Puschmann (2017). enables members to move toward shared visions of aligning their investments, and finding mutually supportive roles.” (Moore, 1993).

28 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 29 Thomas Puschmann Thomas Puschmann

• The easier comparability of banking and the Hypertext Markup Language Chart 2 and products and services leads to an (HTML). The second phase focused Evolution phases of the Internet increased bargaining power of suppliers. on digital platforms like Facebook An example is DNAppstore, an elec- and Google and included standards 3. Internet of Values tronic toolbox for banks to bundle like the Simple Object Access Proto- Values services from different service pro- col (SOAP). The third phase focuses Obect viders. on standards around blockchain, standards for digital payments, smart 3 What we know today about the 2 . Internet of Services contracts and other areas for the Services future: The internet of values exchange of values. The W3C con- and the peer-to-peer-economy sortium for example initiated a stan- The five driving forces introduced before dardization group for online payments. already seem to change the mechanism • Third, the development of cryptocur- Information 1. Internet of of the existing banking value chain. But rencies has led to a new possibility to Information does this mean that we are at the fore- exchange “money” among individuals front of a new global financial order with (peer-to-peer) that do not necessarily Time new actors, new currencies and the pos- know and trust each other. Among 1985–2000 2000 –2015 2015–2030 sibility to conduct financial transactions the examples are Bitcoin or Ether. Source: Author’s compilation. across borders without any limitations? These cryptocurrencies all have the Four drivers might spur this development advantage that they provide a stan- 1 million are exempted from authori- currencies and thus, stock trading could in the future: dard for exchanging “money” across zation. In addition, some countries be settled in real-time. These scenarios • First, the emerging peer-to-peer econ- country borders in almost real-time even launched new FinTech licenses. fundamentally change financial interme- omy leads to a fundamental change of without the limitations of the exist- For example, Switzerland just recently diation and the financial system as they how economies work in the future ing financial infrastructures that re- introduced a banking license “light” decentralize more services than ever (Sundararajan, 2016). Examples are quire currency exchange platforms to accept public funds of up to CHF before. But although the potentials seem Airbnb for renting flats or Getaround’s and banks. This trend is spurred by 100 million. to be huge, there are still some limita- mobility platform for lending and the big technology companies like tions. A first one is the still low technical borrowing cars among private indi- Apple that just recently started to of- 4 What we don’t know yet about maturity of standards including areas like viduals. This peer-to-peer economy fer a peer-to-peer payment service the future: Technology limita- security, etc. Sure, they might evolve tions, regulation and legal is not only characterized by transac- via its iMessaging service or the dif- preconditions over the forthcoming years, but as we tions among peers, but also has an in- ferent approaches for digital wallets. learned from the development of HTTP creasing impact on the existing digital Both, the digital wallet and the pos- All four drivers may have an impact on and HTML, it took many years and the infrastructures. First examples are sibility to exchange “standard” money the future of the financial system. With same will probably apply for blockchain- AKASHA’s peer-to-peer social net- globally is attractive from a consumer the development towards a peer-to-peer, related standards, too. A second limita- working platform or Sharetribe’s peer- point of view, yet the national hur- self-organizing financial system, the tion are the the political and regulatory to-peer service marketplace. They all dles still limit these approaches. existing functions of the financial system preconditions that are not yet given to have in common that they are not built • Fourth, many national regulators to provide liquidity, to govern and coor- foster the internet of values. Still, most on centralized digital platforms like started to decrease hurdles for Fin- dinate financial markets and to reduce national regulations are too different as Google or Facebook (Parker et al., 2016). Tech startups and their solutions information asymmetry may change to if a global standard might emerge in the • Second, from a technical point of which might lead to a de-regulation some extent. If for example a firm can next few years. In addition, many legal view, the internet developed from of this market. Examples are Lon- self-issue security papers fully digital on questions like ownership rights etc. have the “internet of information” to the don, Hong Kong, Singapore, and a blockchain, it can initiate and coordi- to be addressed. “internet of services” and currently Switzerland. All these countries for nate all processes in a decentralized man- Just as the first examples of the early takes another step towards the “in- example introduced so-called regula- ner without the need for a central party internet pioneers have shown, many ideas ternet of values” (chart 2). The first tory sandboxes where startups can like a bank (e.g., for an IPO) or a stock emerged very early (e.g., to watch TV phase covered the standardization test innovative solutions in a pro- exchange (e.g., for trading). In addition, online), but finally took many years to and exchange of information with the tected area. An example is Switzer- cross-country stock trading could be develop. The same can now be observed Hypertext Transfer Protocol (HTTP) land where public funds of up to CHF improved by payments based on crypto- with the internet of values, where many

30 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 31 Thomas Puschmann

new services can already be seen on the become reality, a lesson that we could horizon (Ito et al., 2017). But it may take also learn from the first phases of the inter- some more years until we can finally use net. So the future of the internet of values them. In addition, not all things might remains exciting over the next years.

References

Alt, R. and T. Puschmann. 2012. The Rise of Customer-oriented Banking – Electronic Markets are Paving the Way for Change in the Financial Industry. Electronic Markets 4(22). 203–215. Alt., R. and T. Puschmann. 2016. Digitalisierung der Finanzindustrie: Grundlagen der Fintech- Evolution. Springer Gabler: Berlin & Heidelberg. Arner, D., J. N. Barberis and R. P. Buckley. 2015. Evolution of Fintech: A New Post-Crisis Paradigm? University of Hong Kong and University of New South Wales: Hong Kong & Sydney. Haddad C. and L. Hornuf. 2016. The Emergence of the Global Fintech Market: Economic and Technological Determinants. University of Trier: Lille & Trier. Ito, J., N. Narula and R. Ali. 2017. The Blockchain Will Do to the Financial System What the Internet Did to Media. Harvard Business Review. Digital Article. Retrieved from https://hbr. org/2017/03/the-blockchain-will-do-to-banks-and-law-firms-what-the-internet-did-to-media. Moore, J. F. 1993. Predators and Prey: A new Ecology of Competition. Harvard Business Review 71(3). 75–86. Parker, G. G., M. W. Van Alstyne and S. P. Choudary. 2016. Platform Revolution: How networked Markets are Transforming the Economy – and how to make them work for you. New York (NY): W. W. Norton & Company. Porter, M. E. 2001. Strategy and the internet. Harvard Business Review 79(3). 62–78. Puschmann, T. 2017. Fintech. Business & Information Systems Engineering 59(1). 69–76. Puschmann, T. and R. Weber. 2017. Neuerfindung des Finanzsektors? Schweizerische Zeitschrift für Wirtschafts- und Finanzmarktrecht (SZW) 89 (1). 79–94. Sundararajan, A. 2016. The Sharing Economy: The End of Employment and the Rise of Crowd- Based. Cambridge: MIT Press.

32 OESTERREICHISCHE NATIONALBANK Session 2 Keynote address Andreas Ittner Introductory remarks: Vice Governor Oesterreichische Nationalbank Preparing banking regulation for the future

Introduction Resilience: equity is king Major reforms in banking regulation As an immediate response to the global have been implemented as consequences financial crisis, the G20 and the Basel of financial crises, where each crisis Committee brought on the way major revealed further weaknesses and blind reforms that made the financial sector spots of the existing regulatory frame- more resilient to shocks and promoted work. The history of banking regula- sound risk management. The European tion provides vivid examples for this Union implemented legislation such as intuition: The Glass-Steagall Act of 1933 the Capital Requirements Regulation was introduced in the aftermath of the (CRR) and the Capital Requirements Great Depression in order to protect Directive IV (CRD IV). These reforms depositors and the real economy from resulted in significantly higher levels of turmoil on securities markets. The G20 capital and liquidity than before the and the Financial Stability Forum – crisis and made individual institutions today’s Financial Stability Board (FSB) – more resistant to shocks. were established in 1999 in the wake of In addition to minimum capital the Asian financial crisis. Basel III, the requirements, Pillar 2 requirements a llow CRD IV and the CRR were introduced for bank-specific liquidity and capital after the financial crisis of 2009. regulations to address bank-specific risks. Progress in banking regulation con- In the euro area, the introduction of sists of a gradual learning process. A the Single Supervisory Mechanism (SSM) drawback of such a learning-by-doing effectively contributed to the harmoni- approach, however, is that the regulatory zation of standards in the setting of framework can become quite complex. Pillar 2 requirements. This does not So, what can regulators do to pre- only lead to an increased loss absorbing pare financial regulation for the future? capacity of banks. It also contributes to In the remainder of this text, I briefly a level playing field and the further reflect on some principles that I think integration of the euro area banking could inspire future efforts in banking system and, by that, to gains in eco- regulation to contribute to the efficient nomic efficiency. allocation of financial resources and The assessment of the Internal Rat- fulfilling its key macroeconomic func- ing Based (IRB) approach for the calcu- tions even if financial imbalances and lation of risk-weighted assets (RWAs) is shocks occur. This means that the a key priority for the SSM in 2017. banking system should consistently Both supervisors and investors have direct funds to those activities that de- expressed concerns about “RWA tweak- liver the greatest economic benefits. ing”, where banks exploit blind spots of Under conditions of financial stability, the IRB approach to reduce their RWAs economic agents have confidence in the in order to reduce their capital require- financial system and good access to ments.1 In this respect, I welcome the financial services, such as payments, ongoing Targeted Review of Internal lending, deposits and hedging, which Models (TRIM) and efforts by the B asel also contributes to the effective trans- Committee to improve the IRB ap- mission of monetary policy. proach2 so that banks have to calculate

1 Le Leslè and Avramova (2012) and EBA (2013). 2 BCBS (2016).

44th ECONOMICS CONFERENCE 2017 37 Andreas Ittner Andreas Ittner

Resolution: bank market exit at The BRRD requires European banks approach, and the opacity of the setting acceptable social costs to hold a Minimum Requirement for of Pillar 2 requirements lead to effi- Although banks have become signifi- Own Funds and Eligible Liabilities ciency costs, which put a burden on cantly more resilient, some of them (MREL) eligible for bail-in. According financial markets, the real economy, will at times have to exit the market. to the Final Report on MREL by the and supervisory authorities.6 Hence, This is the simple logic of a market EBA European banks are well advanced reducing the complexity of the regula- economy. In this context, maintaining in fulfilling the MREL requirement tory rulebook must be a key objective the stability of the financial system and and the additional funding needs were of future regulation. One way to do reducing systemic risk associated with estimated between 1.1% and 2% of this could be to rely on more blunt bank resolution constitutes the task of total RWAs.5 I expect well-capitalized measures such as a substantially higher macroprudential supervisors and the bank banks with sustainable business models leverage ratio at the expense of the risk resolution authority. The insolvency of to be able to fulfil their MREL require- adequacy of minimum capital require- a large and highly interconnected bank ments in a timely and cost efficient way. ments. But as long as the global regula- risk weights and hold capital buffers, could lead to contagion and expose an However, there are still ongoing dis- tory community remains committed to which better reflect the risks on their otherwise healthy financial sector to cussions about procedural issues con- risk-weighted capital requirements and balance sheet. severe adverse shocks with possibly severe cerning MREL, which delay the com- the Internal Rating Based approach, The global financial crisis also dem- negative repercussions on the real econ- pletion of the European banking union banks and supervisors will have to cope onstrated that the stability of an indi- omy. In the past this “too-big-too-fail” with respect to an effective resolution with a certain complexity of bank regu- vidual financial institution is not suffi- problem led to large bailouts. This im- mechanism in the EU. This requires lation. cient to ensure the stability of the whole plied wealth transfers from the public regulators to think about credible tools One way to approach this challenge financial system. The additional dimen- to bank shareholders and worsened the for the remainder of the current transi- is to strengthen the principle of pro- sion of systemic risk was neglected un- incentive structure for large banks. tion phase such as, for example, higher portionality in banking regulation. til it materialized during the financial After the financial crisis regulators Pillar 2 requirements or significant Complex regulatory rules in the Euro- crisis and many banks held not enough agreed that they never wanted to be increases in the systemic risk buffer. pean Union put smaller banks at a liquidity and equity to withstand this in a position again, where banks were competitive disadvantage. Hence, they shock. Hence, macroprudential super- “too-big-too-fail”. Therefore, the FSB Proportionality: one size does not should be subject to simplified report- vision was introduced as a key lesson in 2011 published Key Attributes of Ef- fit all ing obligations in accordance with their from the financial crisis. By addressing fective Resolution Regimes for Finan- Although the reforms of financial regu- size, degree of connectedness and riski- the systemic risk arising from the inter- cial Institutions, which provided the lation in the aftermath of the financial ness. In addition, the CRR should rec- connectivity and inherent cyclicality of foundation of legislation such as the crisis significantly improved the stabil- ognize the consistent application of the the financial system, macroprudential Bank Recovery and Resolution Direc- ity of the financial system, they also proportionality principle more system- supervision is an indispensable instru- tive (BRRD).3 The BRRD requires Eu- increased the complexity of regulation. atically. Regulators should identify ment to maintain financial stability. ropean Member States to implement This is the result (i) of the international business models, where a more propor- Preparing banking regulation for bank resolution regimes, which ensure commitment to risk-weighted capital tionate treatment could reduce compli- future challenges requires to closely that shareholders and certain creditors requirements and internal models, (ii) ance costs without cutbacks to the monitor trends in financial services and will bear the burden of failing banks of the complexity of bank business mod- effectiveness of the supervisory regime. to assess whether the potentially associ- through bail-ins.4 Such instruments in- els, and (iii) of the tension between In addition, the rules regarding internal ated risks are captured in the existing ternalize the potential social costs of international harmonization and the governance should consider a more pro- regulatory framework. For example, bank failure by limiting its negative ef- heterogeneous nature of national finan- portionate approach to ensure appro- with the rise of FinTech companies new fects to a clearly defined group of stake- cial systems. priate management regimes, remunera- opportunities can arise for consumers holders in the financial sector, which As already indicated in the intro- tion and disclosure. and businesses, but new types of risk are compensated for bearing that risk. duction, the cohesiveness of the cur- On an international level, coordina- might gain in relevance as well. There- This helps to avoid spillovers to the real rent regulatory framework suffers from tion and harmonization of regulatory fore, the OeNB in cooperation with the economy and lowers the incentives for the gradual extension of existing regu- standards must remain a key objective FMA closely monitors developments in moral hazard, which makes the BRRD lation. Complex rules for the calcula- of future regulatory efforts. This would this area within the European supervi- a welcome contribution to a structurally tion of RWAs of assets and for the gov- simplify the simultaneous compliance sory architecture. stable financial system. ernance of the Internal Rating Based of internationally active banks with dif-

3 FSB (2011). 5 EBA (2016). 4 Deutsche Bundesbank (2014) and Deutsche Bundesbank (2016). 6 Liedorp et al. (2013) and Véron (2014).

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ferent legal frameworks in different mar- regulatory standards will reduce com- kets, reduce their compliance costs and, plexity, support competition and con- by that, support both competition and tribute to global welfare gains. stability across global financial systems. The banking sector and the real economy evolve dynamically. Over the Concluding remarks next decades technological progress Overall, I regard the current frame- and changing consumption patterns work of banking regulation to be fit for will eventually affect the kind of finan- the future. In fact, much has been cial services needed by households and achieved since the global financial cri- firms. New developments such as the sis. Banks are more resilient to shocks mushrooming of FinTechs affect vari- because of higher capital and liquidity ous areas of the financial system and requirements as well as better supervi- might lead to significant changes in the sion of internal risk models. Macropru- structure of the banking business. dential supervision reduces systemic Therefore, banking regulatory, super- risk substantially. Once the BRRD and visors, and central banks need to closely the Single Resolution Mechanism monitor these trends to assess their (SRM) are fully operative, they will implications for economic efficiency, reduce the “too-big-to-fail”-problem. financial stability, and for the transmis- In combination, these reforms mas- sion of monetary policy. sively reduce the probability and potential costs of financial crisis for society. Further cooperation on international

References BCBS. 2012. Core Principles of Effective Banking Supervision. BCBS. 2016. Reducing variation in credit risk-weighted assets – constraints on the use of internal model approaches. Consultative document. Deutsche Bundesbank. 2014. Europe’s new recovery and resolution regime for credit institutions. Monthly Report. June. 31–58. Deutsche Bundesbank. 2016. Bank Recovery and Resolution – the New TLAC and MREL Minimum Requirements. Monthly Report. July. 63–80. EBA. 2013. Interim Results Update of the EBA Review of the Consistency of Risk-Weighted Assets. EBA. 2016. Final Report on MREL: Report on the Implementation and Design of the MREL Framework. FSB. 2011. Key Attributes of Effective Resolution Regimes for Financial Institutions. Gehrig, T. and M. Iannino. 2017. Did the Basel Process of Capital Regulation Enhance the Resiliency of European Banks? CEPR Discussion Paper 11920. Le Leslè, V. and S. Avramova. 2012. Revisiting risk-weighted assets. Why do RWAs differ across countries and what can be done about it? IMF Working Paper 12/90. Liedorp, F., R. Mosch, C. van der Cruijsen and J. de Haan. 2013. Transparency of Banking Supervisors. IMF Economic Review 61(2). 310–335. Vallascas, F. and J. Hagendorff. 2013. The Risk Sensitivity of Capital Requirements: Evidence from an International Sample of Large Banks Review of Finance 17. 1947–1988. Véron, N. 2014. The G20 Financial Reform Agenda After Five Years. Bruegel Policy Contribution 11.

40 OESTERREICHISCHE NATIONALBANK Sir Paul Tucker The political economy of central banking in Systemic Risk Council and Harvard Kennedy School the digital age

It is a great pleasure to be at this confer- of the deep plumbing of the financial ence, which has prompted me to try to system. They must, though, be vigilant pull together my thoughts on how the in not taking on roles that give them new technology might affect central excessive power or which don’t fit with banks: what central banking is and what their core purpose of maintaining mon- central banks do. I am glad to have that etary system stability. opportunity because quite some years 1 A conception of late-20th/early- ago, in 2004, I aired the possibility of st the Bank of England issuing e-money at 21 century central banking an annual strategy meeting.1 In setting out a conception of central Since leaving central banking, my banking, I shall ask why they exist; preoccupations have been less with sub- what their purpose is; what they do; and stance than with the political economy whether they are too powerful for com- of unelected power, of which today’s fort in our constitutional democracies. post-crisis central banks are, of course, the epitome.2 I am therefore going to Why central banks exist: the pivot of try to put the substantive issues raised a monetary economy for your community by the new tech- Towards the end of the 18th century, nology into a political-economy frame- Francis Baring, the founder of the Eng- work. By those lights, it is vital that the lish banking dynasty, described the role purported boundaries to any central of the Bank of England in the following bank e-money ventures or other new terms. It was, he said:3 services be credible. I will start out, in section 1, by out- lining a conception of central banking as it is (or could be) practiced now, just as society starts to grapple with the new technology. I shall then ask, in section 2, whether and how the new technology challenges or even undermines that broad conception. Perhaps surpris- ingly, the big picture answer is that it will not, unless central banks move into providing banking services for everyone, which would make them more like a latent state-credit bank. An important qualification to “things stay “The centre or pivot, for enabling [the the same” is that central banks will monetary and credit] machine to perform need to re-engage with the integrity its functions”.

1 With thanks to Steve Cecchetti for comments on an earlier draft. 2 Forthcoming in a book, contracted to Princeton University Press, with the working title Unelected Power: Central Banking, the Regulatory State, and Democratic Legitimacy. This paper draws heavily on some of that material. 3 Baring, F. 1797. Observations on the Establishment of the Bank of England. And on the Paper Circulation of the Country.

44th ECONOMICS CONFERENCE 2017 43 Sir Paul Tucker Sir Paul Tucker

Today we would make the same point claims amongst themselves. Smaller It also implicitly assumes that only be spotted and excluded from the clear- by saying that central banks are issuers banks might do so by holding accounts banks will have access to the central ing house via which they would settle of the economy’s final settlement asset. with a bigger bank (clearing banks in bank’s facilities. That is a big deal, and their obligations to each other. But, in Britain, money center banks in America). we should therefore take a brief look at contrast to that club-like world, today’s Two types of central bank money Those bigger banks in turn settle amongst the two existence assumptions, precisely banks are so complex and heteroge- From then until now, there have been themselves across the central bank’s because the new technology makes neous that the dynamic would just two types of central bank money: phys- books, and so in central bank money. each of them moot. as likely be towards a collective slide ical notes circulating amongst house- We, households and businesses, towards over-issuance. holds and firms, and balances held by might be able to overdraw our bank ac- Banning central banking Third, and in a quite different register, banks in accounts (today often called counts, and similarly the smaller banks A generation after Baring and on the free-banking also implicitly assumes settlement accounts) with the central might be able to borrow from the big- other side of the Atlantic, President that society could live with even more banks. It is important to remember that ger banks. But the big banks would Andrew Jackson’s conviction that a power than now being in the hands of it was not always grasped that those have to overdraw with the central bank national bank would threaten the coun- private bankers. balances were money. if they did not hold enough reserves try’s welfare prompted him to veto re- So, as the world is currently orga- In 1844, Prime Minister Peel per- there to settle up with their peers. The newal of the charter of the Second Bank nized, the existence of central banks is sonally took through the Westminster central bank is, then, the lender of last of the United States, the descendent no surprise. Parliament legislation that split the resort, a sentiment first captured by of Alexander Hamilton’s First Bank. Bank of England in two accounting Baring when referring to Threadneedle Ever since, this has provided inspira- identities: into an Issue Department that Street as the dernier resort. tion for the free banking movement, issued notes and held gold as backing Another vital point is that monetary which wants to abolish central banking. for them, representing the privately liabilities of the private banking system Deprived of their liquidity backstop owned Bank’s public functions; and a are partly created by their lending. and forced to compete, bankers would, Banking Department that acted as banker They do not arise simply from mem- it is maintained, be driven to prudence, to the banks, purportedly representing bers of the public or small shopkeepers and so the economy could operate with- its continuing private or commercial going to their bank and handing over out the social costs of boom and bust. functions. This, of course, was an egre- bank notes. More important, in terms Over the course of the 19th and gious error. Not only were those bank- of scale, is banks’ lending: every bank early 20th centuries, weaknesses in this ers’ balances central bank money, but the loan creates a deposit liability some- line of argument were exposed. First deposits held with the banks themselves where in the system.4 When a bank’s and foremost, it assumes that the legis- were a form of privately issued money. deposits are no longer accepted as lature and elected executive are some- This is a monetary morality tale for money, it cannot function. When the how themselves deprived of the right to our times, but one which needs some whole of the banking system is no lon- bailout ailing banks: by the middle of To ban or permit fractional- reserve banking? unpacking. ger trusted, bank lending ceases. the 19th century, the U.S. Federal gov- Three things are striking about this ernment was effectively guaranteeing What about private banking itself? A tiered payments-monetary system set up. It takes for granted: privately issued bank notes, giving Between our continent’s two world One vital point is that the payments • that private banking inevitably exists, depositors an incentive to switch into wars, Chicago economists launched the system, and hence the monetary sys- • that, in consequence, the economy’s notes at the first sign of trouble. Surely, other line of attack on the place of tem, is tiered. Most people hold most money system and its credit system in today’s full-franchise democracies banking within a monetary system. of their money in accounts with private are unavoidably intertwined, and the moral hazard problem is not sourced Under the Chicago Plan, fractional- banks, some big, some local and small. • that that calls into the existence a solely in central banking. Indeed, central reserve banking itself would be banned, Since we do not all BANK with the central bank as a monetary institu- banking creates the possibility of sepa- leaving only what are today known as same bank, those banks need to settle tion and liquidity reinsurer. rating liquidity reinsurance for funda- “narrow banks” wholly invested in gov- mentally sound intermediaries from ernment bonds or central bank reserves the political question of whether to res- (with central banks in turn invested in 4 A 2014 article by my former colleague Ryland Thomas has been welcomed in parts of the U.S. scholarly community cue fundamentally insolvent firms. government bonds). as overturning orthodoxy about the very nature of the monetary system. This is, frankly, weird (not a word often Second, it assumes that banks are Why wasn’t that taken up? I think used of central banking debates). The article is very good, but what Thomas describes was orthodoxy at the Bank of England well before I joined in 1980. McLeay, Radia and Thomas, Money creation in the modern economy, sufficiently homogenous and monitor- the best explanation is that we, society, Bank of England Quarterly Bulletin, 2014 Q1. able for an improvident note-issuer to value the liquidity insurance provided

44 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 45 Sir Paul Tucker Sir Paul Tucker

by banks, including through commit- popularity, doing favours for friends, or After more than a decade in the wilder- ist Walter Bagehot. That package was ted credit lines. It reduces the need for approximating a planned economy. I do ness, that wisdom is re-established as deficient in so far as it did not cater households, businesses and other finan- not find that especially attractive, but it orthodoxy. Banking stability is integral explicitly for solvency-crises as opposed cial intermediaries to self-insure against does have lessons for central banking e- to monetary stability. The public policy to liquidity-crises. Worse, as our econ- liquidity risk by holding stocks of liquid money innovations, as discussed below. objective of preserving a stable finan- omies moved to embrace fiat money securities, releasing resources for use in Irrespective of whether those argu- cial system, able to provide the core during the 20th century, policymakers the risky enterprises that can help to ments are persuasive, in the wake of services of payments, credit and risk relaxed the connection between the generate growth and prosperity.5 the 2008-09 phase of the crisis, the insurance in all weathers, is not com- nominal anchor and the binding con- issues were debated, to different degrees pletely separable from monetary stabil- straint on bank balance sheets so com- in different countries.7 Rightly or ity, because it is largely the stability of prehensively that it became non-existent. wrongly, the universal decision was not the private part of an economy’s mone- At a schematic level, a MCC for the to make what would have amounted to tary system, the banks, that is at stake. world as we know it (i. e. today’s famil- a massive change in the constitution of Indeed, we should think of monetary iar technology and public expectations) money. The costs of transitioning from system stability in this broad sense as might have five components: one set up to a radically different one having two components:9 • a target for inflation (or some other were too unknowable for it to be taken • stability in the value of central bank nominal magnitude); seriously by elected politicians. For bet- money in terms of goods and ser- • a requirement for banking interme- ter or worse, the world has persevered vices; and also diaries to hold reserves (or assets with fractional-reserve banking, subject • stability of private-banking system readily exchanged for reserves) that to redesigned regulatory constraints. deposit money in terms of central increases with a firm’s leverage/risk- bank money. iness; What central banks are for: mone- The latter does not mean that no bank • a liquidity-reinsurance regime for It is also worth recalling that, rather tary system stability can be allowed to fail but, rather, that fundamentally solvent banking inter- amazingly, some of the strongest sup- The crisis did, however, prompt recon- the supply of payments services from mediaries; port for the 1930s Chicago Plan came sideration of what central banks are for: the system as a whole must be main- • a resolution regime for bankrupt from advocates of government deciding what social purpose they serve. The tained. banks and other financial firms; and how to allocate credit in the economy. older amongst you here will probably • constraints on how far the central As Senator Bronson Cutting put it at recall the siren words of Paul Volcker’s A Money-Credit Constitution bank is free to pursue its mandate the time, “private financiers are not valedictory lecture to his international The world I have described requires and structure its balance sheet. entitled to any profit on credit”.6 A peers:8 not a monetary constitution of the kind We need five rather than three because project that academics saw as immuniz- once advocated by the late James one (resolution) was missing in the 19th ing money from credit was, in political “I insist that neither monetary policy nor Buchanan but, instead, a Money-Credit century set up and because, in a world eyes, a means of getting the price the financial system will be well served if a Constitution (MCC). By that, I mean of fiat money, the nominal anchor does mechanism out of credit allocation. It is central bank loses interest in, or influence joined-up rules of the game for banking not of itself (seriously) constrain the something to ponder: credit-creation over, the financial system.” and central banking designed to ensure size and composition of central banks’ in the hands of politicians, pandering to (Paul Volcker, 1990) broad monetary system stability. balance sheets. In other words, banking This notion would have been famil- institutions should be forced to self-in- iar to our 19th century and early-20th sure against liquidity risk; and the legal 5 If the likelihood of deposit withdrawals and credit-facility draw-downs are not highly correlated, the aggregate century predecessors. Their money- system should be able to reconstruct benefits increase. Kashyap, Rajan and Stein. 2002. Banks as Liquidity Providers: An Explanation for the Coexistence of Lending and Deposit-taking. Journal of Finance 57/1. 33–73. credit constitution comprised: the gold failed intermediaries so as to combine standard plus a reserves requirement continuation in the supply of services 6 Phillips, Ronnie J. 1992. The Chicago Plan and New Deal Banking Reform. The Jerome Levy Economics Institute of Bard College Working Paper 76. June. for private banks (an indirect claim on with losses falling on equity investors 7 In the UK this was given oxygen when the then Governor Mervyn King expressed interest in the ideas in John Kay’s the central bank’s gold pool) plus the and bondholders. We are going to be in- Narrow Banking. This led the government to establish a review of structural reforms of banking chaired by John lender-of-last-resort function celebrated terested in whether FinTech challenges Vickers, which came down against narrow banking (and against Glass Steagall separation of “commercial” and by the mid-19th century British journal- the need for or composition of the MCC. “investment” banking), but recommended ring-fencing any material retail banks within wider banking groups, after which the ‘narrow banking’ debate subsided. UK Independent Commission on Banking. Interim Report. 97–100. 9 This fed into the UK’s post-crisis reforms: Tucker, Paul. 2009. Remarks at the Turner Review Conference. Bank 8 Volcker, Paul. 1990. The Triumph of Central Banking? The 1990 Per Jacobsson Lecture, Per Jacobsson Foundation. of England. London. March 27.

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What central banks do: manage the ities for short-term Treasury Bills (in • K and B could be higher, the riskier state’s consolidated balance sheet, order to steer the overnight money- or lumpier the asset portfolio. and constrain banking system bal- market rate of interest). The lender of • Where x is set at 100%, this delivers ance sheets last resort (LOLR) function would be full liquid assets cover for short-term Before getting to that, we need to be restricted to accommodating shocks to liabilities.11 clear about what a canonical central the aggregate demand for central bank Given that the fragilities inherent in bank (with some regulatory functions) (base) money, and so plays no role in fractional-reserve banking are not con- does and/or should do under the con- offsetting temporary problems in the fined to de jure banks and, furthermore, ception of the monetary system I have distribution of reserves amongst banks given endemic regulatory arbitrage and described. Basically, it frames and imple in the private money markets.10 Fur- legion financial-system interconnec- ments the various components of an ther, at the effective lower bound for tions, the focus would be on the eco- implicit or explicit MCC in pursuit of nominal interest rates, the only instru- nomic substance of banking (maturity the two pillars of monetary system ment available to the central bank would transformation, leverage, and credit stability. be to talk down expectations of the fu- intermediation) rather than on the legal ture path of the policy rate (what has form of banks. In other words, both the 2 Central banking under the new Monetary policy and LOLR: Managing the become known as “forward guidance”). central bank’s liquidity reinsurance technology state’s consolidated balance sheet At the other, maximalist end of the facilities and the corresponding con- I hope, it will be apparent how that ex- In doing so, it is useful to think of the spectrum, the central bank would be straints would extend to banking-like egesis sets up a series of questions, chal- central bank as conducting financial given free rein to manage the consoli- organisations, structures and vehicles. lenges or threats, according to your taste, operations that change the liability dated balance sheet, buying and lending posed by the new technology. They are, structure and, potentially, the asset against instruments of all kinds, and The problematic power of central staying with the structure I employed: structure of the state’s consolidated being a seller in some phases of the banks • Will central bank money still be the balance sheet in pursuit of the goal of so-called credit cycle. The problem, of course, is that that is a final settlement asset? nominal stability. lot: a lot to do; a lot to explain and • Will fractional-reserve banking con- If a central bank buys (or lends Stability policy: regulatory constraints on defend; and, critically, a lot of power. tinue: i. e. will the money system and against) only government paper, the banking The underlying problem is whether the credit system be coterminous, or structure of the state’s consolidated In framing and pursuing the other pil- it is possible to balance the welfare ad- ƅƅ could they become separate, and liabilities is altered, with monetary lia- lar of monetary system stability, the vantages of the credible commitment ƅƅshould the authorities push things bilities substituted for longer-term debt central bank would put constraints on that central banks can deliver against in that direction? obligations. If it purchases (or lends banking balance sheets. the loss of majoritarian control. • Will only banks need to bank with against) private-sector paper, the state’s Broadly, those constraints take the One question is how to keep central the central bank or could anyone? consolidated balance sheet is enlarged, following broad shape: banks on the “right side” of a blurred ƅƅand if banking with the central its asset portfolio changed, and its risk • x% of the face value of short-term line between monetary policy and fiscal bank is not compulsory, what form exposures affected. In either case, any liabilities (S) to be covered by hold- policy. Another is how far central banks would the intermediaries take? net losses flow to the central treasury ings of liquid assets, discounted to should be able to write the rules of the • Will central banks still shape the via reductions in seigniorage income, the value attributed to them by the game for finance. state’s consolidated balance sheet? entailing either higher taxes or lower central bank (d. LA); I will leave those questions hanging, ƅƅand if so, will the regime move spending in the longer run (and con- • Residual assets ((1-d).LA plus assets because my purpose here is to explore towards the minimalist or maxi- versely for unexpectedly large net prof- ineligible at the central bank) to be whether the new technology makes them malist conception of central bank its). That leaves plenty of room for funded in prescribed minimum pro- go away or exacerbates them. balance-sheet operations? competing visions of central banking. portions by common equity (K) and A minimalist conception would debt that can be converted into eq uity restrict the proper scope of central bank without disruption (known as bail- interventions to open market operations inable debt, B), plus any “uncovered ” (OMOs) that exchange monetary liabil- short-term liabilities ((1-x).S). 11 An idea first floated in the Bank of England as a contingency plan by David Rule when, before the Great Financial Crisis, we were thinking about how to cope with a 9/11-type disaster. A permanent facility of this kind is advocated by Mervyn King, End of Alchemy. Under such a 100%-cover scheme, ongoing industry lobbying (and 10 Tucker, Paul. 2014. The Lender of Last Resort and Modern Central Banking: Principles and Reconstruction. BIS associated political pressure) would be directed at the definition of “short term liabilities”, the population of Papers 79. Bank for International Settlements. eligible instruments, and the level of haircuts.

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• Will the core of the macro/micro- Crucially, the bundles we exchanged and they would set the terms (collateral financial intermediaries make continu- prudential function remain essen- with each other would have real worth, haircuts and margins) designed to keep ous markets in those instruments. Are tially the same? rather than being like the fiat counters the system of credit in each market on we on the brink of such a world? ƅƅor will it extend to a much larger we use at present. This is not Bitcoin; it an even keel.12 It seems unlikely. Today, transac- population of intermediaries? is more fundamental. As such, for each key market, the tions in even the most liquid equities ƅƅand will it revolve around integrity The preconditions for such a trans- clearing house would be the pivot con- and bonds are settled only after a lag of against cyber attacks as much as formation are not merely technological. necting the market in the underlying a few days, so using bundles of securi- around constraining intermediaries’ The integrity of the markets in each of assets with the system of counterparty- ties as the medium of exchange is hardly balance sheets? the assets eligible to be a component in credit-risk control. within reach. • Will central banks become more or a payments bundle (eligible instru- Continuous liquidity in the markets Nevertheless, you might think some less powerful? ments) would matter hugely. In partic- for the eligible instruments would be lesser revolution is upon us given the Needless to say, I don’t know the answer ular, the market infrastructure – the similarly vital. The system would not excitement set off by FinTech. At times, to any of those questions. But I will plumbing – would be vitally important. require a conventional Lender of Last the mental spaces opened up by Bitcoin offer a few thoughts by way of testing Some key infrastructural standards Resort capable of creating money at and blockchain make almost anything whether two hundred years of central would, of necessity, morph. will, but instead a Market Maker of seem possible. At the revolutionary end banking as we know it is approaching In today’s world of money, the stan- Last Resort which insured against of the spectrum, there are two broad its denouement. I will start with a vision dards applying to intermediaries, reflect- unwarranted or contagious liquidity scenarios: where that’s just how things turn out. ing work by my generation in the late- crunches in core capital markets.13 That • The numeraire becomes separated 1980s and early-1990s, include real- MMLR might be government or might from the medium of exchange time Payment versus Payment (PvP) in be delegated to the clearing houses, • Private issuance of a final-settlement the currency markets and Delivery ver- which would become public authorities. instrument that acts as numeraire sus Payment (DvP) in asset markets. In Within the market community, the the new world, there would no P in leaders of these clearing houses might, Unbundling the numeraire from the money. Wholesale intermediaries and plausibly, enjoy the status of a 21st cen- medium of exchange possibly individuals would sometimes tury Montagu Norman or Benjamin The clearing-house world described above exchange an equity directly for, say, a Strong, the human pivots on which all is an extreme case of a class of systems in bond. One key standard would, there- in international finance turned. As which control of the numeraire (unit of fore, be real-time finality in Delivery- time passed, standards for inclusion in account) is separated from supply of the versus-Delivery in eligible instruments: the settlement bundle would no doubt medium of exchange (the final settle- DvD. erode, until eventually this world ment asset). Such systems leave the offi- For each of the eligible assets, there needed its equivalent of Paul Volcker to cial-sector controller of the unit of would still be financial and other trans- restore a standard of stability (and they account in a strange position. actions for deferred or future settle- would, no doubt, in turn, find them- Most obviously, it would not be able Markets without money: clearing ment, and so there would still be coun- selves succeeded by a phase of ‘science’ to supply more money in the face of houses as the new pivot terparty credit exposures. Indeed, left during which some core truths would surges of demand other than by chang- If bundles of (a defined set of) financial in a simple state of nature, the system be marginalised, as in our time). ing the measuring rod (the equivalent assets were routinely accepted in settle- of financial intermediation would, as of adding 000s to notes today). ment of payment obligations, we might now, be rendered fragile by the com- FinTech and monetary revolution In a similar vein, while the supplier dispense with money as a medium of plex interlinkages created by chains of I have been describing a world with no of the medium of exchange could exchange. And if everyone could meet counterparty credit exposures. Clear- monetary instrument; where anyone attempt to impose the inflation tax (by everybody else, however distant, across ing houses, possibly backed by central can settle with anybody else in bundles suddenly increasing the amount of a system that enabled real-time credit counterparties, which are really de- of eligible financial assets; and in which money in circulation), the numeraire- checks, we might dispense with banks vices for mutual insurance, would ac- as payment and settlement intermedi- cordingly be crucial to the system’s re- aries. This is the kind of futurology silience. They would, in effect, control 12 Futurology aside, this matters for today. Tucker, Are Clearing Houses the New Central Banks?, Over-the-Counter Derivatives Symposium, Chicago Fed, 11 April 2014. https://chicagofed.org/~/media/others/events/2014/ opened up by things like blockchain. entry to and handle orderly exit from annual-over-the-counter-derivatives-symposium/tucker-clearinghouses-new-central-banks-tucker-2014-pdf. the markets in eligible instruments; 13 A possible need for a MMLR can also arise in monetary economies (Tucker, BIS 2014, op. cit. but, I suspect, would be unavoidable in a system without a central monetary authority.

50 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 51 Sir Paul Tucker Sir Paul Tucker

controller could in theory take offset- That does not rule out an evolution Universal access to accounts at the accounts would be the end of central ting action. In practice, doing so might towards the real-asset-bundle settle- central bank banks’ insulation from quotidian politics. be reasonably straightforward when the ment-instrument described above. But, If, technologically, the public could This would be (or could be driven to- monetary injection was massive and however much it was used in private bank with the central bank, then why wards) “state banking”, not central bank- abrupt, but might be harder in the face transactions, I find it difficult to envis- not allow everyone to do so in order to ing as we know it. That is the lesson of the of more gradual shifts in the money age a world in which governments do reap various efficiencies from de-layer- U.S. Senate’s debate on the Chicago Plan. supply as it would be necessary to judge not require taxes to be paid in an in- ing the payments system and, more Separately, exploiting the new tech- how far money demand had shifted strument they issue or directly control politically, to spread the privileges as- nology to bring everyone into a direct parri passu. To the thought that we or where delivery of that instrument sociated with access to the central bank? relationship with the monetary institu- coped well enough under the classic did not suffice to settle a private debt In the limit, this would be a world tion would have the perverse effect of gold standard during the 19th century, (legal tender). with a central bank but without private cutting off the incentives for innovation when governments could not easily If that is correct, there will be re- monetary institutions, i.e. without com- in the payments system. For all of its control the discovery and circulation of sidual use of central bank money for mercial banks as we have known them faults, the tiered public/private struc- gold, I would observe simply, first, that some time. But that does not, of itself, over the past two to three hundred ture of today’s monetary system has the gold standard was not infrequently entail an unchanged monetary-system years. Credit intermediaries (CIs) would, been a driver of change over the de- suspended; and, second, that since the structure. no doubt, still exist, but they would fund cades, leading to cheques, ATMs, debit shift to full-franchise democracy, the themselves in the capital markets and, cards, telephone banking, and now people have become less tolerant of What central banks do (1): who has crucially, without the state guarantee- online payments. swings in real economic activity and jobs. access? ing repayment of deposit liabilities. In Even if the private money supplier The big question becomes who can hold law, all CIs’ liabilities would be risky. did not actively pursue actions against central bank money, and on what terms. One principled objection to this the public interest, any official macro- At first sight, the answer is obvious: course is that it might give everyone economic stabilisation policy would everyone. Today, everyone can own access to loans from the central bank. require regular changes in the nu- and use banknotes issued by the central The case for lending to an account meraire. That is a slightly odd way of bank. In the future, we, citizens, could holder who had run out of money would providing a measuring rod. acquire specific quantities of central not rest, as now, on the social costs to bank money loaded into cards or into third parties of not lending to tempo- A new final-settlement asset? phones or whatever. That is what I was rarily illiquid but sound banking inter- Against that rather abstract background, thinking of in 2004. In terms of the mediaries: the negative externalities it becomes easier to evaluate Bitcoin, economics, nothing profound is involved: associated with banking distress. Rather, which simply represents the latest at- merely a substitution of a physical card it would be driven by the political costs tempt to create a private monetary set- or a digital store for paper as the mani- of neglecting private hardship. This is a tlement asset, and has no intrinsic festation of a monetary property right. world where the central bank becomes Beyond banks as we know them? worth. I think it unlikely that govern- That is well short of the vision aired part of the redistributive fiscal state. But if there are arguments against uni- ments will allow their own fiat money by Ken Rogoff: of e-money that pays It is very easy to say that central versality, they don’t make a case for the to be displaced. Not only because of interest, and which could therefore open banks could commit not to lend to status quo. their interest in seigniorage, but also the way to negative interest rates.14 households and small businesses, but Already central banks have been because the identified difficulties in un- Rather than discussing here the through- that is glib. Any such rule could be bro- considering whether the post-crisis bundling the numeraire from monetary the-looking-glass world of negative rates, ken. History shows that what would clearing houses should have access to exchange mean that the final settle- I am interested in the structure of the matter would be the second-order rule: central bank liquidity insurance given ment asset is, in effect, a public good. monetary system. The world conjured i. e., what counts as “exceptional” and their super-systemic status. In a similar Constraining the power of issuing that by Rogoff is a world in which the new how far it is factored into the behaviour spirit, some monetary authorities have instrument, making it ours, played no technology leads to much wider, even of economic agents (otherwise known granted broker dealers access to the small part in our long path to liberal universal, access to accounts at the as people). discount window. FinTech potentially democracy. central bank. Short of introducing a deeply entren transforms the options: why not grant ched constitutional bar on such lending, access to payments companies, peer-to- allowing citizens access to central bank peer lenders, and so on. 14 Rogoff, Ken. 2014. Costs and Benefits to Phasing Out Paper Currency. NBER Working Paper 20126. May.

52 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 53 Sir Paul Tucker Sir Paul Tucker

The stakes are high. As British econ- If the purpose of central banking is a small-scale club, government regula- system’s basic infrastructure will need omist R. G. Hawtrey observed nearly a to maintain monetary system stability, tion inevitably plays a big part in this. to be clear. Sometimes they will be part century ago:15 since the 2007–09 crisis we have come Cyber-integrity is in that sense of the solution, marking the return of to think of this as, pre-eminently, con- merely the latest in a long line of chal- the central banking plumber. “Anyone who can borrow from the cen- straining banking balance sheets. But lenges, but on a scale rarely contem- Back in the 1980s and into the tral bank can thereby procure legal tender that takes for granted the operational plated before. Some years ago Philip 1990s, central banks led on many money.” and legal integrity of the infrastructure Bobbit impressed upon the guests at a core-infrastructure projects, develop- that undergirds the monetary system. dinner held by Mervyn King the pros- ing settlement systems and sometimes This is penetrating on account of its Over the course of the past two pect of warfare via cyber attack: “We operating them. The monetary institute corollaries: centuries, amongst many other things have shut off your peninsula. Here are moment rejected or neglected that ori- • Anyone who can procure legal tender that has meant clarifying the law for ne- our terms.” Central bankers must today entation, just as it neglected or rejected can offer private monetary liabilities. gotiable instruments (bills of exchange engage with the possibility of their an interest in the soundness of individ- • Anyone who can offer monetary lia- and cheques), anti-forgery protections financial infrastructure – the wholesale ual banks. A decent Money-Credit Con- bilities should be regulated as a mon- for banknotes, and delimiting a bank- payments system, the clearing house, stitution for tomorrow will, I suspect, etary institution. er’s duty of confidentiality. During my trading platforms – being switched off have to re-embrace the plumber just as But, and this is the point, at the level of own career, it meant designing what or fatally corrupted. it has already embraced the prudential principle that has nothing to do with we then called a dematerialised system After 9/11, common wisdom was supervisor. the new technology. Hawtrey’s insight of settlement for money-market instru- that “best practice” contingency plans could usefully have guided policy over ments after a Messenger, as they were included real-time, continuous back-up The core of banking will remain prudent the past quarter century, and should called, was mugged and robbed of a of data to a physically distant server balance-sheet management frame the so far inconclusive debate sack of paper instruments in the vicin- site. In a world of cyber-attacks, con- The commercial counterpart of that about shadow banking. Basically, if an ity of Lombard Street. tinuous back-ups might flip to being thought is commonplace amongst Fin- intermediary is likely ex post to gain That wave of infrastructural inno- “worst practice”, because the attacker Tech entrepreneurs and consultants access to central bank credit, then it vation, which led to the Depository can infect the reserve as well as the today. It is not unusual to hear people would be well to anticipate that in the Trust & Clearing Corporation (DTCC) prime system. say that technology and delivery sys- regulatory framework. in the U.S.A. and electronic transfers After 9/11, policy makers focussed tems will be more important to the of title in Euroclear and Clearstream, on disaster recovery at the expense of future of banking than balance-sheet FinTech under the Money-Credit necessitated changes in the law. Poten- standard boom and bust risks. Over the management. I think, I have even heard Constitution tial changes spurred by blockchain and sim- past decade, the effort to contain those it said that balance-sheet management Thought of in that way, the significance ilar technology would likewise require risks might have deflected attention is an artefact of the old technology. of FinTech for central banks is that, at firm legal foundations. It is all very well from cyber crises. The most fundamen- That thought is, let’s be clear, utter the least, it provides another opportu- providing for confidentiality and ano- tal change brought by FinTech is less rubbish. The technology of banking has nity to make clear what is within and nymity, but property rights cannot be likely to be in the economic structure changed radically more than once over what outside the monetary system. But enforced unless it is possible for an of our monetary system than in the the past two hundred and fifty years. It unlike previous episodes, where the adjudicator (the courts) to verify own- very conditions for its survival. seems likely to do so again. But so long opportunity was fatally missed – money ership and transfer of title. Obviously, this is not a field where as the underlying economic service is market funds in the 1980s, broker deal- As the City theft incident a quarter central banks can always lead. Along- liquidity transformation and credit sup- ers in the 1990s, SIVs in the 2000s – it of a century ago illustrates, legal foun- side finance ministries, they will find ply, the changes in technology will not might demand such clarity. That would dations are necessary but not sufficient. themselves engaging with the security alter the public interest in prudent bal- be a good thing. For individual users, trust in the system and intelligence services more than ance sheet management and as resilient demands a warranted conviction that ever before. The gravity of central monetary system. Anyone who holds What central banks do (2): beyond assets will not be stolen or lost. For the banking concerns and demands for the otherwise – and some do – should be a constraints on intermediary balance society as a whole, there is a normative operational integrity of the monetary doubtful candidate for a banking licence. sheets expectation that the system of exchange There is another element in all this, won’t collapse or break. Unless the which also has its precursors. financial-services industry retreats to being

15 Hawtrey, R. G. 1922. The Genoa Resolutions on Currency. The Economic Journal 32/127. 290–304.

54 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 55 Sir Paul Tucker

Conclusions ƅƅAs such, the regulation and over- Here then are my current answers to sight of private monetary institu- the questions posed at the beginning of tions is likely to become broader. section 2: • Central banks will continue to con- • Central bank money will survive as duct financial operations that reshape the final settlement asset the state’s consolidated balance sheet ƅƅas such central banks will remain ƅƅBut they are more likely to find the pivot, but it is a role they could themselves acting as Market Mak- eventually share with central-coun- ers of Last Resort, so they will not terparty clearing houses. be at the minimalist end of the • Fractional-reserve banking will con- spectrum. tinue, so the money and credit sys- • The central banker as plumber is tems will remain inter-twined likely to be resurrected. ƅƅBut many more types of intermedi- As such, in answer to my final ques- ary involved in payments services, tion, far from withering away, the cen- clearing or liquidity-insurance might tral banks are likely to to be even more gain access to the central bank. powerful. The challenge is to minimise ƅƅIf so, that should be recognised for- the scope and depth of their role, and mally rather than stumbled into in to ensure that it enjoys wide public and the midst of crisis. political support. That might end up being a greater challenge than technological change itself.

56 OESTERREICHISCHE NATIONALBANK Session 3 Technological change and the future of financial intermediation Martin Summer Introductory statement: Head of Economic Studies Division Oesterreichische Nationalbank Technological change and the future of financial intermediation

The future of the financial system will panies and contributes a weekly column be shaped to a large extend by the to the Financial Times. He recently future of financial intermediaries. If we chaired the Review of UK Equity Mar- follow media comments and the public kets and Long-Term Decision-Making debate, we could get the impression which reported to the Secretary of that technology will make financial State for Business, Innovation and Skills intermediaries redundant. Is this expected in July 2012. He is the author of many demise of financial intermediaries real books, including The Truth about Mar- or an illusion? On the other hand, is the kets (2003), The Long and the Short of future of financial intermediation some- It: Finance and Investment for Nor- thing quite to the contrary, a future mally Intelligent People Who Are Not with an all-encompassing power of banks, in the Industry (2009) and Obliquity where their already existing power is (2010). His latest book, Other People’s levered and enhanced by digitalisation, Money – towards a financial system for data science and unlimited computing the needs of the economy rather than power? Is technological innovation in financial market participants – pub- financial services – FinTech – “disrup- lished by Profile Books and (in North tive” as many FinTech-entrepreneurs America) by Public Affairs in Septem- like to suggest, or is it rather traditional ber 2015. banking with other means, something Patricia Jackson is a member of the that changes the interface by which banks, EY Global Regulatory Network in the businesses and consumers interact with Financial Services Risk Management each other but otherwise remains quite Group. Patricia joined EY in 2004 as similar to banking as we know it? Is the Partner leading the banking risk this technological change an issue regu- practice and then later financial regula- lators should be concerned about and if tory advice. She was involved in proj- so, which are the specific issues of con- ects with the major banks globally on cern? If we would enter a time machine all the risk types as well as Basel III and that catapults us 50 years into the future, stress testing. She is also increasingly would we still recognise banks and involved in risk governance issues financial services, as we know it based including developing an approach to on our experiences from today? setting and embedding risk appetite To discuss these and other issues and risk culture. She is now a strategic related to the consequences of techno- adviser to EY. Prior to this she was the logical change on the future of banking Head of the Financial Industry and and financial intermediation, I am happy Regulation Division in the Bank of to welcome two leading experts: England and represented the UK on the John Kay is an economist whose Basel Committee for Banking Supervi- career has spanned the academic world, sion for 7 years, leading the global QIS business and public affairs. Currently, studies and calibration of Basel II. he is a visiting Professor of Economics Patricia has published a wide range of at the London School of Economics, a papers on market and credit risk and Fellow of St John’s College, Oxford. bank capital. She is a non-executive He is a Fellow of the British Academy director on the board of the digital and of the Royal Society of Edinburgh. challenger bank Atom and is involved He is a director of several public com- in setting their strategy going forward.

44th ECONOMICS CONFERENCE 2017 61 Patricia Jackson PSD2 and open banking: the policy issues Strategic Adviser, Ernst & Young Council Member, SUERF Non-executive Director, Atom Bank The digital revolution raises a range of income ratios of the largest banks in policy issues for the authorities. In Europe vary between around 55% to Europe the move to open banking is over 90%.2 However, costs cannot be regulatory-driven, but will authorities brought down significantly without fully build a legislative framework which streamlining operations using digital. fully embraces the potential for future For example, banks are experimenting change? There are also strategic chal- with blockchain, have already moved to lenges facing the industry itself. Will robotics for various repetitive processes, existing players move fast enough to and are developing cognitive systems take advantage of the new environ- using artificial intelligence as well as ment, or will new players gain an edge smart analytics. in some areas? Traditional banking is under pressure from low interest rates, much higher capital requirements which have reduced ROE and resulted in pressure from shareholders,1 new entrants, including digital players, and shadow banks. Yet, digital also offers opportunities for banks in terms of the way they interface with clients and reengineer internal processeses to cut costs. The question is whether the intense cost pressures traditional banks are facing will deter the upfront spend needed to achieve long-term digital goals. Again Open banking, which is about the new challengers with a more flexible external environment is also an oppor- architecture may benefit much faster. tunity. It changes the way that banks Under the developing requirements can interface with their customers and in Europe, banks will be forced to em- the range of products offered. It is also brace at least part of the digital world. a threat. It will provide a framework European banks will have to build a for a wider variety of players outside new architecture such as open Applica- banking to engage in a revolution tion Programming Interfaces (APIs) to around personal and small business meet the new regulatory requirements, finance. The thinking behind open and they need to consider carefully the banking is that it will enable banks’ strategy which they need to follow to customers to use the banking services maximise the benefits. to which they have access, in the context of other FinTech services – literally Digital opportunities integrating banking and wider cutting- Banks are facing considerable pressure edge services. on business models, and need to reduce A core part of open banking centres costs and improve efficiency: cost-to- on the standardisation of how banks

1 A Set of Blueprints for Success: Seventh annual global EY/IIF Bank risk management survey 2016. Available from www.ey.com/bankingrisk. 2 LeDonne, G. and F. Garrido. 2016. Global cost-to-income ratios show regional diversions for banks. SNL Data Dispatch. 31 May.

44th ECONOMICS CONFERENCE 2017 63 Patricia Jackson Patricia Jackson

share customer data with third parties vices. APIs are the interfaces between have been very successful at disinter- at the customer’s request, for use in software applications within an organ- mediating banks.4 Mint started in 2010 new third party services, in a secure isation, and between one organisation and now claims it is acting as an aggre- way. Banks develop products and dis- and another using a standard sets of re- gator for 10 million users – providing a tribute them. In the future, with open quirements which make the interface free service collecting customer infor- banking, they could partner with Fin- easy to use and protect quality.3 mation across different accounts and Techs over the creation of new prod- PSD2 provides the way forward for aggregating it. Mint customers can cre- ucts; or FinTech firms could create new a variety of players to aggregate a cus- ate budgets, know what payments are products that would be distributed by tomer’s information across all their dif- coming in, receive customised advice either the bank or the FinTech. Author- ferent bank accounts – analysing spend- on actions to save money and receive a ities envision that it will lead to more ing, total savings and so on. PSD2 will free credit score. Mint makes money customer choice and enhance competi- come into force early next year, but from banner advertising on its website tion, driving lower cost and a wider with much still to be agreed, full im- and from referral payments from finan- scope of services. plementation it is likely to be delayed. cial services, products or credit cards With bank customers increasingly The final impact is dependent on the that a customer takes up after advice the European Banking Authority (EBA). using digital channels such as internet full regulatory environment including from Mint. In Asia too, banks and Fin- These standards were expected by Jan- or mobile banking, this is an extension customer authentication to be in place Techs are looking at open banking to uary 2018 but two core standards are of the current journey and takes the in- which currently seems likely to be early drive innovation. likely to lag by even as much as eighteen dustry towards integration of a range of 2019. The second major innovation of months. These are the standards around bank and non-bank players into a wider PSD2 will create scope for new ser- PSD2 is to allow third parties, for strong customer authentication, and network of services. However, it is a vices, such as money managers offering example merchants, to initiate a pay- common and secure communication. path that requires rules and standardi- a highly tailored service for customers. ment direct from the bank account of Both are critical parts of the design, sation. Without standards there would By using the data on the customer that the customer through APIs – bypassing and fundamental to the strategy of the not be interoperability, making cross- will now be available from a customer’s the need for a credit card transaction. different players and it is important that company integration cumbersome and bank accounts /credit card transactions, The move to open banking is likely these are completed as soon as is practi- substantially reducing the potential for the money manager could use artificial to spread globally. For example, the cal. It is also essential that they are re- substantial change. intelligence to predict what products authorities in Singapore and Australia ally effective while not hampering ease the customer needs and then find the have expressed intent to adopt open of use. PSD2 exact array of products which offer the banking with use of APIs. An important policy question cur- In Europe, regulators are driving open best features and terms, given the cus- rently on the table is whether PSD2 banking. The revised Payments Ser- tomers’ needs and circumstances. Legislative framework should require APIs to be used as the vices Directive (PSD2) requires banks The extent to which customers will Unlike the private sector solutions in sole channel through which data could to enable customers to authorise licensed be willing to give third parties access to the U.S.A. and currently in Europe, be accessed as originally envisioned, or third parties to access their transactions all their financial data to support these PSD2 will provide a legislative frame- whether current scraping techniques history. It also requires banks to enable services is unclear. Nonetheless there is work requiring open banking. This is should also be allowed. Players cur- third parties authorised by the cus- quite a lot of evidence that customers what gives rise to the policy choices. rently using scraping are lobbying the tomer to initiate payments from the are willing to share information if they PSD2 is accompanied by the General EU Commission intensely to allow it in customer’s bank account to another can save money. This seems to be the Data Protection Regulation (GDPR). the future: a coalition of 62 FinTech party through the use of dedicated inter case even with the current aggregators, This reforms the data protection require- firms and lobbying organisations is faces such as APIs – direct channels which are using scraping techniques ments for companies operating in the fighting plans by the EBA to ban screen into the bank. Open APIs enable banks where they use the current passwords/ EU which handle their customers’ per- scraping from online banking inter- to connect with their customers in a credentials of the customer to in effect sonal data. PSD2 will also have its own faces on the grounds it would damage different way, and to connect with new “impersonate” them to acquire the data. regulatory technical standards set by their business models.5 The EBA had styles of player to offer different ser- In the U.S.A., aggregators such as Mint 4 MuleSoft. Open Banking and the Future of Financial Services: Are you a survivor or a thriver? https://www.mulesoft.com/lp/whitepaper/api/psd2-open-banking-financial-services. 3 For a more detailed description see the European Banking Association information paper Understanding the 5 Ainger, N. 2016. FinTechs fight plan to bar screen scraping and protect European banks. CNBC news, retrieved business relevance of Open APIs and Open Banking for banks. 2016. Working Group on Electronic Alternative from www.cnbc.com/2017/05/08/FinTechs-fight-plan-to-bar-screen-scraping-and-protect-european-banks.html Payments. May. on 14 June 2016.

64 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 65 Patricia Jackson Patricia Jackson

been proposing to use the technical objective which is enabling the initia- using scraping will still need customer market and whether it would provide standards surrounding PSD2 to ban tion of payments from a customer’s ac- passwords to access customer data, rather the right incentives. screen scraping. count, given the complexity of authenti- than computers talking direct to each The whole process of certification Allowing screen scraping would cation in the payments area. other through APIs. of the third party and authentication by change the end point of open banking. The importance of an API architec- Of course in this open banking the customer of information and pay- It also raises important cyber security ture to ensure that the full benefits of world there needs to be protection for ment requests to a bank also needs to questions which need to be addressed. open banking are achieved is under- customers covering their data and their be worked out. This needs to be secure Unlike using open API technology, lined by the thinking of leading players payments. GDPR provides some of the but not cumbersome. A mechanism scraping requires the “impersonation” across a wider selection of the industry. framework and further EBA rules will which ensured authorisation and certi- of the customer. The scraper acquires For example, Goldman Sachs has made provide more. However, policy ques- fication at the same time would be the passwords and account details from clear that they are packaging every- tions remain to be answered in this areas much more steamlined. the customer, accesses the bank as if it thing they do around APIs.6 Goldman too. Participants in the open banking The policy decisions taken are criti- were the customer, calls up the data re- has built a data lake pulling in informa- architecture – those triggering pay- cal and will affect the extent to which quired on the screen and collects and tion from across the firm – transac- ments through a customer’s bank or PSD2 heralds a new style industry. tions, markets, investment research, requesting information from a custom- materials from emails, phone calls etc. er’s bank – will have to be licensed, but Winners and losers Using artificial intelligence, their sales the details of this licensing regime have The changes brought by PSD2 will alter forces can decide who to call and what not yet been agreed. the value chain in banking for retail and to offer them. The importance of the With regard to payments triggered SME products. The credit card value APIs is that they enable clients to access by a third party, there are concerns chain is likely to be undermined over directly the data available in the lake. about liability if the payment was fraud- time by the ability of licensed third Goldman Sachs say they will have more ulent. The bank which made the pay- parties to trigger a direct payment from than a thousand unique data sets avail- ment initiated by the third party has to a customer’s bank account. able for clients. The APIs make access make good the customer and then sue Organisations that are quick to em- quick, usage can be measured and the the third party. This raises issues about brace the scope to aggregate informa- impact on clients assessed. APIs are the the stringency of regulation of the third tion from customers’ accounts and use standard way for computer programmes party – who should be able to initiate a artificial intelligence will be able to of- to interact with each other and this is payment? fer customers savings in search time translates it so that it can be used by an- what makes the API based solution This raises an important policy issue and cost when selecting a wide range of other application. Currently, the wave much more robust and straightforward. about the size and structure of the open products, assessing the appropriateness of activity from the “scrapers” can The same will be true of retail oper- banking ecosystem. Will the regulators of products in a much more granular appear to a bank as a hacker. Given the ations involved in open banking. APIs favour an ecosystem of hundreds of way reflecting the richness of customer small number of current players and offer a sound mechanism to underpin firms licensed to request data on cus- data to which they have access. An the set times of day when they seek in- the new architecture – enabling infor- tomers from banks and initiate pay- example here is Yolt, an ING tool being formation, this has been more or less mation to be pulled from different ments through banks or will they favour tested in the UK, offering the customer manageable – although in the U.S.A., accounts of a client and payments to be a small number of interface players who a comparison of bank account fees, in- such problems have been substantial, triggered. The benefits for customers stand between the FinTech companies terest rates, cost of energy contracts, causing some banks to produce APIs of a fully API based model rather than a and the banks. The FinTech company and insurance. The new landscape will for scrapers to use. Once access to mix of API and scraping are substan- with approval of the client would send offer customers the benefits of money information by aggregators becomes a tial. The risk of the latter is that rather an information request or a payment management and price comparison. core part of financial services, the than one universal approach providing request to one of the 10 or so interface Using artificial intelligence a custom- effects of scraping on cyber security ease of use, some interactions based on companies who would then access the er’s needs can be predicted. could become unmanageable. It is also scraping will fail or trigger cyber reac- information from the bank and trans- The net effect is likely to be a move hard to see how a route that does not tions in a bank where data is being mit it back to the FinTech or initiate the to a much more fluid banking and require mandatory use of an open API extracted. Standard processes for cus- payment through the bank. The choices financial services model, with many framework can meet the second PSD2 tomers will not be possible because firms need to weigh up whether an approach more customers willing to switch pro- might create barriers impeding the viders. This will mirror and progress 6 Turner, M. 2017. Goldman Sachs wants to become the Google of Wall Street. Business Insider. 6 April. development of a flexible competitive the revolution that has already occurred

66 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 67 Patricia Jackson

in terms of retail insurance, where use Conclusion of price comparison websites in the The whole process has the potential to UK, for example has resulted in much create a tectonic shift in the landscape. lower renewal likelihood on policies as However, the regulatory framework customers search at each renewal date will affect the confidence in the new for the most advantageous product. environment through the success of the It is hard to predict the effect that protections built into it. Regulation this could have on traditional financial will also affect potential development services or the speed. But both could in other ways. Processes of certification be substantial. Amazon has shown the of FinTechs (a digital ID for the third speed with which retail customers have party) and authentication of informa- been willing to adopt a new more con- tion requests or payment requests by venient purchasing mechanism which customers, which are cumbersome, offers monetary savings and greater will reduce take-up of new services. convenience. Price comparison web- Likewise, lack of commonality through sites in the UK have also shown how not requiring use of APIs could also quickly buying patterns for insurance damage the rate of progress – particu- or energy can change when better value larly if the attempt to use scraping as can be achieved. Without regulatory well as open APIs results in failure of impediments, and indeed with regula- processes because cyber defences in the tory support through the design of the banks are triggered. This will become framework, this could snowball very more likely given the expected sharp quickly. increase in data requests. It is also pos- Over time, this could start to erode sible that existing and highly regulated incumbents’ retail and SME profits. retail banking markets may not benefit The major banks are fast building their fully from the potential developments own response, but the challenge is to because other regulations stand in the move flexibly given their existing prod- way. The choice of how FinTechs can uct ranges, processes and so on. An interface with the banks, directly or existing player will not want to offer through special intermediaries, could products that undercut its existing also potentially create barriers keeping services. some players out. This creates major strategic ques- The benefits from the standpoint of tions for existing banks. How quickly the authorities lie in the increased flex- they should move to build a new range ibility of services provided to retail and of customer interfaces, where they use SME customers in particular and much the new potential to aggregate informa- greater competition between players. tion rather than just being a provider? This will almost certainly result in im- Or do they want to remain focused on proved pricing and choice for consum- their current products and customer ers. With services provided on the back interfaces in which case they will be a of aggregation of data from different provider not a user of the information bank accounts, retail and SME custom- available? ers will also be able to track expendi- ture patterns and saving more effectively. Another goal is to open up the payments world to greater competition.

68 OESTERREICHISCHE NATIONALBANK John Kay Economist Technological change and the future of St. John’s College financial intermediation

In London I am often asked to give talks cated version of that question asks about developments in the finance sec- “What value-added can be gained from tor to a general audience. One question a group of people trading paper claims which routinely comes up is “What do on existing assets with each other in people who work in the finance sector, secondary markets?” in those large office blocks and in the City of London and Canary Wharf, actually do?” And the answer I give is that – to an extent that almost defies belief – “What they do is trade with each other.” World trade in goods and services has expanded greatly since the Second World War. But today the volume of global trading in foreign exchange is a hundred times the volume of global trade in goods and services.1 The total value of exposures under derivative contracts amounts to between two and three times the total value of all the Of course there can be no doubt assets in the world.2 And when I wrote that finance is indispensable to modern about this process of financialisation in economies.4 We need finance for four 2014, I highlighted the activity of a primary purposes. The payment system company called Spread Networks in is the essential utility of finance, the building a telecommunications link mechanism by which we receive our across the Appalachian Mountains to wages and salaries, pay our bills and reduce the time to transmit data enable businesses to transact with each between Chicago and New York from other. A second role of finance is to 7.3 to 6.6 milliseconds. Since then, allow wealth management. We need to improvements in microwave technol- finance education when young, retire- ogy have reduced the time required to ment when old, and we need to save in something closer to the physical lower the intervening years in order to make bound, which is the four milliseconds it these things possible. takes for light to travel between the Wholesale financial markets as they two cities.3 operate today are directed at two other My description of this activity typi- functions: capital allocation, the pro- cally prompts further questions. The cess of directing funds from savers and obvious one is “What is the purpose of investors to companies and borrowers all this activity?” And a more sophisti- and risk management, the business of

1 Bank for International Settlements. 2016. Triennial central bank survey of foreign exchange and OTC derivatives markets in 2016. World Trade Organisation. World Trade Statistics 2016. 2 Bank for International Statistics. 2017. Semi annual derivative statistics. June. Credit Suisse Global Wealth Report. 2016. 3 MacKenzie. D. 2017. A Material Sociology of Markets: the Case of “Futures Lag” in High-Frequency Trading. Auguste Comte Memorial Lecture. Edinburgh. February. 4 See, for example, the survey in Levine, R. 2014. Finance and Growth: Theory and Evidence. In: Aghion, P. and St. Durlauf (eds.). Handbook of Economic Growth. Elsevier/North Holland.

44th ECONOMICS CONFERENCE 2017 71 John Kay John Kay

reducing the costs of bearing the risks But by the 1980s, the market had And so it proved when a series of 1960’s. The nature of equity markets inseparable from modern economic and changed. Aggressively entrepreneurial disasters hit the insurance industry changed also. social life. Lloyd’s brokers realised that if you generally and the Lloyd’s market in The equity markets with which we My introduction to modern devel- could sell reinsurance, you would also particular in the late 1980s. The first are familiar came into being in the 19th opments in finance came when I became sell reinsurance of reinsurance. And such incident was the destruction by century to finance railways and rail- involved in the process of reconstruc- reinsurance of reinsurance of reinsur- fire of Piper Alpha, an oil rig in the roads. Railways and railroads were cap- tion in the Lloyd’s insurance market, ance. In what became known as the North Sea. That loss was then the larg- ital intensive projects, and the capital following the near collapse of that mar- LMX spiral, complex contracts were est single marine insurance claim ever required was specific to that particular ket at the end of the 1980s.5 Lloyd’s constructed which involve multiple made, and it turned out that the total use. There is little you can do with a came into being in the 17th century. layers of insurance, in which it was volume of claims at Lloyd’s which railway except run trains on it. The The institution famously originated in simply impossible to drill down and resulted from it amounted to more than savings needed were collected in mod- Thomas Lloyd’s coffee shop, where identify the structure of the underlying ten times the original value of the loss. est amounts from large numbers of English gentlemen would gamble on risks. All that could be done was to People who had never heard of Piper moderately well-off individuals. These many things, including the fate of ships model some of these contracts and Alpha had in fact insured it over and individuals bought both equity and and the state of tides. Lloyd’s remains establish that in the past nothing would over again. And that was how some of bonds in the new enterprises, and were today the centre of the global marine have been paid out on them. the stately homes of England were emp- provided with a degree of liquidity insurance market, but by the 20th cen- I recall two particular moments of tied of furniture in order to meet the through expanded capital markets.6 tury had come to be predominantly a revelation as I learnt about these mar- losses of Lloyd’s names. This financing model, then closely reinsurance market. ket developments. I asked how much of All this was preparation for under- bound up with imperialism and the Lloyd’s was above all the place to the growth in business, of which the standing what was happening in the development of the interior of the which brokers would bring idiosyn- market was so proud, had come in rapid credit expansion from 2003 to United States, was then extended to re- cratic risks. The modus operandi was “through the front door”, as distinct 2007. During that period I found source companies, and in due course to that a lead underwriter would price the from being generated within the mar- myself asking “Who are the equivalent the manufacturing businesses which risk and take a proportion of it. Other ket itself. My surprise was not just that in credit markets today of those stately came to dominate Western economies underwriters operating from what was it took time to establish the answers, homeowners who did not understand in the course of the 20th century. The known as “The Room’, literally a large but that people were surprised by the the magnitude of the exposures which zenith was reached in mid-century – in room, would follow that lead and question. Another salutary exchange they had assumed?” In 2008, we found the first Fortune 500 list in 1956 – nine determine what proportion of the over- was when I asked a particularly arro- the answers to that questions; much of out of the 10 top companies were man- all risk they were prepared to take. The gant underwriter to explain why he had the exposure lay in large banks, many ufacturers. Among them were three system worked on the basis of mutual not “blown the whistle” on the col- of them in Europe. automobile companies and three steel knowledge and respect within the under- leagues whose incompetence he had The widespread trading of credit companies.7 writing community. been denouncing with such vehemence. exposures began with the securitisation If one looks at the 10 largest compa- His answer was simple. “Because they first of mortgages and then of other nies by market capitalisation today, the were willing to buy risks at prices at loans in the 1980s. The shift in empha- picture has radically changed. The list is which I was delighted to sell them.” sis from syndication of primary issues dominated by new economy businesses: The market had changed from one in to secondary markets in securities orig- Apple, Alphabet (Google), Amazon, which the process was primarily one of inated by a single lender directly paral- Microsoft and Facebook. There is only mutualisation of risks to one in which leled the prior developments I had ob- one manufacturing company on the list risks were being transferred from peo- served at Lloyd’s. But these changes and that, Johnson & Johnson, is a very ple understood a lot about them to peo- represented only a small part of the different kind of business from the steel ple who knew little. The trading of overall process of financialisation of and automobile makers of 50 years risks within the market was not spread- Western economies, the putting of before. Berkshire Hathaway, sui generis, ing these risks but concentrating them finance at the centre of economic life, includes manufacturing businesses among in the hands of those who did not r ealise which gathered pace steadily from the its collection of investments.8 That com- what they were doing. 6 Hannah, L. 2010. The rise of the corporate economy. Routledge. 7 5 For a description of this crisis see Duguid, A. 2014. On the Brink: How a Crisis Transformed Lloyd’s of London. See archive.fortune.com/magazines/fortune/fortune500_archive/full/1956 . Houndmills, Basingstoke, Hampshire: Palgrave Macmillan. 8 In May 2017, the others were JPMorgan Chase, Exxon Mobil and significantly Alibaba.

72 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 73 John Kay John Kay

pany may be at once relic of the past The paradox of modern capital mar- disaster at Lloyd’s. If we think for a tures of regulation or lengthy and com- and portent of the future - the era of kets is that although there is less and moment outside the context of finan- plex chains of intermediation by pro- the diversified manufacturing conglom- less need for market activity from the cial markets, we see how rare it is in viding immediate verification of the erate is coming to an end, but the hold- point of view of either the end users of the modern economy that transactions reliability of both buyer and seller. ing company and the private equity finance, or the investors who are the are anonymous; even our everyday pur- house which internalizes the process of ultimate beneficiaries of finance, the chases are not simple or transparent or capital allocation are direct responses volume of market activity has increased standardised. For small value transac- to the excessive costs, burdensome reg- exponentially. And yet policy towards tions we rely on the reputation of the ulation, and weak governance character- capital allocation places more and more seller, for larger value transactions we istic of modern public equity markets. emphasis on markets. European regula- make our own specific enquiries. Apple’s market capitalisation today tion, centred inevitably around acro- The notion that through standardi- exceeds USD 800 billion, and Alphabet nyms, finds M as its most frequent sation of financial transactions we can the holding company for Google, is not abbreviation, so we have MAD, the resist the universal tendency away from far behind. For both these companies, Market Abuse Directive, rather than CAD, standardisation in markets of all kinds operating assets account for less than the Customer Abuse Directive, as though it represents a fundamental misunder- USD 30 million of that value. Modern were the market rather than the cus- standing of basic economics. Standardi- businesses like these employ very little tomer which required protection. The sation is not an answer to the problem capital, and such assets as they do use centrepiece of European financial regu- of information provision in financial mostly need not be owned by the com- lation is MIFID, the Markets in Financial markets, nor is pervasive information The rise of Uber and Airbnb is a pany that operates from them and typi- Instruments Directive. And today the pri- asymmetry successfully resolved by forceful illustration that although we cally are not. mary objective of European financial insistence on the provision of detailed need less intermediation in financial As a source of capital for business, policy is to create a Capital Markets Union. financial information on a standardised markets than we have today, the right equity markets no longer register on We have extensive discussion in basis, whether in company accounts or level of intermediation in future is not the radar screen9. In Britain and United Europe today of the promotion of “sim- key features documents. zero. Some people take the view that States, the countries with the largest ple, transparent, standardised securiti- I have described how excessive trad- disintermediation through peer-to-peer equity markets, funds withdrawn from sation”. It is intrinsic to securitisation ing amongst intermediaries is created lending and crowdfunding will trans- these markets through acquisitions for that it is neither simple nor transparent. not solved the problems we encounter form the provision of finance to indi- cash and share buybacks have recently And the belief that mortgages could in markets for risk, markets for debt, viduals and businesses. I am sceptical of routinely exceeded the amounts raised advantageously be standardised and and markets in equity securities. I this claim. The thesis I have been devel- in rights issues and IPOs. securitised, perhaps with the assistance believe it is time to raise question marks oping is that both investment and risk At the same time, savings have of government agencies, led more or over the entire market based model of transfer are unavoidably heterogeneous, become institutionalised. Initially such less directly to the 2008 global finan- financial services provision. We should idiosyncratic transactions. In conse- institutionalisation took place mainly cial crisis. The notion that securitisa- be talking about risk management and quence, algorithmic scoring can never through the investment activities of tion is the answer to deficiencies in the capital allocation without any presump- replace, although it may be able to assist, pension funds and insurance compa- availability of small business finance tion that markets are the best way of a qualitative and quantitative assessment nies. Today much of their activity has can only be promoted by people, handling these issues. of an experienced loan officer or shrewd been outsourced and while pension whether policy makers or lobbyists for It is instructive to look at the eco- investor. Like most people interested in funds and insurance companies are still investment banks, who have no idea nomic role that many of the new econ- business, I have never seen a business important players, the equity invest- what is really involved in the provision omy companies I described above now plan for a start-up which did not look ment chain is today dominated by the of small business finance. play. The primary role of intermediar- superficially promising. It is only once major asset managers Blackrock, Van- The growth of secondary market ies like eBay and Amazon is to enable you have seen 20 or 30 similarly prom- guard, Fidelity and their competitors. trading at the expense of an under- people to transact with confidence with ising proposals, and have e xperience of And sovereign wealth funds are an standing of the underlying exposure led suppliers and providers of whom they what happened to them that you are increasingly important fraction of public to disaster in the global financial crisis themselves have no knowledge. Even able to begin to distinguish effectively market equity ownership. of 2008, just as it had earlier led to more strikingly, Uber and Airbnb are between the effective entrepreneur and innovative business models which have the perennial optimist. I think the 9 See the Kay Review, https://www.gov.uk/government/publications/kay-review-of-uk-equity-markets-and-long- come into being to serve precisely this future of peer-to-peer lending is that term-decision-making. function; to replace traditional struc- the institutions which survive fraud,

74 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 75 John Kay

losses and increased regulatory scrutiny teaching career at Oxford, careers in will increasingly resemble the organisa- the City of London were mostly for tions which we used to call banks. undergraduates who were not academi- The appropriate number of inter- cally distinguished but nevertheless mediaries in finance is in most cases socially polished and well-connected. somewhere between one and two. An All that has changed, and not altogether intermediary who genuinely adds value for the better, as was evident when the will generally be one who has some Bank of Scotland and the Royal Bank of specialist knowledge of one or both of Scotland failed in 2008, after three the end-users of finance – either the centuries of prudent success, under the companies in which an equity invest- stewardship of able individuals with ment takes place, the individuals will good degrees from the finest universi- take out loans, and established corpo- ties and business schools. rate borrowers, or the depositors and Larry Summers, former president investors whose savings are necessarily of Harvard and US Treasury Secretary, the ultimate source of such finance. A once observed that finance had once few minutes on a trading floor today been the preserve of people whose pri- demonstrates that the principal knowl- mary skills were those of good com- edge many intermediaries have is that panions at the 19th hole of the golf the behaviour of other intermediaries. course, but had become the province of When I was a schoolboy in Scotland people with the sophisticated mathe- in the 1960s, joining the Bank of Scot- matical skills required to price complex land or the Royal Bank of Scotland was derivatives.10 Summers, with skills bet- a career for the boys in my class who ter adapted to solving differential equa- were not going to get good enough tions than conviviality at the 19th hole, grades to go to leading universities. noted this shift with evident approval. Even when a few years later I began my I am not so sure.

10 Summers, L. 1985. On Economics and Finance. In: The Journal of Finance 07/1985.

76 OESTERREICHISCHE NATIONALBANK Session 4 The capital markets of the future The capital markets of the future: Ernest Gnan positive versus normative aspects Council to the Board and Head Economic Analysis Division Oesterreichische Nationalbank Secretary General SUERF Capital markets are a key element in today’s A first, positive, perspective attempts financial system. Their development is to forecast what will most likely happen. also central in shaping the overall char- Several aspects are relevant , for instance: acteristics of the financial system of the • First, how will technological game future. This is to say, it is worth thinking changers such as artificial intelligence about where capital markets are heading and algorithm trading affect asset for, what the underlying driving forces management? What impact will the are and what the possible consequences dismal performance of active asset might be. management strategies and that by Before the crisis, it was common hedge funds have? Will the trend wisdom to distinguish between capital towards low-cost, standardized prod- market-based, Anglo-Saxon financial ucts such as Exchange-Traded Funds systems and continental European, (ETFs) continue? How will the trend bank-based systems, with various authors towards online brokerage and more emphasizing pros and cons of each explicit pricing of advisory services system. As the financial crisis started in to different customer segments affect 2007 and evolved, views differed on access to higher yielding investments? whether capital markets or banks were • Second, what implications might the mostly responsible for the financial increasing importance of passively crisis and its propagation. In fact, both managed investment funds and ETFs sectors, including their interlinkages, have on systemic stability, if they had a massive impact. encourage synchronized behavior? In response to the crisis, the author- Would more global harmonization of ities substantially reinforced bank regu- capital market and shadow bank reg- lation, more than regulation of other ulation contribute to systemic stabil- areas of the financial industry, such as ity or the opposite? shadow banks. SUERF addressed the • Third, on the demand side of capital issue of Shadow Banking: Financial Inter- markets, the question arises how mediation beyond Banks in a SUERF Col- central banks’ future policies towards loquium, jointly organized with Suomen outright asset purchases will affect Pankki, in Helsinki on September 14– global demand for low-risk fixed 15, 2017. Combined with the need for income products on prices and yields. consolidation in banking, due to mar- When and how will a tapering of gin squeeze and cost pressures, capital purchases happen? How about rein- market financing has gained in impor- vestment policies? How about the size tance relative to bank financing in con- of central banks’ outright securities tinental European countries over the holdings in the longer term? How past years. Corporate bonds are boom- about their future monetary policy ing. Besides, securitization, which had toolkit and balance sheet structure? been identified as one source of the fi- Another important factor in a long- nancial crisis, has strongly expanded term perspective are of course again meanwhile. Global M&A activity pension systems: How will future is also expanding strongly. needs to save privately for pensions – So, where are capital markets heading globally, not only in the developed for? In investigating this question, two world – influence the demand for principal perspectives can be adopted: securities?

44th ECONOMICS CONFERENCE 2017 81 Ernest Gnan Ernest Gnan

• Another relevant topic is how to areas, by weighing pros and cons, and improve market pricing and avoid by offering solutions to the problems. exuberance, booms and busts, and how The first paper by Professor Nikolaus to further improve crisis resilience. Hautsch, University of Vienna, addresses a • Of course, normative visions of what complex topic which is seen quite the capital markets of the future ambivalently among economists, regula- should look like, can differ considerably tors and in the public debate, namely depending on whose vision we are high frequency trading. In line with talking about: „society“, borrowers this ambivalence, Professor Hautsch (including governments), savers and will address both the costs and benefits investors, monetary policy makers, of high frequency trading. regulators and supervisors, and various The second paper by Professor David types of financial firms might all have Yermack, NYU, Stern School of Business, different normative visions. addresses the interesting topic of smart • Fourth, on the supply side of capital Finally, these two – forecasting and nor- contracts. By making a breach of contract tive forecasting perspective – one might markets, the future of sovereign mative – perspectives are linked with expensive, smart contracts increase the – due to their advantages, expect smart borrowing is key. How will sovereign one another. Depending on one’s judge- incentive to fulfil the contract and thus contracts to gain in importance in the debt levels evolve over the longer ment on what various stakeholders and increase security to the parties of the future. Taking a normative perspective, term? How will debt sustainability be interest groups regard as a desirable fu- contract, without requiring trust, and on might even welcome this for reasons affected by an eventual normalization ture for capital markets, and on one’s in this way also economize on contracting of efficiency, as long as possible risks of interest rate levels? What will, in assessment of the influence these groups and enforcement costs. Taking a posi- are understood fully and taken care of. fact, likely be a future „normal“ may have on law and rule making, one interest rate level? How will the euro might forecast in which direction regu- area sovereign debt evolve? lation and supervision of capital markets A second, normative perspective asks might actually develop. This would in in what direction capital markets should turn affect one’s forecast of how capital develop. markets will evolve. Conversely, based • What role should capital markets and on one’s forecasts on the likely secular shadow banks play as compared to development of capital markets due to bank financing in the future? For long-term trends such as technology, instance, one might postulate that demographics and government debt, capital markets should grant broader one might conclude that measures access to finance also for medium- should be taken to reinforce or contain sized enterprises, through various certain tendencies. forms of loan bundling, tranching Obviously, the subject of this session etc. In the EU, the project of a Euro- itself could easily fill a two-day confer- pean Capital Markets Union explicitly ence. Instead, this session picks out two aims to further integrate capital markets specific topics relevant for the future across the 28 (or 27) Member States, evolution of capital markets. Both papers in order to improve financing possi- contribute to the first, positive or fore- bilities across the Single Market for casting, perspective by providing deep financial services and capital. insights into the subject matter, thus • In the euro area, a long-debated allowing more informed forecasts on theme is how to standardize, pool or their potential usefulness and limita- even mutualize, in one way or another, tions. At the same time, both papers euro area governments’ debt financ- contribute to the second, normative, ing, while maintaining incentives for perspective on the future of capital fiscal responsibility. markets, by identifying problematic

82 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 83 Nikolaus Hautsch High-frequency trading: risks and benefits Professor University of Vienna 1 Introduction links are the current state of the art and Nowadays a substantial part of trading push the latency, i.e., the time it takes for activity in equity, derivative and currency a signal to travel from point A to point markets is due to algorithmic high-fre- B, close to natural limits induced by the quency trading (HFT). The role and effect speed of light. of HFT on financial markets is controversially discussed and in the center of attention of market operators, regulators, and market participants. This article briefly introduces to the concepts of HFT, reviews its developments through the last decade and summarizes the current state of discussion. It moreover gives an overview of current empirical evidence on the effects of HFT and provides an outlook on its future in light of upcoming regulation. HFT is characterized as automated trading that employs (i) algorithms for order execution and automatic order HFTs perform various kinds of strat- routing, i.e., the distribution of (large) egies where speed advantages, low reac- orders through time and across different tion times and the ability to post (and market places, (ii) low-latency technol- cancel) a large amount of orders within ogy and co-location services, and (iii) very short time periods, are beneficial. high message rates. HFT is typically car- One major strategy is market making, ried out by proprietary firms, hedge funds i.e., providing liquidity on both sides of or broker-dealer proprietary desks. High- the market. Accordingly, HFTs post limit frequency traders (HFTs) use short hold- orders on the best ask and best price level ing periods and do no take significant and earn the bid-ask spread, similarly to over-night positions. They neither take designated market makers in classical highly leveraged positions, but face rather floor trading, see, e.g. Demsetz (1968). low margins per trade, while making In some markets, liquidity providers addi- profits by executing many (small) trades tionally earn a liquidity rebate offered by through a day. Accordingly, they typically the exchange to reward market participants focus on highly liquid assets. for providing market making service. This A central aspect of HFT is to exploit incentivizes HFTs to serve as passive liquid- speed advantage. A central requirement ity suppliers in possibly many transactions. is that the server of the HFT firm is Other examples are order detection co-located, i.e., it is placed in near dis- strategies. In many markets, posted limit tance to the server of the exchange. orders are partly or entirely hidden. The Exchanges offer this as a paid service, motivation for hiding an order is to get and promise certain latencies. Likewise, protected from front-running and to HFTs pay for high-speed connections avoid price impact, i.e., unfavorable mar- between different market places. While ket movements as a reaction to a posted fiber-optic cable connections have been limit order, see, e.g., Cebiroglu, Hautsch used in the early days of HFT (around and Horst (2014). For HFTs it is benefi- 2005), microwave connections and laser cial to identify hidden orders placed in

44th ECONOMICS CONFERENCE 2017 85 Nikolaus Hautsch Nikolaus Hautsch

the spread as they induce lower transc- tion earlier on and can benefit by lever- prices in decimals instead of fractions, mostly harms the HFT firms themselves, tion costs. A common way to identify aging the subsequent price movement. bringing down the minimum spread. In there is no convincing evidence for HFT hidden liquidity is to post so-called imme- “Spoofing” is a more extreme form of it, 2005, the SEC passed the Regulation causing flash crashes, see, e.g., Kirilenko diate-or-cancel (IOC) orders that are where orders are posted with the intent National Market System (Reg. NMS) et al. (2017). In fact, recent empirical automatically canceled if they do not get to cancel them before they get filled. requiring trade orders to be posted research predominantly shows that HFT executed. An obvious downside of such This is a manipulative strategy, which is nationally and not on individual exchanges improves liquidity and market efficiency, strategies is that they create substantial illegal. A further example for an illegal (“trade-through rule”). Simultaneously, thus showing a positive effect of HFT. message traffic with high order-to-trade strategy is “quote stuffing” with the aim in Europe, the Markets in Financial Hendershott et al. (2011) find that algo- and cancelation ratios. For instance, on to increase the message traffic, such that Instruments Directive (MiFID) intro- rithmic trading enhances the informa- Nasdaq, up to 90%–95% of all posted the bandwidth and thus the access of duced a principles-based best execution tiveness of quotes. Hasbrouck & Saar limit orders are canceled shortly after other market participants is slowed down. regime compared to the rules based U.S. (2013) show that increased low-latency submission and thus get never executed. approach. This openend the door for activity decreases spreads, increases dis- 2 Discussion and history of HFT Smart Order Routing. In 2007, new played depth and lowers short-term vol- The role of HFT is controversially dis- market access models have been intro- atility. Menkveld (2013) stresses the role cussed. The public discussion and media duced. Some market participants obtained of HFTs as high-frequency market mak- coverage is dominated by the view that “direct market access” without sufficient ers. Brogaard et al. (2014) show that HFT degrades the function of the market, control mechanisms on the validity of HFTs facilitate price efficiency. Hence, discriminates non-HFTs, makes markets orders. Finally, regulation allowed the criticism of HFT degrading the mar- less stable and wastes resources by an exchanges to introduce co-location and ket function is empirically not necessar- unreasonable technological arms race. proximity services. Hence, unequal market ily confirmed. The most famous critique comes from access has been systematically established. Nevertheless, some evidence supports Michael Lewis in his book Flash Boys Regulation thus established a level more critical views. While Kirilenko et (Lewis, 2014). According to Lewis, playing field for HFT. Accordingly, the al. (2017) find that HFTs did not trigger “speed traders prey on retail investors extent of HFT rapidly increased since the May 2010 flash crash, it is shown that and rig the stock market”. Likewise, Sti- 2005. In 2010, HFT accounted for HFTs are nonetheless not helpful in sta- glitz (2014) argues that HFT steals infor- approximately 56% by volume of the bilizing markets in such a situation. The Another important strategy is statis- mation rents and that markets are ulti- entire equity turnover in the U.S., see, authors find evidence for latency arbitrage tical arbitrage. Traders try to make prof- mately too active and too volatile. He Agarwal (2012). In Europe, this percent- and inventory changes of HFTs being its by exploiting temporary inconsisten- asserts that there is no social value as age amounts to approximately 38% in positively related to contemporaneous cies in prices between different exchanges HFT degrades the market function. 2010. Since 2009/10, the extent of HFT price changes. Thus HFTs tend to trade or assets. Due to a high market fragmen- Public perception, however, often in U.S. and Europe equity trading in the direction of the market, which is tation, such strategies are particularly tends to regard HFT as an isolated phe- declines and ranges between 40% and contrary to “classical” market making. pronounced in the U.S.A. Other domi- nomenon disconnected from general 50% in 2014. Similar developments and Budish et al. (2015) argue that the high- nant strategies are latency arbitrage, developments in the trading landscape. quantities are observed in U.S. futures frequency trading arms race is a symp exploiting direct market access and the In fact, HFT is a consequence of techno- trading and FX trading. In Asia, the tom of flawed market design and that possibility to receive market data a few logical progress and regulatory changes extent of HFT is generally lower, while the re-introduction of (high-frequency) milliseconds earlier than other market during the last decade. The starting point in China HFT basically does not exist. batch auctions would be a favorable alter- participants. With such a speed advantage was the change from classical floor trad- In public perception, HFT is often native to continuous trading. it is possible to react faster on corresponding to electronic trading and the intro- associated with male-functioning algo- ing trading signals or to anticipate order duction of ECNs in the 1990s. In 1998, rithms getting out of control as, e.g., in 3 Empirical evidence flow that is automatically routed through the U.S. Securities and Exchange Com- case of the Knight Capital Group on Hautsch, Noé and Zhang (2017) (hence- smart order routers. mission (SEC) passed the Regulation August 1, 2012, or with (flash) crashes, forth HNZ) provide evidence on the role Momentum ignition strategies involve Alternative Trading Systems (so-called such as the flash crash on May 2010, of HFTs as market makers in Bund Futures posting and cancelling a large number of Reg. ATS) to restrict the monopoly where leading U.S. indices dropped by trading at the derivatives exchange Eurex. trades and orders in a particular direc- enjoyed by NYSE and NASDAQ in the nearly 10% within a few minutes. While HNZ exploit access to proprietary order- tion in order to trigger a price movement U.S.A. This was the starting point for incidences based on male-functioning level message data with member ID and and to cause other algorithms to react an increase of market fragmentation. In algorithms seem to be an existing (though trader ID allowing for an institutional on it. HFT firms have established a posi- 2001, U.S. stock exchanges began quoting low) operational risk which typically HFT identification. In addition, they

86 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 87 Nikolaus Hautsch Nikolaus Hautsch

Chart 1 Chart 2 HFT Liquidity in the Bund Futures market Trading proﬁts of high- frequency trades in the Bund Futures market HFT Liquidity supply participation rate HFT Liquidity demand participation rate Positioning proﬁt Net spread

% % EUR thousand EUR thousand

Source: hart reproduced from Hautsch, No and hang (2017). Source: hart reproduced from Hautsch, No and hang (2017). Note: Profits through trade positions (left) and through market making during 60 minute windows around scheduled macroeconomic announcements with extreme price Note: HFT liquidity supply participation rate (left) and demand participation rate (right) in traded contracts through 60 minute windows around scheduled macroeconomic movements in Eurex Bund Futures trading, 2014–2015. Averages across announcements with shaded areas indicating 95% confidence intervals. announcements with extreme price movements in Eurex Bund Futures trading, 2014–201. Averages across announcements with shaded areas indicating 9% confidence intervals. The solid line is the overall mean across all trading days excluding the one hour window around the release. Chart 2 gives the average profits and spread as they predominantly act as employ a statistical identification of HFT is shortly before the news arrival. In the losses of HFTs and non-HFTs during the liquidity demanders. Hence, these results activity by considering trading desks with last minute before the news is released, 60 minute period around an announce- seem to suggest that HFTs serve as high- a given number of order submissions per HFT liquidity supply drops from roughly ment under the assumption of an initial frequency market makers and just take day, low end-of-day positions and very 50% to less than 35%. At the same time, inventory of zero 30 minutes before the over the function of designated market short order life times. This allows for a their trading strategies become more aggres- news release. The red curve in the left makers, standing ready to supply liquid- quite precise identification of activity sive and they significantly increase their picture gives the average profit made by ity whenever needed and earning the stemming from HFTs and non-HFTs. liquidity demand. Hence, in periods the entire HFT activity in periods around bid-ask spread. HNZ, however, show HNZ particularly focus on turbulent where uncertainty becomes very high news announcements. The blue curve that this conclusion can be misleading. market periods during periods around and the risk of a limit order becoming indicates the average profits and losses Chart 3 shows HFT activity from scheduled macroeconomic news mispriced peaks, HFTs considerably of all non-HFTs. The two pictures are 9:00 a.m.to 21:00 p.m. on the day after announcements. reduce their inventory and at the same based on a decomposition of the overall Brexit (June 24, 2016). The black line is Chart 1 shows the development of time increase their trading activities, pre- (average) profits into the profits from the proportion of all trades initiated by liquidity supply and liquidity demand sumably trying to exploit latency arbitrage. pure market making, i.e., earning the HFTs, whereas the blue curve is the cor- participation ratios around scheduled As documented by HNZ, this is also bid-ask spread (chart 2, right picture), responding proportion on “normal” days news announcements creating large price reflected in the bid-ask spreads as a mea- and the profits by active directional trad- without any particular news events. We changes. The liquidity supply and demand sure for trading costs in the market. They ing through this period (chart 2, left observe that on this day, the order aggres- participation ratio corresponds to the show that bid-ask spreads, where HFTs picture). Correspondingly, during the siveness of HFTs is significantly higher percentage of trading volume where make the market on both sides are gen- hour around a news announcement, HFTs than during periods around scheduled liquidity is supplied and demanded, erally lower than bid-ask spreads origi- in the Bund future market earn on aver- news announcements. Hence, on such a respectively, by HFTs. In general up to nating from order submissions by nHFTs. age close to EUR 100,000. Conversely, day of high market turbulence, HFTs do 60% of all liquidity supply in the market Shortly before the news arrival, however, non-HFTs loose up to EUR 130,000.1 not serve as passive market makers but stems from HFTs. In contrast, less than HFT-implied bid-ask spreads widen by Chart 2, however, shows that basically are heavily involved in directional trad- 25% of all trades are initiated by HFTs. approximately 25%. While this behavior all the profits made by HFTs during this ing. This behavior is in stark contrast to Thus, HFTs are rather passive and tend is widely in line with the behavior of a period result from liquidity provision. the behavior of a “classical” (designated) to do more market making (i.e. liquidity “classical” (designated) market maker, Likewise, non-HFTs repeatedly pay the market maker. provision) than aggressive trading (i.e. such a drop in liquidity provision can 1 The fact that the losses of non-HFTs are higher than the gains of HFTs is due to the existence of trading fees. As liquidity demand). The only exception happen very rapidly. non-HFTs tend to initiate trades much more often than HFTs, non-HFTs face significantly higher transaction costs.

88 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 89 Nikolaus Hautsch Nikolaus Hautsch

Chart 3 response to the May 2010 flash crash, planned details on risk control and the HFT liquidity demand and trading profits in the Bund Futures market after the Brexit decision the SEC introduced trading pause regu- testing of algorithms. Third and most HFT Liquidity demand partcipation rate Profit and loss lation preventing further flash crashes. importantly, current regulation plans are % EUR thousand In the same year, the Dodd-Frank legis- too rigid for market making. Empirical lation restricted the so-called proprietary evidence, as discussed above, demon- trading of banks and the SEC (Security strates that HFT market making is ben- Exchange Commission) issued a ban on eficial for market quality and other mar- “naked” (unfiltered) market access. Cur- ket participants. Regulation thus should rent developments go into the direction try to strengthen these strategies and of more monitoring, recording and thus to preserve the benefits from HFT registration of HFT activity. Since 2015, while simultaneously mitigating risks. the SEC forces certain HFT broker-deal- Hence, a negative scenario could be that ers to register with the Financial Indus- of a too rigid and misguided regulation, try Regulatory Authority (FINRA) which will reduce HFT, but will also strengthening the SEC’s oversight of pro- reduce market quality in terms of lower prietary firms. In 2015, the CFTC pro- liquidity, higher transaction costs and posed rules for a regulation of automated higher volatility. HFT and liquidity will trading (Reg AT), governing certain HFT flee into other – potentially non-regulated Source: hart reproduced from Hautsch, No and hang (2017). practices. – markets while we are confronted with Note: eft picture: HFT participation rate in liquidity demand on June 24, 2016 (black line). The blue line presents the average across normal trading days. Right picture: Total profits and losses by HFTs and non-HFTs on June 24, 2016 in Eurex Bund Futures trading. In Europe, MiFID II will become in high (maybe too high) regulation costs. force in 2018. MiFID will require HFT Ideally, technological innovation The right picture in chart 3 displays 4 Future of HFT – regulatory firms to provide details on the nature of should go hand in hand with smart reg- the profits and losses by HFTs and nHFTs. perspectives algorithmic trading strategies, trading ulation. For instance, the idea of limiting Hence, HFTs earned approximately EUR Current evidence shows that the extent parameters, and risk controls. There will latency differences is a good way to stop 4 million on this day. As shown by HNZ, of HFT will decline due to increasing be specific obligations for trading venues the arms race for speed and to reduce these profits, however, predominantly costs of infrastructure, increasing com- in terms of monitoring, circuit breakers, predatory trading and a major amount result from active (directional) trading petition among HFTs and the introduc- capacity requirements, pre-trade and of harmful HFT strategies. Such an arti- but not from market making. Further tion of alternative trading systems which post-trade transparency and manual “kill ficial delay of trading, a so-called “speed evidence provided by HNZ shows that partly rule out HFT, e.g. via dark pools, functionality”. HFT firms will also have bump”, is the major concept of the HFTs obviously do not replace “classical” or so-called “speed bumps”, where mar- to test the conformance of their trading exchange IEX, which has been officially designated market makers but differ in ket access is artificially and randomly systems and algorithms. There will be approved by the SEC in June 2016 and an important respect: HFTs (rapidly) delayed, such that millisecond speed algorithm-tagging rules in order to iden- is a growing exchange that is even partly change their strategy according to the advantages disappear. According to esti- tify market manipulation. Finally, HFTs supported by HFT firms themselves. market situation. In a situation where mates by Kaya (2016), the overall HFT have to fulfill certain obligations if they With such a speed bump (on IEX it is trading opportunities through latency revenues in the U.S. decline from approx- want to pursue market making strategies. 350ms), HFT market making could be arbitrage come up, they become aggres- imately USD 7 billion in 2009 to less There are, however, potential regu- still a beneficial strategy, while the down- sive and exploit their speed advantage. than USD 2 billion in 2014. Though the latory pitfalls. First, there might be too sides of HFT, such as predatory trading Then, market making functionality can very glory times of HFT in 2009 seem much focus on monitoring, registration and the arms race for millisecond speed be severely limited. to be over, it is not expected that HFT and (massive) data collection. Though it advantages could be limited. In combina- Currently, it is still very unclear what will disappear. As long as trading designs opens up the possibility to investigate tion with a well-balanced use of “circuit the effects on volatility and market sta- are not systematically changed, HFT will potential market manipulation and to breakers” and general safeguards, we bility in such extreme situations might remain an integral part of electronic trad- detect fraud, it will require substantial could accept HFT as a “normal” integral be. It is still widely unknown whether ing and should be understood as a con- resources to process and analyze this part of modern trading, which would HFT increase the risk of tail events and sequence of market evolution and past massive data. Currently, it is unclear settle down to a moderate level and will increase volatility on turbulent days, as regulation. Correspondingly, the future whether this will be efficient and effec- predominantly concentrate on strategies the day after the Brexit. More research of HFT will strongly depend on upcom- tive. Second, in the MiFID II regulation, which are favorable for market quality, is clearly needed to gain a better under- ing regulation. it is unclear how to implement all the such as liquidity provision. standing of the possibly dangerous sides In fact, currently there exists severe of HFT. regulatory uncertainty. In the U.S., as a

90 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 91 Nikolaus Hautsch

References Agarwal, A. 2012. High Frequency Trading: Evolution and the Future. www.capgemini.com/capi- talmarkets. Brogaard, J., Hendershott, T. and R. Riordan. 2014. High Frequency Trading and Price Discovery. Review of Financial Studies 27(8). 2267–2306. Budish, E., P. Cramton and J. Shim. 2015. The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response. In: Quarterly Journal of Economics 130(4). 1547–1621. Cebiroglu, G., N. Hautsch and U. Horst. 2014. Does Hidden Liquidity Harm Price Efficiency? Equilibrium Exposure under Latent Demand. CFS Working Paper 468. Demsetz, H. 1968. The Cost of Transacting. In: Quarterly Journal of Economics 82. 33–53. Hautsch, N., M. Noé and S. S. Zhang. 2017. The Ambivalent Role of High-Frequency Trading in Turbulent Market Periods. Working Paper. Hasbrouck, J. and G. Saar. 2013. Low-latency trading. In: Journal of Financial Markets 16(4). 646–679. Hendershott, T., C. M. Jones and A. J. Menkveld. 2011. Does Algorithmic Trading Improve Liquidity? In: Journal of Finance 66(1). 1–33. Kaya, O., 2016. High-frequency trading – Reaching the limits. Research Briefing Global Financial Markets. Deutsche Bank Research. May 24. Kirilenko, A., A. S. Kyle, M. Samadi and T. Tuzun. 2017. The Flash Crash: High-Frequency Trading in an Electronic Market. In: Journal of Finance 72. 967–998. Lewis, M. 2014. Flash Boys. W. W. Norten & Company. Menkveld, A. J. 2013. High Frequency Trading and The New-Market Makers. In: Journal of Financial Markets 16. 712–740. Stiglitz, J. E. 2014. Tapping the Brakes: Are Less Active Markets Safer and Better for the Economy? Working Paper presented at the Federal Reserve Bank of Atlanta 2014. Financial Markets Conference “Tuning Financial Regulation for Stability and Efficiency”.

92 OESTERREICHISCHE NATIONALBANK David Yermack Smart contracts and corporate governance Professor NYU Stern School of Business and National Bureau of Economic Research 1 Introduction moral hazard by the seller. In the car Smart contracts are commercial agree- loan example, verification and enforce- ments implemented by the use of ment costs disappear, since the lender machinery and computer technology. does not need to hire a lawyer to go to As first described by Szabo’s (1997) court and obtain a lien to repossess the treatise, “The basic idea behind smart collateral from the borrower, and then contracts is that many kinds of contrac- hire a repo man to retrieve the vehicle. tual clauses (such as collateral, bond- In this case, the seller does not need to ing, delineation of property rights, etc.) worry about strategic behavior on the can be embedded in the hardware and part of the buyer. software we deal with, in such a way as This screening out of moral hazard to make breach of contract expensive.” behavior will have the effect of remov- The author points out the smart con- ing from the market those parties who tracts are hardly new, with the mechan- may intend to default on their obliga- ical candy vending machine, introduced tions, improving the credit quality of in 1880s Britain, representing perhaps the overall pool and driving down the the earliest example. cost of capital. In short, by guarantee- Advances in information technol- ing performance, smart contracts reduce ogy have made smart contracts more the need for trust in commercial rela- and more common in routine com- tionships. Trustless contracting has merce. Today, the advent of blockchain become a common theme motivating technology and its implementation on the creation of digital currency and flexible contracting platforms such as other blockchain applications. Ethereum have greatly expanded their potential use. Smart contracts automate the performance by one or both sides to an agreement, and typically they cannot be rescinded or interrupted without the consent of both parties. Szabo (1997) offers the example of a consumer automobile loan in which the car serves as collateral and the borrower agrees to a fixed number of monthly payments. If the borrower misses a payment, a computer would remotely and automatically shut off the borrower’s access to the car’s ignition system; a more up-to- At the same time, smart contracts date example would probably have the certainly create new risks and prob- car drive itself autonomously back to lems. In the example of the car loan, the lot of the lender. one would not want the ignition to The certainty of performance of a autonomously deactivate if the bor- smart contract offers clear potential rower is operating the vehicle on a benefits. In the case of the vending crowded highway at rush hour, for in- machine, negotiation costs between stance. One might also not want to rule buyer and seller are driven to zero, and out strategic non-performance in all the buyer has no need to worry about states of the world, as shown by Pos- strategic default or other forms of ner’s (1973) famous popularization of

44th ECONOMICS CONFERENCE 2017 95 David Yermack David Yermack

the idea of “efficient breach” of contracts, future exercise period. Other deriva- A smart contract could short-cir- a foundational concept in the Law and tives are intended to execute automati- cuit the bankruptcy process by auto- Economics literature. cally if certain conditions are satisfied; matically conveying collateral from these include instruments such as credit borrower to lender if a covenant is vio- 2 Smart contracts in corporate default swaps, which pay off to outside lated. In principle, compliance could be governance investors if a company defaults on its debt, monitored in real time, and not just on Jensen and Meckling’s seminal (1976) and Contingent Convertible (“CoCo”) the four days of the year in which a firm article on agency costs describes the debt securities, which might be issued publishes its balance sheet. The con- firm as a “nexus of contracts” between by a bank and convert into equity if the tract could also execute other financial suppliers of capital, skilled and unskilled bank’s equity falls below the regulatory transfers and governance changes imme- labor, raw materials, customers, and minimum requirement. diately if a default event occurs. other groups. The growing interest in In all these examples, the exercise While the description above is quite smart contracts naturally leads to the decisions could easily be automated by general, the reader should see immedi- question of how corporate governance smart contracts. If a choice by the secu- ately that smart contracts can poten- 2017 increased the per-share buyout might change if more and more of these rity holder is required to trigger the tially resolve financial distress much price from USD 13.50 to USD 16.24. relationships become automated. Some exercise, the smart contract could be more quickly and cheaply than the judi- Owners of more than 49 million shares applications, such as self-executing deriv- programmed to execute when certain cial processes that operate in most made legal claims for the increased pay- ative securities, are easy to anticipate, optimality conditions are achieved in countries. Contracting around the judi- ment, but the company had less than 37 while others, such as self-enforcing the marketplace. This would overcome cial resolution of financial distress has million shares outstanding. Causes of labor agreements or employment con- well-known problems in which inves- for years been a closely studied topic in this large discrepancy still remain tracts, may be far off but could also tors sometimes exercise options or con- the finance and governance literatures. partly unexplained, but observers have offer opportunities for joint gains between vert debt at sub-optimal times. If con- With self-executing smart contracts, blamed the difference on the decentral- contracting parties. Like any new or version of a security is contingent on a many costly negotiating strategies involv- ized custodial system, in which each emerging technology, smart contracts future event, again a smart contract ing brinksmanship and risk-shifting brokerage essentially keeps track of its surely pose risks that may not yet be could be used to verify the contingency might be precluded, generating net sav- own investor accounts and often per- understood. continuously and automatically execute ings that could be shared ex ante by the mits shares to be lent out to short sell- the conversion if the contingency is borrower and lender. ers. A short seller then sells the shares 3 Three examples ever met. This would save costs of veri- to other investors, without the knowl- In this section, I discuss three simple fication and potential litigation, while 3.3 Share registration edge of the ultimate owner whose applications of smart contracts in cor- also avoiding strategic behavior some- Over centuries, stock markets have shares are held in custody. In the case porate governance, in the areas of times seen in the marketplace to fore- evolved elaborate systems for the cus- of Dole, there appear to have been mil- derivative securities, secured debt, and stall the triggering of contracts. tody, lending, and voting of shares of lions of shares sold short, and the short equity share registration. These exam- stock. Many investors delegate these sellers rather than the company should ples are meant to be introductory and 3.2 Corporate debt tasks to brokers, for reasons that in- be liable for the increased payment of only hint at the possibility for more Companies often pledge collateral and clude cost savings, tax avoidance, pri- USD 2.74 per share. However, the buy- elaborate smart contracts. make various balance sheet commit- vacy, and simplicity. The involvement ers of these shares had no idea they ments as conditions of obtaining loans. of these custodians as intermediaries were buying from short sellers, and 3.1 Financial derivatives If a company cannot stay in compliance between companies and their own they would have applied for payment Many aspects of a firm’s capital struc- with these loan covenants, in theory a shareholders has led to many problems from the company. All of this should be ture involve contingent claims that can process should begin in which the in areas such as payment of dividends sorted out by the intermediary broker- be exercised or extinguished under lender can obtain title to the collateral and accurately tabulating votes, as ages, but with the passage of four years, certain future conditions. In some and demand repayment of the remain- described by Kahan and Rock (2008). the failures and mergers of various cases, these involve a choice by the ing loan balance. In practice, compa- A recent fiasco involving the 2013 firms, and the unexpectedly generous security holder; representative exam- nies have recourse to judicial bank- management buyout of Dole Food Co. court decision, it has proven impossible ples would include executive stock ruptcy procedures that often forestall vividly illustrates the weaknesses of the to locate all the responsible parties. options or convertible debt, either or the lender’s recoveries and provide legal current share registration system in the Smart contracts seem like a straight- which may be converted to shares at a incentives for the borrower and lender U.S.A. After years of litigation over the forward solution to the types of prob- certain fixed price during a limited to renegotiate. buyout price, a court in Delaware in lems seen in the Dole example and at

96 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 97 David Yermack David Yermack

other companies. If a share of stock ex- ties to inspect and fully understand the terventions. These included amending ated a troubling precedent, showing isted virtually on a blockchain, it could written code underlying a contract be- the Ethereum blockchain’s code to iso- that the sponsors of a blockchain have be embedded with smart contracts that fore they implement it. In practice, it late the assets stolen by the hacker, so the power to rewind it as a type of rem- could, variously, transfer dividend pay- may not be possible for the parties to that they could not be moved or other- edy if a smart contract runs off the ments from the account of a short-seller exclude courts from intervening if and wise spent, or rewinding the block- rails. The conditions under which such to the account of the buyer, sell securities when smart contracts run amok, and chain itself to negate the transactions interventions might occur in the future when margin calls are triggered against they may potentially assign liability not implemented by the hacker. seem uncertain at best, and victims of leveraged investors, and prohibit the only to one or both of the parties, but The latter approach, essentially “re- smart contracts with unhappy endings double-voting that frequently occurs if also to programmers, blockchain hosts, writing history” on the Ethereum will surely try to invoke them, citing shares are lent out by a custodian with- and other entities involved in creating blockchain, was ultimately supported the precedent of TheDAO. out knowledge of the true owner. or providing the platforms for smart by about 85% of the user community contracts. and was implemented. However, the Conclusion An object lesson exists in the expe- 15% minority that disagreed continued Smart contracts, which use informa- rience of TheDAO, a “decentralized au- to use the original Ethereum block- tion technology for verification and ex- tonomous organization” on the Ethe- chain, renaming it “Ethereum Classic” ecution, represent a promising facet of reum blockchain that became the target and essentially creating a schism that the Fintech movement. They may solve of a successful hack in 2016. A DAO is caused two versions of the ether cur- longstanding problems of cost and de- essentially an organization run by com- rency to begin circulating. The split has lay in contract enforcement, but their puter code, with no human managers endured to this day; as of the date of greater potential may be in screening or employees. TheDAO was an ambi- this writing, the Ethereum currency from the credit markets potential bor- tious attempt to create a decentralized has a market capitalization of about rowers who are predisposed to moral venture capitalist that would facilitate a USD 21 billion, while Ethereum Clas- hazard problems such as strategic debt voting process for investors to select sic’s currency is worth about USD 1.5 default. In the corporate governance from a menu of potential start-up in- billion, both much higher than the USD area, smart contracts may reduce nu- vestment proposals. 1 billion value of the original Ethereum merous agency costs that arise between TheDAO astonished investors by at the time of the hack in June 2016. investors, managers, and other parties. 4 What could go wrong? attracting USD 150 million worth of This so-called “hard fork” in the However, like any new technology Smart contracts have many potential investment (in ether tokens) in a 28-day Ethereum blockchain may have satisifed smart contracts may be misunderstood risks. They could autonomously execute crowdfunding period that began on many normative tests of fairness, and it and create new problems, and today’s in situations that neither party antici- April 30, 2016, despite warnings from may even have resembled the outcome markets are still in the early stages of pates nor would wish for, causing irre- observers and analysts that the underly- that a court would have imposed if liti- discovering the potentials and pitfalls of versible losses or collateral damage to ing code left it vulnerable to hacking. gation had occurred. However, it cre- these instruments. third parties. They may invoke other As feared by these commentators, a smart contracts, in a sequence that causes theft did occur on June 18, with the at- References a cascade of escalating losses or so- tacker – who has still not been identi- Atlas, R. D. 2001. Where Donald Trump Sees Trouble in Atlantic City. Bondholders See an called “death spiral” of a firm. The ground fied – draining about USD 60 million Effort to Cut a Deal. The New York Times. October 31. rules for interrupting smart contracts of ether from TheDAO into a cloned Birmingham, R. 1970. Breach of Contract, Damage Measures, and Economic Efficiency. In: or resolving disputes ex post are very “child DAO.” Siegel (2016) prevents a Rutgers Law Review 24. 273–292. unclear, and perhaps non-existent. lucid account of these events. Jensen, M. C. and W. H. Meckling. 1976. Theory of the Firm: Managerial Behavior, Agency Purists sometimes take a “code is In the aftermath of this catastrophe, Costs and Ownership Structure. In: Journal of Financial Economics 3. 305–360. law” view of smart contracts, implying adherents to the “code is law” philoso- Kahan, M. and E. Rock. 2008. The Hanging Chads of Corporate Voting. In: Georgetown Law that the parties must follow the conse- phy felt that TheDAO’s investors had Journal 96. 1227–1281. quences of the contract’s written code learned a hard lesson about the need to Nakamoto, S. 2008. Bitcoin: A Peer-to-Peer Electronic Cash System. Available at https://bitcoin. if disagreements or unforeseen circum- inspect smart contracts carefully be- org/bitcoin.pdf. stances lead to outcomes that either fore entering into them. However, the Posner, R. 1973. Economic Analysis of Law. Little, Brown and Company. Boston. party regrets. This viewpoint leaves no sponsors of Ethereum, who technically Siegel, D. 2016. Understanding The DAO Attack. Coindesk. June 25. room for intervention by courts, and it had no role in TheDAO, decided other- Szabo, N. 1997. Formalizing and Securing Relationships on Public Networks, First Mind 2:9. puts a great burden upon the two par- wise, and proposed several possible in- Available at http://ojphi.org/ojs/index.php/fm/article/view/548/469.

98 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 99 Klaus Liebscher Award 13th Klaus Liebscher Award 2017

On the occasion of the 65th birthday of access of listed companies to external Governor Klaus Liebscher and in recog- financing as well as the impact on nition of his commitment to Austria’s investment and employment. He finds participation in European monetary union quantitatively significant effects: In addi- and to the cause of European integration to a doubling of external financing tion, the Oesterreichische Nationalbank through a Europe-wide regulation, there (OeNB) established in 2005 the “Klaus is also a significant increase in invest- Liebscher Award”. This award is the ment and employment. highest scientific distinction, the OeNB In his paper, Bank Lending and the offers every year for up to two excel- European Sovereign Debt Crisis, Filippo lent papers on European monetary De Marco examines the impact of the union and European integration issues interdependence between sovereign written by young economists (up to 35 debt and the banking system on the real years) from EU member or EU candi- economy. Using data from the Euro- date countries. The award is worth pean sovereign debt crisis of 2010/2012, EUR 10,000 per paper. A panel of highly he analyzes the effects on the financing qualified reviewers referees the papers. of loans from companies. The main The Klaus Liebscher Award was granted mechanism that restricts bank lending this year for the 13th time. Governor to firms in a sovereign debt crisis is not Nowotny and President Raidl presented the loss of valuation of government the award and the award winners of 2017. bonds, but the elimination of short- The winners of 2017 are Jean-Marie term refinancing opportunities through A. Meier, London Business School for his unsecured, short-term liabilities at US- paper Regulatory Integration of Interna- based money market funds. These tional Capital Markets and Filippo De funding stops force the banks to either Marco, Bocconi University, for his paper reduce equity or limit credit supply. Bank Lending and the European Sovereign Debt Crisis. In his empirical paper, Regulatory Integration of International Capital Mar- kets, Jean-Marie A. Meier analyzes the effects of an integrated regulatory framework for European financial markets on the financial system and the real economy. Using data from the process of the various EU regulatory steps to establish a single European capital market and a European market for financial services, he specifically examines the impact of this policy on the

44th ECONOMICS CONFERENCE 2017 101 Hans Jörg Schelling The banking sector – fit for the future? Austrian Federal Minister of Finance

Looking back to 2016, the European The impact on risk-weighted assets banking industry suffered a significant (RWA) was even more pronounced. setback. Revenues declined across the They were cut by 7% to EUR 6.600 board, cost reductions were unable to billion, the lowest level since 2008, keep pace and low interest margins despite large-scale inflation from tighter kept away the industry from increasing regulation (Basel 2.5 and Basel III). interest income. As a result, net income Over this period, banks have slashed fell by almost half. Banks resorted to more than EUR 1,000 billion in RWA, or aggressive de-risking, but a shrinking 14% – an impressive achievement. equity base meant that capital and The most spectacular figure, how- leverage ratios stagnated for the first ever, came neither from balance sheets time since the financial crisis. By con- nor the profit and loss statement: for trast, U.S. banks continued to grow and the first time since the financial crisis, set a new record in terms of nominal European banks on aggregate did not profits, widening the gap to their Euro- manage to strengthen their capital levels pean peers. in the past 12 months, in spite of de-risk- All in all 2016 was not a good year ing. The fully loaded CET1 ratio remained for European banks. Though the econ- flat at 12.7%. Admittedly, capital ratios omy picked up speed in most countries, have risen enormously since 2008. banks suffered a setback caused mainly Still, many banks are not yet com- by market turmoil at the beginning of fortably above levels for both measures the year, high litigation expenses and which would provide them with sub- large write downs on loans and good- stantial flexibility and freedom to either will in the final quarter. But cost levels invest in business growth or return also remained stubbornly high. much of future earnings to their owners. On the revenue side European banks This also shows that the European faced the same challenges as American banking industry is far from a position banks. where it could easily absorb a signifi- This would not have been such a cant further tightening in capital problem if banks had been able to requirements. In this regard, the effec- reduce costs to the same extent, or if tive standstill of the Basel IV discussions the cost of risk had continued to following the U.S. election has pro- decline. Yet administrative expenses vided some relief to European banks. fell less than revenues. In addition, loan loss provisions, which had provided tailwind in the past three years, increased by 27%. Having reached the lowest level since 2007 in 2015, this pickup, which burdened specific Euro- pean countries, was hardly a surprise given the modest improvement in loan growth. With profitability that much under pressure, banks again resorted to de- risking, deleveraging and shrinking. Total assets fell by another 2%, and total equity declined by 3%.

44th ECONOMICS CONFERENCE 2017 103 Hans Jörg Schelling Hans Jörg Schelling

How does the situation of European the regulatory framework to reduce the 2,170 people in 2016. In Austria it was This is to say, the banks must pre- banks compare with the performance likelihood of failures in the banking 2,100, near this average. But in Belgium pare themselves for a changing envi- of their peers in Austria? sector. the population size per local branch ronment. For this to be successful, they Austrian banks’ profits increased in Now it’s up to supervisory and res- reached 3,200, in Finland 5,600 and in need to question their business models 2016, but this rise was to a large extent olution authorities to apply the new or the Netherlands 9,600. and make adjustments. attributable to lower risk provisioning. improved tool. And it is the task of DG But let me also mention some posi- Some of them might be painful – Income from core business lines, such COMP to assess whether the measures tive developments, as we were able to but if these adjustments are postponed as interest and commissions income, was are in line with state aid rules or not. find a solution on the Heta issue. Look- all the time, the day will be coming, down on the previous year. If a bank is in deep, deep troubles, ing at the individual figures the resolu- when it will be too late to manage the More precisely, all major compo- the authorities have to decide on the tion seems to be successful: The recovery turn around. nents declined year-over-year. Interest consequences. But it can’t be the case ratio increases from 46% to 64.4%. But And please, don’t expect me then to income was under pressure due to that the bank asks for public support. It I have to emphasize, a significant win- step in and pay for the bank’s inability to the ECB-policy. Modest loan growth can’t be the case either that authorities ner is also the Austrian banking indus- read the signals of time and act accordingly. could not compensate the contraction and institutions try to avoid decisions try, getting back its market presence of interest margins. and try to pass the responsibility for especially in Germany. Banks seem to be unable to com- actions to the next. But all in all, it seems that the banks pensate for this even in part through If it happens this way, ailing banks haven’t done all their homework yet and a shift towards a more strongly fee- are being kept alive – and they will I really urge them to do so since they and commission-based business model. continue struggling for the rest of their might see themselves confronted with Despite efforts to increase income from life until severe measures will be taken. more and more growing competition from accounts, cards, transactions and asset Alternatively the public sector has to other areas such as FinTechs. management, fees and overall commis- step in again, but that’s what I want to Considering figures and the fact sions dropped due to reduced client avoid for sure. that FinTech start-ups and mobile bank- activity in volatile capital markets over We need banks that are fit for the ing are changing consumers’ use of the course of the year. Similarly, trad- future and we need authorities that banking products the traditional banking income slumped. support the development of the sector. ing model is threatened. Over the past few years, restruc- One crucial element here is cer- turing at individual banks has been a tainly the decision by the authorities on key driver of improvements in the Aus- the capital provisions. A carful balance trian banking sector’s credit quality. has to be reached between caring for That said, the amount of nonperform- risks and supporting the real economy, ing loans, which are to a large part in but I know that this trade-off is not easy the books of Austrian banks’ CESEE to manage. subsidiaries, remains a burden for some Taking a look at the Austrian sec- banks that should be addressed proac- tor, the capitalisation of the Austrian tively in order to support new lending. banking sector has improved significantly But let us be clear: it should not be since the onset of the financial crisis. addressed at the expense of the public This trend continued 2016. However, sector! It is definitely not the task of the domestic banks’ capital ratios were still Government to rescue the financial below the European average and its sector again and again. European peers. The costs for stabilising the banking The decline in operating profits accel- sector in and after the crisis have been erated banks’ restructuring and adjust- tremendous and as a consequence we ment measures as deemed necessary have agreed on a resolution framework by the authorities but a lot of work is to ensure that bail-out by taxpayer’s still waiting. For example, according to money is not on the agenda anymore. Eurostat the population size per branch And we are continuously strengthening average for all euro area countries was

104 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 105 44th ECONOMICS CONFERENCE 2017 44th ECONOMICS CONFERENCE 2017 Session 5 Technological change and the future of cash Kurt Pribil Introductory statement: Technological Executive Director Oesterreichische Nationalbank change and the future of cash

Ladies and Gentlemen, headlines in newspapers two weeks Welcome to our morning session on ago: A global cyberattack infected tens Technological change and the future of of thousands of computers in 99 coun- cash. In this session, we are going to tries. The hackers blocked computers discuss new payment technologies and and demanded a ransom of USD 300 in the future of cash. bitcoins from users seeking to regain As Aristotle once said: “Life requires access to their computer systems. movement.” Therefore, it is not surpris- To quote Bundesbank President ing that payment behavior, which is part Jens Weidmann: “The question is no of our daily life, is undergoing changes as longer if a financial infrastructure or well. institution will be subject to an attack Payment behavior is very important but rather when and how often.” for the economy. It is important because With this in mind, I would like to it ensures there are sufficient and effi- introduce our two distinguished speak- cient payment options in all possible ers for this session, who will give us transactions. This means it is essential valuable insights into technological to identify possible dynamics and devel- change and the future of cash. opments that will shape the future pay- First, a very warm welcome to our ment landscape. first speaker, Mr. François Velde, who is At present, payment systems in Senior Economist and Research Advi- Europe are experiencing lively growth in sor in the Economic Research depart- innovation. Noncash payment options ment at the Federal Reserve Bank of have been increasing in recent years. The Chicago. He is an expert in the field of digital revolution offers faster means for monetary history and theory. making payments. We are talking about Today, he is going to discuss the contactless transactions, instant payments functionality of distributed ledger tech- and virtual currencies. The emergence of nologies – in particular virtual curren- blockchain technologies indicates that cies – and the impact they might have further change may be on the horizon. on traditional payment systems. In light of these developments you Also a very warm welcome to our might get the impression that cash has second speaker, Mr. Helmut Stix, who no future. What I am trying to say: Is is Senior Expert in the Economic Stud- cash fading away? ies Division at the Oesterreichische Before I hand over to our guests to Nationalbank. His current research address this issue, allow me to bring focuses on households’ reactions to two arguments in support of cash: financial crises, as well as on cash First argument: People love cash – in demand and payment innovations. particular in Austria. To prove that ar- He has published papers in academic gument I can tell you that the amount journals on topics like consumer cash of euro cash in circulation is now four usage across countries, why people save times higher than it was when the euro in cash, the choice and use of payment was introduced. instruments, trust in banks during nor- Second argument: Cash is obviously mal times and times of crisis, the deter- more secure than electronic payment minants of financial dollarization, and instruments. We all remember the inflation perceptions.

44th ECONOMICS CONFERENCE 2017 111 Is cash back? Helmut Stix1 2 Senior Economist Assessing the recent increase in cash demand Oesterreichische Nationalbank

Contrary to predictions that demand for cash will decline with the increased availability and use of non-cash payment means, currency demand has increased in the euro area and the U.S.A. over the past 15 years. In this context, this short article summarizes recent findings from Jobst and Stix (2017), who look beyond the recent developments of the euro and the U.S. dollar by analyzing many economies and very long time series. Data on currency circulation from 2001 until 2014 for a sample of 70 economies reveals that the recent increase in circulation is not confined to international currencies like the U.S. dollar or the euro but can be observed in various other economies. Investigating evidence for the United States and Germany for the past 140 years shows that the recent increase is sizeable and compares to a similar upsurge in the wake of the 1930s financial crisis. Finally, in economies where currency d emand increased, the increase typically took place after the start of the economic and financial crisis of 2007/08. Panel money demand models show that conventional economic factors like low interest rates can account for some part of the increase but leave a notable part unexplained, in particular in rich economies. While hard evidence is d ifficult to come by, we conjecture that cash demand was driven by the higher level of economic uncertainty pertaining since the financial crisis of 2008, which resulted in hoarding.

1 Introduction Chart 1 If we were to believe technology cheer- Currency in circulation over nominal GDP leaders (c.f. BBC, 2015), cash is about % to disappear. It has already almost done 20

so in Sweden and it will do so every- 18 where else rather soon. Thanks to internet, mobile phones and NFC the use of 16 cashless payment technologies in indus- 14 trialized economies, which has already 12

been progressing over the past decades 10 (Amromin and Chakravorti 2009; Bag- nall et al. 2014), is about to enter a fun- 8 damentally new phase. 6 This story, however, does not match 4 up with the empirical evidence. People 2001 2003 2005 2007 2009 2011 2013 2015 U.S.A. Euro area (still) hold enormous amounts of physi- Switzerland Japan cal cash: In 2014, per capita holdings Source: Jobst and Stix (2017). were around USD 4,000 in the euro Note: The ﬁgures show currency in circulation to nominal GDP ratios for area and the U.S.A. What is even more individual economies. puzzling, in recent years cash circulation has gone up sizably in the euro explains the puzzling size of cash circu- area, the U.S.A., Switzerland and Japan, lation? Can the extent and the increase notably after 2007 (chart 1). over time be explained by conventional Both the magnitude of cash circulation economic forces, e.g. lower interest and its increase over the past decade(s) rates, or are there alternative explana- raise crucial questions for central banks tions? What does the apparent demand and economic policy makers alike: What for cash imply for plans to phase out or

2 The views expressed in this paper are exclusively those of the authors and do not necessarily reflect those of the 1 Co-author Clemens Jobst, Lead Economist, Oesterreichische Nationalbank, Economic Oesterreichische Nationalbank or the Eurosystem. We thank Professor Schneider (University of Linz) for sharing Analysis Division. the shadow economic indicators and Tobias Himmelbauer for excellent research assistance.

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at least restrict the use of cash as recently and euros circulates outside their mon- Table 1 proposed by several economists? etary area, which explains part of the Size of currency holdings in U.S. dollar in 2014 In this short paper we summarize high per capita holdings of these two Country Currency in circulation per Currency in circulation per Currency in circulation over results of Jobst and Stix (2017). To assess currencies (Bartzsch, Rösl and Seitz, capita capita nominal GDP and to understand recent trends, we 2013; Judson, 2017; Assenmacher, USD PPP–USD % suggest to analyze currency demand Seitz and Tenhofen, 2017 for Switzer- 1 Switzerland 9,009 6,024 10.5 from a broader perspective by going land). Potentially, the recent upsurge in 2 Japan 7,257 7,303 19.0 3 Hong Kong 5,874 8,055 14.6 beyond the literature’s typically rather the circulation of U.S. dollars and euros 4 Singapore 4,546 6,685 8.1 narrow focus on either relatively short could have been due to international 5 Euro area 4,085 3,997 10.3 time periods (e.g. the post-World War demand. To separate out domestic and 6 United States 4,059 4,059 7.4 7 Australia 2,565 1,853 4.2 II period) or on relatively few econo- international factors, we have to e nlarge 8 Czech Republic 2,144 3,338 10.8 mies (e.g. the U.S.A., the euro area, our sample. Specifically, Jobst and Stix 9 Denmark 2,127 1,574 3.4 etc.). We extend the investigation back (2017) have collected data from around 10 Israel 1,927 1,721 5.1 th 11 Canada 1,781 1,562 3.5 to the late 19 century for the United 70 economies for the p eriod from 2001 12 Qatar 1,705 2,556 1.9 States and Germany. This perspective to 2014. In essence, the sample covers 13 Hungary 1,634 2,880 11.7 shows that the recent increase is sizeable the richest economies in terms of their 14 Norway 1,525 1,016 1.6 15 Kuwait 1,507 x 3.2 and compares to a similar upsurge in absolute economic size plus regionally 16 Azerbaijan 1,450 3,221 18.4 the wake of the financial crisis of the important economies that were added 17 South Korea 1,409 1,731 5.0 18 United Kingdom 1,399 1,201 3.1 1930s. Second, we collected data on for breadth of geographical coverage. 19 Saudi Arabia 1,396 3,001 5.4 currency circulation from 2001 until Overall, all included economies account 20 Iceland 1,306 1,087 2.5 2014 for a sample of 70 economies. for about 96% of World GDP in each year This perspective underscores that the from 2001 to 2014. Henceforth, this Source: Jobst and Stix (2017). Note: The table shows per capita values of currency in circulation expressed in U.S. dollar, in purchasing power adjusted U.S. dollar (PPP–USD) and 3 recent increase is broad-based and can sample will be denoted as the “World”. as a percentage of nominal GDP for the year 2014. The table shows the 20 countries with the highest values for currency in circulation (USD). be observed in structurally different econ- Four stylized facts emerge: omies. The panel setting also allows us to econometrically study the recent 1. C urrency ratios diverge widely, but even the countries considered as frontrunners “World” sample. The ratio slopes upward drivers of cash demand. We show that in low-cash economies cash holdings per in electronic payments. But even in throughout the period and a discernible conventional economic factors like low capita are difficult to reconcile with these countries, per capita holdings are level shift can be observed between interest rates can account for some part transaction demand. still very high and much higher than 2007 and 2009. Part of the observed of the increase but leave a notable part Per capita circulation ranges enormously can be explained by transaction motives. increase of the CiC over the nominal unexplained. While hard evidence is dif- from about USD 30 to 70 in African Table 1 thus substantiates that interna- GDP ratio is the result of a declining ficult to come by, our results support economies like Kenya, Tanzania, Uganda, tional circulation alone cannot explain GDP in the course of the global finan- the conjecture that cash demand was Nigeria or Cameroon to USD 9,000 in high per-capita holdings in some econo- cial crisis. The right panel of chart 2 driven by a higher level of economic Switzerland. Table 1 lists the 20 economies. Rather, cash must be hoarded in depicts the indexed temporal evolution uncertainty pertaining since the finan- mies with the highest per capita values many economies and/or serve other of nominal CiC and nominal GDP. cial crisis of 2008. of currency in circulation both using purposes than pure transaction needs. Nominal GDP remained roughly con- market exchange rates (USD) and pur- stant from 2008 to 2009 but increased 2 Stylized facts on the recent chasing power adjusted exchange rates 2. Aggregate currency circulation at the afterwards. At the same time, nominal upsurge in cash demand (PPP-USD). The euro area and the world-level has increased. CiC increased from 2008 to 2009. Developments in the circulation of the U.S.A. had a per capita circulation of A related question raised by the recent Therefore, the ratio of these two vari- U.S. dollar and the euro are unrepre- around USD 4,000. This compares increases in the circulation of U.S. dollar ables increased from 2008 to 2009. sentative for the circulation of cash at with values of USD 1,250 in Sweden and euro is whether this phenomenon is However, in addition to this one-time large. A significant part of U.S. dollars and USD 1,520 in Norway, which are restricted to international currencies level shift, the gap between CiC and or more broad-based. The left panel of nominal GDP was growing throughout 3 Aggregating economies raises the issue of which exchange rate has to be applied. In this paper, all results which chart 2 depicts the currency in circula- the entire observation period. Given refer to aggregations are based on USD exchange rates that are fixed as of 2006. This eliminates the impact of tion (CiC) over nominal GDP ratio for the presumed shift to non-cash payments, exchange rate movements that have occurred in the course of the economic and financial crisis. Jobst and Stix (2017) provide results on aggregations based on other exchange rates and find that results are largely unaffected, the aggregate of all economies in our this increase needs to be explained. qualitatively.

114 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 115 Helmut Stix Helmut Stix

Chart 2 Chart 3 Currency in circulation over nominal GDP – “World” Currency in circulation over nominal GDP – Subaggregates % 20011 Euro area – U.S.A. – Switzerland Rest of the “World” 9.0 3.0 % % 10 10 8.5 2.5 9 9 8.0 8 8 7.5 2.0 7 7 7.0 1.5 6 6 6.5 5 5 6.0 1.0 2001 2003 2005 2007 2009 2011 2013 2001 2003 2005 2007 2009 2011 2013 4 4 CiC over nominal GDP (in fixed USD) CiC (in fixed-USD), Index (2001=1) 2001 2003 2005 2007 2009 2011 2013 2001 2003 2005 2007 2009 2011 2013 GDP (in fixed-USD), Index (2001=1) CiC over nominal GDP (in fixed USD) Dollarized Source: Jobst and Stix (2017). Non-dollarized, OECD, non-EA-U.S.-CH-JP Note: The figures show the currency in circulation to nominal GDP ratios (left panel) as well as the evolution of currency in circulation and nominal Non-dollarized, non-OECD GDP (right panel). All figures refer to the “World” as specified in Jobst and Stix (2017). The aggregation is based on market USD exchange Source: Jobst and Stix (2017). rates that are fixed at 2006. Sources and methods are described in Jobst and Stix (2017). Note: The figures show currency in circulation to nominal GDP for various aggregates of economies. The left panel refers to the aggregate of the euro area, the U.S.A. and Switzerland. The right panel refers to (i) dollarized economies, (ii) non-dollarized non-OECD economies and to (iii) non-dollarized OECD economies excluding euro area, the U.S.A., Switzerland and Japan. The yen was excluded because of its high weight in 3. T he increase in currency circulation can Here the currency ratio increased until this aggregate. All aggregations are based on market USD exchange rates that are fixed at 2006. Sources and methods are described in Jobst be observed for international and 2007 but declined afterwards. We con- and Stix (2017). non-international currencies as well as jecture that this increase is due to the for OECD- and non-OECD economies. benign economic conditions associated Chart 3 contrasts the development in with the “great moderation”, i.e., low Chart 4 the main economies that face overseas interest rates and increasing levels of Changes in currency in circulation over nominal GDP ratios from 2004/05 to 2013/14 demand, United States (US), euro area trust in national currencies resulting in % (number of countries in each group in parenthesis) (EA) and Switzerland (CH) with the devel- a reduction of currency substitution. 100 opment in the remaining economies. From 2007 onwards, the trend appar- 80

Among the remaining economies, three ently reverted as the ratio was first de- 60 sub-aggregates are shown: (i) dollarized clining and then relatively constant. economies, (ii) non-dollarized economies 40 that are not members of the OECD and 4. Also within country groups the increase 20 in circulation is broad-based. (iii) non-dollarized economies that are 0 World Non-dollarized EA, U.S., CH Other OECD Other non-OECD Dollarized OECD members. In the latter aggre- Last, the increase in aggregate circula- (n72) (n40) (n3) (n19) (n18) (n32) gate Japan has been excluded because of tion figures is not due to a handful of Increase in ratio 10 Change between –10 and 10 Decrease in ratio 10 its large weight within this group. large economies but is broad-based. Source: Jobst and Stix (2017). The comparison shows that the in- Chart 4 provides a summary of the Note: The chart shows descriptive statistics about changes in the currency in circulation over nominal GDP ratios over the period from 2004/0 to 2013/14 for the “World and several sub-aggregates. The blue bars depict the relative share of economies with an increase of the ratio by more crease in the CiC to GDP ratio is not con- temporal development of currency in than 10% (within each group). The purple bars show the relative share of economies with an decrease of the ratio by more than –10%. The fined to the international currencies – circulation to nominal GDP ratios for group size is indicated in parenthesis. Averages are taken for 2004/05 and 2013/14 to reduce the eﬀect of outliers. although the increase has been stronger individual economies. Specifically, we for the euro, the U.S. dollar and the focus on the change in the ratios from Swiss franc. In non-dollarized non- 2004/05 to 2013/14 (both means of of economies faced an increase by more Overall, the descriptive account OECD member economies, there is an the two years) and show the relative than 37%. Chart 4 shows that the share shows (i) that cash demand has in- increase from 2008 to 2009 and a con- proportion of economies in which the of economies with an increase (blue creased in the “World” as a whole, (ii) stant ratio afterwards. Among non-dol- ratio increased by more than +10% as bar) is higher than the share of econo- that cash demand has increased not larized OECD member, the increase well as the proportion of economies in mies with a decrease (purple bar). This only in the euro area and the U.S.A. around 2008 is smaller but the positive which the ratio decreased by more than holds for the “World”, for dollarized but in the majority of economies from trend has continued until 2014. The –10%. In the sample of all economies and for non-dollarized economies (the 2003 to 2014 and (iii) that the increases only exception to the general trend is (“World”), the unweighted mean (me- latter group is further separated in cannot be assigned to only poorer or provided by the dollarized economies. dian) change is 17% (13%). One quarter OECD and non-OECD members). richer economies.

116 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 117 Helmut Stix Helmut Stix

3 How does the recent upsurge 3. O ver the post-World War II period, fits well to political/economic events tractions because agents’ demand for compare historically? there is a secular decline in cur- (e.g. the breakdown of Communism, cash is based on permanent income rather In order to assess the significance of rency demand. This is the time developments in Latin American than period income. In this line of recent increases it is useful to put them frame that is usually analyzed in economies) which fueled interna- argument, cash holdings could be higher into a long-run perspective. Chart 5 dis- studies on the use of currency. It is tional demand for the U.S. dollar and relative to GDP if agents have not adjusted plays the ratio of currency in circulation evident that the focus on only the Deutsche mark (Porter and Judson, their pre-crisis estimate of permanent over nominal GDP from the last quarter post-World War II period biases the 1996; Seitz, 1997). income to the lower income growth that of the 19th century to 2015 for the U.S.A., picture as CiC levels were excep- 5. Since 2007, CiC over nominal GDP occurred after 2008. Germany and the euro area.4 In the fol- tionally high after the war. There is has increased further in the U.S.A. In order to analyze the relative impor- lowing, we focus on the most important large agreement as to the causes of and the euro area. The recent in- tance of these factors Jobst and Stix long-run trends. the decline after World War II: creases are large even if seen over a (2017) estimate a panel money demand The following main observations increase in the dissemination of 150-year horizon. With the excep- model where (log) real per capita cash can be taken from chart 5: transaction accounts, the non-cash tion of World War II, there is only holdings is related to (log) real per capita 1. Comparing the values of 1990 with payment of wages, the increased use one episode with a comparable in- GDP, deposit interest rates and a mea- those from around 1890 informs us of payment cards and cheques and crease: the Great Depression, even sure of shadow economic activities.5 In that cash use has declined: from the dissemination of ATMs which though back then the increase was addition time dummy variables for the 13% to 6% in Germany and from allowed consumers to economize on considerably steeper and more sud- years after 2008 are employed to mea- 6% to 4% in the U.S.A. cash balances (e.g. Krüger, 2016). den than after 2007/08. sure whether any shift can be observed 2. However, the decline in currency 4. Since the mid-1980s, the long-run after 2008 that cannot be assigned to demand is not uniform. World War II trend decline has come to a halt or 4 Reasons for recent increases in the other independent variables. The marks the strongest reversal in the sec- even reverted: CiC has increased in currency demand panel estimation is based on a fixed ular downward trend; other events are the U.S.A. and in Germany. The There are four plausible arguments that effects model such that the focus of the World War I and the Great Depression. increase in CiC after the mid-1980s could rationalize the increase in cash analysis is on changes over time (with demand. First, after 2007/08 interest different levels in cash demand across Chart 5 rates decreased in the majority of econ- economies being controlled for). Also, Currency in circulation over nominal GDP in Germany, the U.S.A. and the euro area omies and reached near-zero levels in it is important to note that point esti- some economies. Second, some authors mates reflect an average effect across % 20 have argued that increases in shadow economies, not accounting for their economic activities, tax evasion and/or relative size. 18 higher shares of self-employed could be Given the difficulties in isolating the 16 drivers of higher cash demand (Goodhart foreign demand component we omit 14 and Ashworth, 2014). Third, the increases the U.S.A., euro area, Switzerland,

12 could be a consequence of portfolio Singapore and Hong Kong from our shifts either due to lower confidence in sample such that all estimated effects 10 banks or due to increased uncertainty. primarily refer to domestic demand. 8 This interpretation focuses on the asset Similarly, the estimations focus on non- 6 (safe haven) role of cash. Note that this dollarized economies only. The main

4 interpretation does not necessarily rely results can be summarized as follows: on the occurrence of banking panics as 1. In general, estimated income and 2 in the 1930s. Goodhart and Ashworth interest rate elasticities are within 0 (2015 and 2017), for example, exclude plausible ranges as found previously 1875 1900 1925 1950 1975 2000 banking panics as a driver of cash in- in the literature. This is reassuring U.S.A. Euro area Germany Germany – excluding coins creases in some major economies. Fourth, as the economies that are included Source: Jobst and Stix (2017). Note: The shaded areas mark the period from 1929 to 1933 and from 2007 to 201. The series for the euro area was constructed prior to 2002. Friedman and Schwartz (1963) argue in the estimation differ substantially that velocity tends to decrease in con- by their economic and financial devel- 4 Historically, in some countries a significant part of cash circulation consisted of specie coins. These are also included here in addition to banknotes. On the construction of the series see Jobst and Stix (2017). The euro series for the period from 1980 to 2001 reflects a synthetic aggregate of the future euro area members. 5 This measure is based on Schneider (2017) and does not employ cash as an input in its computation.

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opment.6 For example, the income that changes in shadow economic mendier and Nagel, 2011; Osili and explain parts of the increase. However, elasticity, which is allowed to vary activities might not have been of im- Paulson, 2014; Stix, 2013) even if no in economies with a higher GDP, the across economies, is on average be- portance for cash demand in some crisis occurred in the specific economy increases after 2009 cannot fully be low one in higher GDP economies economies as, for example, stated in in 2007/08. We then estimated the accounted for by these conventional which suggest that there are econo- Goodhart and Ashworth (2015). More- currency demand model for the first economic forces. The increase in the mies of scale in the use of cash. over, it should be made clear that we and third group and tested whether the use of cash cannot be explained by an 2. Interest rates are found to exert a focus on changes in cash demand and time dummy variables remain signifi- increase in shadow economic activities significant negative impact on cash not on level differences across econ- cant. The approach suffers from rela- either. Interestingly, the unexplained demand. Given the changes in inter- omies and that we just use one indi- tively small group sizes. Moreover, increase in cash demand can be mainly est rates after 2008, Jobst and Stix cator of shadow economic activities. there might be unobserved variables observed for the relatively rich econo- (2017) conduct various specifica- The key question is whether the tempo- which affect cash demand that are cor- mies – whereas one would expect a tions to check for the robustness ral evolution of GDP and interest rates related with the groups. Therefore, results decline in these economies due to the and to analyze whether the elastic- can account for the observed increases are indicative only and cannot be inter- proliferation of cashless payments (Bag- ity of cash demand changes as inter- in cash circulation. We find that results preted as causal. nall et al., 2016). This result suggests est rates become very low (log-log, differ depending on the characteristics Yet, the estimation results are in that overall currency in circulation is semi-log, different slopes after 2008, of the economies. For economies with line with expectations. In the group of dominated by hoarding and other mo- different parameters for interest rates below median GDP per capita, all of economies without a systemic banking tives rather than by transaction motives. below and above 1%). The findings the changes (increases) can be explained crisis no unexplained level shift is found. What are the drivers for the unex- suggest a saturation level of cash by these conventional economic forces. In the group of economies with a bank- plained increase in cash demand? While that agents are willing to hold even However, for economies with above ing crisis before 2007/08 (but not in many factors other than income and in- if interest rates are (very) close to median GDP the time dummy variables 2007/08) a significant level shift is terest rates could be important for the zero. In general, this result implies that are included in the regressions indi- found.9 For the group with a financial increase in cash demand, empirical that part of the increase in cash cate an upward shift after 2009 that can- crisis in 2007/08 (but not before), we analysis is limited by the lack of good demand can be attributed to lower not be explained by GDP or interest rates. could not estimate a model because of a empirical measures. Therefore, any expla- interest rates. A natural next extension would be small number of economies. On a descrip- nation of the unexplained increase in 3. The use of (an incomplete proxy to include measures of trust in banks or tive scale, we note that three out of four cash demand in higher GDP economies for) permanent income instead of perceived uncertainty and to study economies had sizeable increases in necessarily has to remain speculative. period income as a scale variable whether these variables account for the cash demand after 2007/08. Overall, We conjecture that the financial crisis renders the unexplained shift smaller unexplained level shift. As such data these results suggest that banking cri- of 2007/08 and the subsequent turbu- but does not eliminate it. are unavailable for the full sample, we ses have had an impact on post-2007 lences in some economies have lowered 4. No significant effect is found for the conduct an indirect test by splitting the cash demand. confidence in banks and/or increased shadow economy indicator, suggesting sample into groups of economies that uncertainty, notably also in economies that changes in shadow economic ac- (i) did not experience any systemic 5 Conclusions without a financial crisis. It is well pos- tivities exerted no impact on changes banking crisis in the post World War II The paper summarizes results from Jobst sible that the increase in uncertainty, in in cash demand during the period period, (ii) experienced a systemic bank- and Stix (2017) and provides some addi- combination with very low interest under study. The reason for this finding crisis in 2007/08 (but not before) tional descriptive evidence. Findings show rates and thus low opportunity costs of ing is that the shadow economic indi- or had (iii) experienced a systemic that cash demand has increased not holding cash, is an important additional cator is declining in many econo- banking crisis before 2007/08 (but not only in the euro area and the U.S.A. reason for the increase in cash demand mies over the sample period, while in 2007/08).8 The idea for the inclusion but also in many other economies over in many richer economies after 2009. demand for cash is increasing.7 As of the latter group is that memories of a the past decade. In order to explain the observed pattern results represent an average effect crisis can have a persistent impact on The results from panel estimations in cash demand, however, the argument across economies this does not mean financial behavior of individuals (Mal- for non-dollarized economies and for requires a rather persistent increase in currencies that are not circulating uncertainty/decrease in confidence and 6 A few economies with very implausible point estimates for the income (scale) elasticity were omitted from the internationally indicate that lower in- not just a short-term shock in 2008/09. sample. terest rates and the evolution of income Evidence from news-based indices (Baker 7 For example, it declined in 30 out of 32 OECD economies from 2003 to 2014. Although cash demand estimations omit the euro area it should be noted that an increase of shadow economic activities is only found in Cyprus, Spain and Portugal. In the U.S.A, U.K. and Japan there is a slight decrease. 9 With regard to the effect of the financial crisis of 2007/08, results depend on the functional form of money 8 The separation of economies into these groups is based on Laeven and Valencia (2012). demand (log-log or semi-log) and are not unambiguous.

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et al., 2016) indicate that economic policy reasons of the recent increases in cur- Laeven, L. and F. Valencia. 2012. Systemic Banking Crises Database: An update. IMF Working uncertainty increased substantially in rency demand highlights the dire need Papers. 12/163. 2008 and remained at elevated levels, for more data and more research to bet- Malmendier, U. and S. Nagel. 2011. Depression Babies: Do Macroeconomic Experiences at least in Europe. ter understand the people’s use of cash Affect Risk Taking? In: The Quarterly Journal of Economics 126. 373–416. To conclude, Friedman’s and Schwartz’ in calm times and in times of crisis/ Osili, U. O. and A. Paulson. 2014. Crises and Confidence: Systemic Banking Crises and (1963) emphasis on the key importance uncertainty. Without a better under- Depositor Behavior. In: Journal of Financial Economics 111. 646–660. of sentiment seems to be alive and well: standing of this development, it does Porter, R. D. and R. A. Judson. 1996. The Location of U.S. Currency: How Much Is Abroad? “The more uncertain the future, the greater not seem to be a good idea to phase out Federal Reserve Bulletin 82. October. 883–903. the value of [the] flexibility [of cash] and physical currency and to replace it by Rogoff, K. S. 2016. The Curse of Cash. Princeton and Oxford: Princeton University Press. hence the greater the demand for money is electronic means of payments as has Schneider, F. 2017. Unpublished data. Source: Professor Dr. Friedrich Schneider. Department of likely to be” (p. 673). The fact that we been advocated by some scholars (e.g. Economics. University of Linz. Austria. still know so little about the underlying Rogoff, 2016). Seitz, F. 1997. How Many Deutschmarks are Held Abroad? In: Intereconomics 32(2). March/ April. 67–73. Stix, H. 2013. Why do People Save in Cash? Distrust, Memories of Banking Crises, Weak Institutions and Dollarization. In: Journal of Banking & Finance 37. 4087–4106.

References Amromin, G. and S. Chakravorti. 2009. Whither Loose Change? The Diminishing Demand for Small-Denomination Currency. In: Journal of Money, Credit and Banking 41(2–3). 315–335. Assenmacher, K., F. Seitz and J. Tenhofen. 2017. The use of large denomination banknotes in Switzerland. Paper presented at the 3rd International Cash Conference. Deutsche Bundes- bank. April. Bagnall, J., D. Bounie, A. Kosse, K. P. Huynh, T. Schmidt, S. Schuh and H. Stix. 2016. Consumer Cash Usage and Management: A Cross-Country Comparison with Diary Survey Data. In: International Journal of Central Banking 12(4). 1–61. Baker, S. R., N. Bloom and St. J. Davis. 2016. Measuring Economic Policy Uncertainty. http://www.policyuncertainty.com/media/EPU_BBD_Mar2016.pdf. Bartzsch, N., G. Rösl and F. Seitz. 2013. Currency movements within and outside a currency union: The case of Germany and the euro area. In: The Quarterly Review of Economics and Finance 53. 393–401. BBC. 2015. The truth about the death of cash. http://www.bbc.com/future/story/20150724-the- truth-about-the-death-of-cash. Goodhart, C. A. E. and J. Ashworth. 2014. Trying to Glimpse the “Grey Economy”. VOX – CEPR’s Policy Portal. http://voxeu.org/article/trying-glimpse-grey-economy. Goodhart, C. A. E. and J. Ashworth. 2015. Measuring Public Panic in the Great Financial Crisis. VOX – CEPR’s Policy Portal. http://voxeu.org/article/measuring-public-panic-great-financial-crisis. Goodhart, C. A. E. and J. Ashworth. 2017. The Surprising Recovery of Currency Usage. Paper presented at the 3rd International Cash Conference. Deutsche Bundesbank. April. Google Trends. 2017. http://trends.google.at/trends. Friedman, M. and A. J. Schwartz. 1963. A Monetary History of the United States, 1867– 1960. Princeton: Princeton University Press for NBER. Jobst, C. and H. Stix. 2017. Doomed to Disappear? The Surprising Return of Cash Across Time and Across Countries. CEPR Discussion Paper. 12327. September. Judson, R. 2017. The Death of Cash? Not So Fast: Demand for U.S. Currency at Home and Abroad, 1990–2016. Paper presented at the 3rd International Cash Conference. Deutsche Bundesbank. April. Krüger, M. 2016. The Spread of Branch Banking and the Demand for Cash in Post-War Germany. ROME Discussion Paper Series. 16-09. October.

122 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 123 François R. Velde Money and payments in the digital age: Senior Economist and Research Advisor Federal Reserve Bank of Chicago1 innovations and challenges

Information technology (IT) is having a have, which makes a direct, quid pro quo growing impact on the financial indus- exchange impossible. try. In some ways this is not new: com- This problem arises only under cer- puting power has been harnessed by tain assumptions. Some are natural: banks and other financial intermediar- there is diversity in tastes and in goods, ies for decades. But now it is IT’s ability production and encounters occur at to process information (the “I” part of IT) different times and cannot be synchro- that is opening new avenues. Indeed, nized. But the most critical assumption finance to a large extent is a matter of is the lack of information and record- information, or lack thereof. In a fric- keeping technology. If we had a ledger tionless world with no informational where we kept track of what everyone asymmetries and perfect record-keep- had exchanged, I could get what I want ing there is no place for financial inter- from you, inscribe it as a debit on my mediation. Now that increasing num- account, and later I give what I have to bers of transactions are taking place in someone else and credit my account. a realm (the Internet) where informa- The classic solution, which allows tion can be acquired and exploited in many trades to take place that would novel ways, financial intermediation not otherwise, is to use secure tokens will be transformed. that will embody your claim on soci- This essay focuses on one early devel- ety’s resources arising from your act of opment, namely distributed ledger giving me what I want. This is called technology (DLT), starting from its use money. in creating a money-like asset, Bitcoin. A new problem arises: how to make I first briefly review the past of money, the tokens secure? Again, the classic using the insights we can gain from this solution is to make them costly to coun- new technology into the nature of terfeit, by using a costly material: gold money. I then turn to DLT, exploring or silver, which have been used to make its basic features, asking what promise coins since the 6th century BC.2 While it really holds. I conclude with some the exact origins of coined money are thoughts on how central banks may still obscure, coins have usually been have to react to these developments. produced in a standardized format and certified by political authorities, either 1 An overview of monetary directly or under license. evolution Tokens are now costly to counter- Tokens feit, but also costly to make as well. Why does money exist? We can start The real value of resources devoted to from the classic presentation of the bar- securing the tokens is roughly the value ter problem, whose earliest known for- of the money stock’s content, that is, mulation is nearly 2000 years old. The the total real balances held by the econ- setting is one of decentralized interac- omy, and this can be substantial.3 There tions. You and I meet and we each will naturally be a tendency to seek have some good. But I want what you ways to economize on this resource have while you do not want what I cost. 1 2 Curiously, the very first coins were made of a mixture of the two metals, but within a hundred years pure gold and 1 The views expressed here do not necessarily represent those of the Federal Reserve Bank of Chicago or the Federal Reserve System. pure silver coinage came into use. 3 The use of precious metal can also serve another purpose, which is to anchor the price level to the relative value of the metal used.

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One method is to use cheaper efficient technology for keeping debt kinds of “attackers.” Most were seeking liest, it was a mere form of certifica- tokens, made of a cheaper material such records, which becomes readily avail- to make a profit, namely the difference tion: the central authority (or its desig- as copper (from the 15th century) or able with the adoption of double-entry between the market value of a real nees) stamped its seal on standardized paper (from the 17th century). But coun- book-keeping in the 13th century. Also token and the cost of production of a lumps of metal to certify the contents. terfeiting becomes increasingly profit- needed is a technology for sending secure plausible-looking token: the wider the Eventually it became the legal privilege able as the cost of making the tokens is messages. The simplest technology is difference, the greater the incentive. to define what is, or isn’t, money, in lowered relative to their value in e xchange, walking over to the banker’s o ffice, but Less common but occasionally occur- legal terms, which can be seen as a so a combination of technology and over time paper-based messages devel- ring were what one might call “mali- standard-setting function, forming an enforcement is required to keep coun- oped. The name we still use for them cious” attackers, typically State actors unambiguous consensus on what will terfeiters at bay. In the 16th century a (“checks”) indicates that security was a intent on impairing an enemy’s mone- discharge debts, effect payments in new technology for minting coins gave concern from the very beginning. tary system.5 Finally, one might place transactions, or serve as a unit of account. governments a temporary advantage in The earliest centralized payment sys- in the category of “attackers” desperate Modern constitutions (such as the U.S. making recognizably better struck coins tems emerged when political authori- governments impairing their own cur- constitution) and legal codes make clear and allowed them to experiment with ties set up their own public banks, often rency through debasement or inflation that money remains a regalian right. token copper, sometimes on a large times making settlement legal tender (either one seen as legal counterfeiting). scale. Later, the introduction of paper and final. A final theme is the presence of a 2 Bitcoin and distributed ledger money was also accompanied by the central authority. Historically, wher- technology use of various techniques (watermarks, Recurring themes ever there is money the State is not far Bearing these themes in mind, let us counterfoils, high-quality engraving, From this terse overview of monetary away. That does not mean that privately turn to recent the technological changes secret points) to defeat counterfeiters. history some recurring themes emerge. issued currencies have not existed, but that could affect the future of money. Another method is to transfer pri- One is that trust has always been at by and large they have either when vate liabilities. Suppose that debtor B the core of money; and trust, ulti- there was no functioning State, or Bitcoin owes 10 to A and also 10 to C. A can mately, results from a lack of informa- when the State tolerated these private We may start with Bitcoin because, make a payment of 5 to C by instruct- tion. If I knew everything about your issues. From the beginnings of coinage although it is not the first attempt at ing B to decrease the first balance by 5 motives and your circumstances, I or soon after, coins were issued by creating electronic forms of currency, and increase the second by 5. This could predict your future actions and political authorities (cities, kings). it is the first to reach widespread recog- transforms the debtor B into a “bank”, choose mine accordingly, without hav- Roman law codified the notion that nition and (in some sense) use. not in the sense of an intermediary ing to trust you. It is also lack of infor- control of the currency was a regalian Bitcoin was designed under the between borrowers and lenders but in mation that precludes nonmonetary (or right, a prerogative of the sovereign, pseudonym of Satoshi Nakamoto and the sense of an agent whose liabilities credit-based) solutions to the lack of and this notion passed into both feudal launched in 2009. It is a protocol for are used in payments.4 The prerequi- double coincidence and hence makes law and Roman civil law of medieval communicating over the internet, but a sites for such operations include an money useful. Understandably, then, Europe. It is true that weak sovereigns highly specialized one. Whereas SMTP technological advances that improve let feudal lords exercise the preroga- transmits e-mails with few limitations our ability to collect and use informa- tive, but in most cases they regained on their content, Bitcoin transmits for- tion can change both the degree to control of the currency as their powers matted messages about transactions which money is useful and the form grew; or, if they did not, it was because between pairs of agents (sender and that useful money can take. they lost their sovereignty (as in the receiver). The design problem that Another recurrent theme is that all Holy Roman Empire). By the 19th cen- Bitcoin solves is to transfer value over monetary instruments have been sub- tury it became commonplace to think the Internet, by issuing and managing a ject to various forms of “attacks”. As of currency as one of the marks of sov- quantity of monetary tokens, without soon as the first coins appeared in the ereignty, as symbolic as flags and an- any central authority but rather letting 7th century BC, counterfeits appeared thems, even if States at times tolerated anyone transfer value or even issue and as well in the form of coins with a ve- privately issued currencies, such as manage the tokens. neer of precious metal over a cheap trade tokens and private bank-notes. Bitcoin is remarkable. Monetary copper core, and the race has been on The State’s involvement took vari- history abounds in examples of mone- ever since. There have been various ous forms. At the simplest and the ear- tary tokens that are not explicitly backed

5 4 In the Ripple protocol, the “rippling” feature potentially allows anyone to play that role in a given transaction. Examples include the British counterfeiting the French paper currency during the 1790s and the Germans counterfeiting British currency during World War II.

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or managed by a central authority, but brought attention to its underlying actor to ascertain that it conforms to The lottery requires the solution to they usually are tokens with an alterna- technology: distributed ledger technology, the rules and to the last known state of a numerical problem that can only be tive use: a gold coin can always be also called blockchain. I now describe its the ledger. But in a decentralized and found by random guessing, and guess- melted down and turned into some- mains characteristics, not just in terms asynchronous system, how do we reach ing requires time and effort (a process thing else. Conversely, there are many of creating monetary tokens but also the new consensus? The problem arises called “mining”); but verifying that the examples of tokens that are intrinsically from a more general point of view.6 when actors disagree after the fact on solution is correct is easy. valueless, but there is always an issuing the order in which transactions were entity, private or public, that is sup- Design elements made, because this allows me to send posed to provide some convertibility, The original purpose of this technology two mutually incompatible messages, guarantee, or acceptability. Bitcoin is is to ascertain and transfer property each valid on its own (“I cede my coin not only the first completely demateri- rights. These rights may be over assets to A”, “I cede my coin to B”) and each alized token: it is unique in monetary that exist independently of the technology believed by a fraction of the network. history in being intrinsically valueless or not: the latter are called native or This is the so-called “double-spending (there are no alternative uses to a bit- on-blockchain assets. Assume for now problem” and it is due to the combina- coin if the protocol ceased to be used) that the assets are well defined: what a tion of both features, decentralization yet it is no one’s liability. native asset is will become clear shortly. and asynchronicity. There would be no I hasten to add that I view Bitcoin as The concept of ownership is as fol- conceptual difficulty if multiple actors a proof of concept rather than a fully- lows: I own an asset X because every- could get together at fixed times to fledged currency: eight years after its one knows, and agrees, that I do. This evaluate all new transactions jointly appearance, and five years after it differs from physical possession (e.g. (synchronicity), or if a single actor eval- gained worldwide notoriety, the aggre- cash) as well as from possession based uated all transactions as they came in gate value of its stock is tiny compared on a registry (e.g., land). One way to (centralization). In either case the choice of the to existing monetary stocks, its use in formulate the process is recursive. Sup- There are two broad methods of dictator is embedded in the rule that ordinary transactions remains limited. pose that at some point in time T there establishing consensus, representing two the longest blockchain (more exactly, Its value remains extremely volatile, is an agreed-upon state of the world, conceptual extremes. The first is to the one embodying the most proof of and (as of writing) seems to be sought essentially a list of who owns what (a appoint a dictator who chooses the work) is the valid one. The lottery is either for speculative reasons or as a ledger). The technology provides a pro- block to be added to the blockchain. running continuously, and every time a way to evade capital controls. There seems cess for moving from T to T+1, which The first approach sounds like a terrible node wins it broadcasts the new block, little chance for Bitcoin to become much will consist in aggregating all valid idea, but the trick is that the dictator is with proof of work (the solution to the more, at least in advanced economies. changes of ownership. The result will chosen at random for each block. Of numerical problem) included in it. If Be that as it may, Bitcoin is at mini- be a new agreed-upon state of the world course, in a decentralized environment two nodes find the solution nearly at mum a working prototype that has at T+1. The design correspondingly has where actors know little or nothing the same time and the network does three elements: a way to describe the about each other, we have to be careful not agree (because part of the network Chart 1 state of the ledger, a language for trans- in how the selection takes place: effec- received one new block and the rest the A blockchain actions (changing ownership, in which tively, there is no list of registered vot- other new block) there is temporary cryptography will serve to verify iden- ers from which to select the dictator, disagreement and a fork in the chain. header header header tities of the previous and new owner, or and a malicious actor could create mul- But the lottery keeps running, nodes sender and receiver), and finally a pro- tiple fake identities to increase the will keep adding to both ends of the A B A B tocol for updating the ledger with vali- chances of being selected. One method chain until one becomes longer than Y Y dated transactions. is to require the candidates to pay a the other. Z Z The third design element is the cost, so that the one who adds the new The other general method of estab- C E most difficult one, given the posited block is the winner in a costly lottery: lishing consensus is to hold a vote on C D D E design problem. Updating the ledger this is called “proof-of-work” and is the the contents of the new block. This may owners block T block T1 block T2 owners means achieving a new consensus on concept used by Bitcoin. Another method sound better than random dictators,

Source: Author’s compilation. who owns what. Each individual trans- is to require candidates to post collat- but, as with political elections, it raises action can be easily evaluated by each eral: this is called “proof-of-stake” and the preliminary question of who is en- may come into use for Ethereum. titled to vote. In general, it is difficult 6 I will therefore not describe the specifics of Bitcoin any further, except by way of illustration.

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to maintain the free access and ano- in the world of DLT, trust in the protocol mutability. But these properties are For example, a decentralized network nymity of the bitcoin model in this is what dispenses with trust between those of the solution to a particular may be more resilient to shocks that case. The method will therefore be parties. problem. In many proposed applica- might affect individual nodes, but the mainly implemented in “permissioned” With the three design elements in tions, it is far from clear that decentral- protocol itself becomes a single point of networks, where access is restricted. place, we see that ownership ultimately ization and lack of trust are essential failure. Likewise the record of owner- This of course raises the further ques- rests on a sequence of valid transfers, features of the relevant problem, lead- ship is immutable only to the extent tion of who “permissions” the network, starting from some point and ending ing to the nagging suspicion that DLT is that the consensus does not change. but I will set that aside. Assuming, with the current owner. This sequence a solution in search of a problem. The events surrounding Ethereum in then, that potential voters are identi- is what uniquely defines each bitcoin, Furthermore, these desirable prop- August 2016 are a case in point.10 fied and vetted to some degree, we still and the blockchain is the collection of erties are not absolute or immutable: Finally, it always bears repeating have to deal with the asynchronicity of all such sequences. When the creation they arise from tradeoffs that might be that even if arrangement B is better the network (not everyone is voting on of these starting points is part of the resolved differently in other applica- than the status quo A, the costs of mov- the same thing, or at the same time) protocol these chains constitute assets tions. I will cite a few. First, there is a ing from A to B might be greater than and with the possibility of malicious “native” to the technology, whose essential tradeoff between scale and speed (or its the gains. Many of the touted advan- users, either because vetted users are property is that they can be transferred inverse, latency). A truly decentralized tages of DLT (e.g., transaction, settle- impersonated, or because users are not with the technology. As the protocol or distributed system has to confront ment, and reconciliation will be faster willing to trust all other users blindly. regulates the creation of new starting the problem of latency, because DLT and more reliable) come from multiple points, the chains of ownership are in requires full histories and multilateral actors using a common language to restricted supply. Thus, a bitcoin is use- transmissions of information, which store and update information, not from ful because it can be transferred and is implies amounts of data far beyond the DLT per se. These advantages have in limited supply. needs of an equivalent centralized sys- been obvious to industry participants Bitcoins are monetary tokens, but tem (one hub talking bilaterally with for decades, and one might wonder if of a new kind: just as medieval bankers many spokes). Second, DLT bases own- high transition costs are not the reason received coins in deposit and replaced ership on public information, that is, why they have not been reaped earlier.11 the hand-to-hand exchange of the coins massive public disclosure. It is true that with written operations on ledgers, pseudonymity in Bitcoin mitigates the 3 Central Banks and DLT Bitcoin dispenses with the physical publicity,8 but the tradeoff between Today central banks have a number of token, but contrary to medieval bank- information and privacy might be re- functions that could be affected by the ers there is no single ledger. Also, Bit- solved differently in more restricted development of DLT: among other coin replaces the natural scarcity of networks where participants are more things, they regulate financial actors, precious metals with the artificial scar- readily identified. Third, Bitcoin’s recent they often manage large payments sys- The classic solution to this type of city of controlled money creation.7 history illustrates the tension between tems, and they issue and manage out- problem, called the “Byzantine generals openness and governance. Bitcoin is side money which is also the legal tender problem”, relies on multiple rounds of DLT: a solution in search of a problem? open-source protocol that Bitcoin users and unit of account. voting and an algorithm that is expected About two years ago the notoriety of use, nothing more. Changes to the pro- As regulators, central banks are to reach consensus with very high prob- Bitcoin generated growing interest in tocol are in principle endorsed by con- challenged in many ways by DLT. In ability. A high-profile example is the its underlying technology. But Bitcoin sensus, but difficult or strategic deci- the most extreme form of open consen- Ripple protocol, in which users do not was designed to solve a particular prob- sions are difficult to coordinate and can sus-based protocols, it is difficult to say trust all other users but a subset, spe- lem: a monetary token on the Internet lead to fragmentation and incompatible who or what could or should be regu- cific to each user. that does not rely on any central splits.9 Finally, several properties are lated. Here again Bitcoin’s experience, Whatever the method used, it is im- authority. Much of the interest in DLT more limited than is often recognized. whether or not one counts is as a form portant to remember that trust is never does not come from anyone genuinely eliminated, but rather displaced. Par- interested in that problem. Instead, 8 On Bitcoin’s blockchain, parties to transactions are only identified by addresses (randomly generated strings of letters and numbers). The link to an individual exists only through the individual’s knowledge of the password ties to a transaction need not trust each many have been taken with the attrac- associated with the address. other, but, as in all monetary exchange, tive properties of DLT, which include 9 I refer here to recent debates on raising the block size limit in the Bitcoin protocol. they have to trust the token exchanged: resilience, speed, decentralization, im- 10 To erase the consequences of a faulty smart contract, part of the Ethereum community agreed to go back in time to an earlier version of the blockchain. This was not accepted by all and two versions of Ethereum now coexist. 7 Cleverly, Bitcoin’s money creation mechanism is used to compensate the costs of proof-of-work. 11 The failure of the Global Straight Through Processing Association in the 1990s is instructive.

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of money, has blazed trails and brought age of the Internet. Perhaps metallic provided by central banks is the ulti- applications to asset transfers. Central DLT generally to the front of regula- coins and paper notes, relics or vestiges mate final means of payment, and par- banks and regulators face a host of tors’ minds. It has also shown that a of monetary history, are destined to be ticipants may well demand the option potential challenges, and the time may good part of the Bitcoin community, replaced, just as paper as physical sup- of settling in central bank money. But come soon when they will have to especially those who provide additional port to convey information.12 Some aspects here again the key question remains: is become involved in blockchains. services around the use of Bitcoin, have of a digital currency, like the vast a decentralized system needed to im- themselves sought legal clarity. More amounts of information it could gener- plement a digital version of a central broadly DLT can change the risk profile ate, would be attractive to some (regu- bank’s currency? The Bank of Canada of existing regulated actors, allow the lators, law enforcement, and econo- recently concluded that the answer is emergence of new actors who perhaps mists!) but not others (those who see not obviously positive. ought to be regulated, and create new value in the anonymity that cash offers). systemic risks. On this last point word Similarly, the ability to pay interest on 4 Conclusion on smart contracts is in order. Once currency could be attractive to policy In summary, Bitcoin is in my view transfers of ownership can be effected makers because it could make mone- a remarkable achievement, although by lines of code, it is conceptually a tary policy more potent; this ability unlikely by itself to replace monies in small steps to making transfers contin- might be welcome or not, depending well-functioning monetary systems. It gent on any variety of events either on whether the interest paid is positive has nevertheless offered an interesting on-chain or (less easily) off-chain. The or negative. Of course, improvements prototype and has generated interest in simplest example would be a transfer to SVPs could come from the private its underlying principles with potential from A to B contingent on a prior trans- sector, and if physical cash is destined fer from C to D. Ethereum is to a large to be replaced then central banks may extent an attempt to extend Bitcoin’s only need to manage its gradual disap- design to exploit the full potential of pearance. But is physical cash doomed? smart contracts. The recent history of It has resisted well to the emergence algorithmic trading, high-speed trad- over recent decades of electronic means ing, and occasional “flash crashes” make of payment, in part because the use of clear, however, the possibility for unin- cash protects the privacy of individuals’ tended consequences in a complex and transactions in ways that even the partly automated system. pseudonymity of Bitcoin cannot fully The other two functions of central duplicate. banks, providing payments and legal But other considerations might lead tender, are possible avenues through some central banks to investigate their which they might find themselves in- own version of digital currency, volved in DLT, either because of pay- whether for small or large payments. ments or because of legal tender. Even First, there might be a reluctance on central banks that do not directly man- the part of the public to deal only with age large value payments systems (LVP) inside money (liabilities of the private do manage a “small value” payment sys- sector). Second, suppose that DLT tem (SVP), namely physical currency. becomes widely adopted in a variety of Payments systems, like any other way contexts to record and transfer owner- of doing things, should be improved ship of assets. In such transfers the when a more efficient technology other leg will often be a settlement in comes along. The initial promise of cash. This “cash” will often be inside Bitcoin was to offer a currency for the money, but as legal tender, the c urrency

12 The scroll was replaced by the codex, or book, in the early centuries AD; parchment was replaced by rag-based paper in the 16th century and wood-based paper in the 19th century. No doubt the emergence of paper money in the 17th century was facilitated by the availability of a support that was both cheaper than parchment and still offered devices (such as watermark) to hinder counterfeiting.

132 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 133 Session 6 Fintech: opportunities and challenges for banks and regulators Peter Mooslechner The FinTech Revolution: More important Executive Director Oesterreichische Nationalbank than the ATM?

„…the most important financial It is necessary to put the FinTech innovation that I have seen [in] the focus in a much broader context, in past 20 years is the automatic teller order to set the scene for a fruitful machine.“ discussion and analysis of the many Paul Volcker (2009) complex topics that will have to be tackled in this context. At least this is „…Something New Under the Sun?“ key with regard to the three main ele- Mark Carney (2017) ments: (i) financial markets, (ii) the institutional setup as well as (iii) the At the moment, the FinTech arena importance of technical progress and seems to be more prepared for stone historical developments. Therefore, it age unregulated fighting as to serve as a is also necessary to bring representa- “cooperative” playground in an advanced tives of the different teams on the play- global community under the roof of ground together to talk to each other in common institutions, like the United a constructive and neutral setting. Nations in the area of politics. What As a starting point for a much more seems to be urgent today is to bring all in-depth analysis and for addressing dif- relevant agents in markets targeted and ferent views on the subject, three elements affected by FinTechs together to discuss of the much broader focus mentioned the consequences of the rise of Fin- above may help to prepare the topic on Techs from different perspectives and the one hand but also to raise awareness in an encompassing way. of the issues on the other hand: It is obvious – and not meant as a critique – that all agents acting in this From a macroeconomic point of FinTech arena have different prefer- view….. ences, different starting points and that …..quotes from three eminent econo- they follow different objectives. For mists may help to reveal the „character“ example, they are of very different age, of the FinTech innovation in an eco- come from different historical (often nomic sense and the potential conse- national) traditions, are extremely dif- quences it might produce. Robert M. ferent in size, market share and product Solow (1987), the outstanding pioneer portfolio, concentrate on different of growth theory, concluded in a his- functions and tasks. In the end, it comes torical New York Times Book Review as no surprise, that they see each other article characterizing the nature of the as coming from different tribes or even technical progress of that time: „You planets, not even sharing the same lan- can see the computer age everywhere guage to talk to each other. However, but in the productivity statistics.“ Paul this becomes more complicated by the Volcker (2009) commenting on the mere fact that their playing field is more crisis experience famously remarked as or less the same, at least they are active a criticism of financial innovation and in significantly overlapping markets the behavior of financial market partic- addressing the same customer base po- ipants: „…the most important financial tential to a large extent. innovation that I have seen [in] the past

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20 years is the automatic teller machine.“1 nologies), on each individual as well as Last but not least and most recently on overall GDP in the end. Will we see Robert Gordon (2016) in his monu- this type of revolutionary technical mental book The Rise and Fall of Ameri- progress impact or will FinTechs simply can Growth writes: „The Rise and Fall of complement what we have already seen American Growth demonstrates that over the last centuries, for example online the life-altering scale of innovations be- banking and electronic communication. tween 1870 and 1970 cannot be repeated.“ Two well known photographs illus- What do these quotes want to tell trate perfectly, what in particular Gordon us, do they have a common message? but also Volcker have in mind. These From an economic point of view the two photographs compare the New interesting questions are: What is the York Easter Parade on the Fifth Avenue personal welfare enhancing benefit of a in 1900 and in 1913. In 1900, we see a consumer or firm and what is the over- crowd of pedestrians as well as a large all social benefit of, for example, a pay- number of horse coaches. In 1913, only ment transaction executed in 2 seconds a little bit more than a d ecade later, the or less instead of 2 hours or 1 day? In Fifth Avenue is full of cars but there are fact, these are very tricky questions to no horse coaches anymore and signifi- answer and the measurable impact of cantly less pedestrians as well. This is these innovations on GDP and produc- an illustration of this type of revolu- tivity is difficult to quantify, in particular tionary technical progress, which really as some (or many) of them come as pro- changes everyday life and almost com- cess innovations without a price. At the pletely covers our entire social activi-

same time, negative consequences for ex- ties and shrinks the old technology to a the horse? Where’s 1913: isting financial institutions in the form minimum, to very specific uses only. In of market share losses and reduction in comparison, no horse coaches are left employment become much more directly in 1913 and later on as a significant part visible and are easily to understand. of transportation. Although, we know that horses still exist and they play some From a historical point of view….. role on the countryside, in sports and …..the core questions relate to the in leisure activities. A comparable gen- type of technical change we will or eral purpose technology might have might potentially see as a consequence been the introduction of electricity (or of the FinTech revolution. What Robert air transport), but it is surprising how Gordon has in mind is innovation of the few comparable examples come to our type of revolutionary change, which mind that really have changed our lives than has a significant impact on the in a revolutionary way. Even if many of whole society (general purpose tech- us might have the personal feeling that

1 More in detail, here is the full quotation from the New York Post Website: „The most important financial innovation that I have seen the past 20 years is the automatic teller machine, that really helps people and prevents visits to the bank and it is a real convenience. How many other innovations can you tell me of that have been as important to the individual as the automatic teller machine, which is more of a mechanical innovation than a financial one? I have found very little evidence that vast amounts of innovation in financial markets in recent years has had a visible effect on the productivity of the economy, maybe you can show me that I am wrong. All I know is that the economy was rising very nicely in the 1950s and 1960s without all of these innovations. Indeed, it was quite good in the 1980s without Credit Default Swaps or CDOs. I do not know if something happened that suddenly made these innovations essential for growth. In fact, we had greater speed of growth in the 1960s and more importantly 1900: Where’s the car? Where’s 1900: it did not put the whole economy at risk of collapse.” Congress Library. City, NationalSource: at Archives New York The Easter Parade on the Fifth Avenue in New York as time went on went as time York New in Avenue Fifth Easter the The on Parade

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almost everything has changed com- with financial innovation around digi- foster new approaches of providing finan- financial sector compatible with stabil- pletely during our lifetimes because of talization: On the one hand, there is cial services, in particular new techno ity and overall welfare has been strongly computers, internet, mobile phones and the threat of excessive competition, a logies. underlined. Stakeholders expect authori- many other things more. use of innovation for regulatory arbi- Behind this dichotomy, there are ties to ensure efficient financial services trage or speculative purposes, breeding different approaches on what the goals that add value to users and the economy From a regulatory point of instability by fostering excessive risk of regulation are and what the potential without increasing risks. Two questions view….. taking. A development, which we have roles of FinTech and financial innova- come to the forefront when these ex- …..it is very important to „preserve“ seen many times in financial behavior tion in an existing financial environ- pectations are translated in the context the potential economic dynamics cre- in the past that has contributed to the ment in general are. There is a case for of a broader financial system’s view: ated by FinTechs with regard to the im- creation of financial crises. On the modesty with respect to ex ante devis- First, what and how can FinTechs pact of digitalization and other key other hand, there is the threat of rising ing a grand scheme for the future evo- and digital innovation contribute to drivers on the future financial system. market concentration induced by digi- lution of the financial industry by regu- these overall goals of creating value and At the same time, there is the need to talization, for instance via integration lators and supervisors. Instead, as the welfare and what kind of regulatory provide a level playing field for all of financial services by large online path and the dynamics of changes in and supervisory approach would fit best actors in the respective markets, for platform suppliers with oligopolistic financial markets and to financial insti- to maximize this contribution? newcomers as FinTechs as well as for market structures and a tendency to tutions cannot be known in advance, The second question concerns the established financial institutions. monopolize value added chains in the let new competitors try to convince au- more direct impact of digitalization on To a large extent, the modernization financial industry. thorities that they can and how they regulation and supervision, associated of the regulatory framework will shape Due to the transnational nature of will contribute to these developments. with the term „RegTech“. What can dig- the impact digital innovation and the digital service supply and the existence Regulation is sometimes/often por- italization contribute to enhance the appearance of FinTech companies will of a European Single Market in finan- trayed exclusively as a burden. That is quality and efficiency of regulation and have on the financial system. At the cial services, an appropriate regulatory certainly misleading in many respects. supervision? current stage, many FinTech innova- response will require either interna- Overall, there is the expectation (or tions do not fit easily in the existing tional coordination or has to be of a hope) that regulation and supervision Summing up regulatory framework. If we expect supranational character. As a result, a contribute decisively to overall welfare Though the term FinTech is rather new, FinTechs to be more than a short-lived process has been started on the Euro- of a society. financial technology had already been a fad that will soon either wane or be pean level already to investigate the As history has proven on many occa- major phenomenon before the term absorbed by incumbents, regulation possible scope and shape of a common sions, at least the absence of an appro- FinTech became such a fascinating topic will have to address the challenge. EU response. In March 2017, the Euro- priate regulatory framework has led recently. This calls for particular ana- By doing so, regulation must navigate pean Commission has launched an into situations of financial turmoil reg- lytical precision in dealing with all the between two opposing threats associated encompassing consultation on the future ularly. However, regulation also con- related issues in a sophisticated way, as regulatory and supervisory framework tributes to the legitimacy of market the rise of FinTech is seen as having the for FinTech. participants. In a trust-based market potential to “disrupt” (OECD, 2016) In this context, a large number of like the financial sector, driven by mar- the financial industry. Without a doubt, fundamental theoretical and practical ket expectations and characterized by questions to be addressed are challeng- questions must be approached with intertemporal contracts, such legiti- ing but they provide interesting oppor- respect to the goals of regulation in macy is a key factor for all suppliers to tunities as well. The main difficulty relation to digital innovation in the gain customer confidence. In order to obviously is to find the right balance financial sector. There is a certain ten- obtain legitimacy provided by regula- between the many relevant perspec- dency in the current debate to frame tion, FinTechs have to demonstrate tives involved. In particular, decision the discussion in terms of whether new how they can contribute to and comply makers should facilitate the positive players will need to fit by and large into with the goals of financial regulation in innovation dynamics FinTechs obvi- the existing regulatory framework or their own interest. ously provide while safeguarding finan- whether a tailor-made new framework In the wake of the Global Financial cial markets and institutions against has to be designed in order to suit and Crisis, the need for regulation and super negative and destabilizing developments vision to make competition in the at the same time.

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References Brunnermeier, M., A. Crockett, C. Goodhart, A. Persaud and H. S. Shin. 2009. The Fundamental Principles of Financial Regulation. International Center for Monetary and Banking Studies. Geneva. Carney, M. 2017. The Promise of FinTech – Something New Under the Sun? Deutsche Bundesbank G20 conference. Wiesbaden. January 25. Deloitte. 2015. RegTech Is The New FinTech. How Agile Regulatory Technology Is Helping Firms Better Understand and Manage Their Risks. Galway. Deloitte. 2016. Bitcoin, Blockchain, and Distributed Ledgers: Caught Between Promise and Reality. Melbourne. European Commission. 2017. Fintech Consultation. https://ec.europa.eu/info/finance-consultations-2017-fintech_en. Financial Stability Board. 2016. Key Elements Underlying Fintech and their Financial Stability Implications. Basel. Financial Stability Board. 2017. Financial Stability Implications from Fintech: Supervisory and Regulatory Issues that Merit Authorities’ Attention. Basel. Gordon, R. 2016. The Rise and Fall of American Growth. Princeton. IMF. 2017. Fintech and Financial Services: Initial Considerations. SDN/17/05. June. Institute for International Finance. 2016. RegTech in Financial Services: Technology Solutions for Compliance and Reporting. Washington DC. International Organization of Securities Commissions. 2017. IOSCO Research Report on Financial Technologies (Fintech). Madrid. Kregel, J. 2016. The Regulatory Future FESSUD Working Paper Series 164. KPMG. 2017. The Pulse of Fintech. Amstelveen Netherlands. Lagarde, C. 2017. Fintech: Capturing the Benefits, Avoiding the Risks IMF Blog. June, 20. Mori, N. 2017. Will Fintech Create Shared Values? Presentation at the Annual Tokyo Conference of the Center on Japanese Economy and Business. Columbia Business School. New York. May 25. OECD. 2016. FinTech: Implications for the Shape of the Banking Sector and Challenges for Policy Makers. DAF/CMF (2016) 21. 27 October. Philippon, T. 2016. The FinTech Opportunity. BIS Working Papers 655. Solow, R. M. 1987. We’d Better Watch Out. The New York Times Review of Books. July 12. Volcker, P. 2009. New York Post. December 13. Wilkins, C. 2016. Fintech and the Financial Ecosystem – Evolution or Revolution? Presentation at Payments Canada. Calgary Alberta. June 17.

142 OESTERREICHISCHE NATIONALBANK Klaus Kumpfmüller Financial innovation – a regulator’s perspective Executive Director Financial Market Authority 1 Making innovation happen need more guidance about regulation As regulator and supervisor of Austria’s than others. The vast majority of our financial markets the Austrian Finan- market participants is committed to cial Market Authority (FMA) is com- complying with the law, but some need mitted to make financial innovation to understand better what the precise happen – as long as it complies with the requirements are. law. Our commitment to enabling innovation entails focusing on a dialogue for innovation and sharing our experience and expertise with stakeholders. We are keen to get more insight into new business models whilst ensuring financial stability and investor protection. We know that financial markets are at the forefront of digitalisation and either market participants will innovate or they risk to be out of business rather sooner than later. FinTechs bring opportunities and challenges to banks and regulators. The FMA defines FinTech products as refer- 2 FMA’s FinTech Contact Point ring to innovations in the area of financial services that are based on informa- To address the need for information we tion technology and that: have established the FinTech Contact • are frequently but not necessarily Point accessible via the FMA’s website: developed by non-licensed companies; Not only do we provide easily under- • typically include interfaces to the sys- standable information about FinTechs tems of licensed enterprises; and including a practical “Navigator” that • have the potential of causing changes guides through regulatory questions, that permanently affect how the finan- but entrepreneurs can also use our Fin- cial sector currently operates. Tech contact form to submit questions From our supervisory perspective, regarding their specific business proj- there is no such thing as a “typical Fin- ects to our experts: https://www.fma. Tech” – some FinTechs are small start- gv.at/en/cross-sectoral-topics/fintech/ ups with little legal knowledge, other fintech-contact-form/. FinTechs are part of blue chip compa- We are an integrated financial super nies authorised as banks or insurance visor and thus have an in-house net- undertakings with large compliance work of FinTech experts in all different divisions. Our stance as FMA is very areas of our competences: banking simple and very clear: we are com- including payment services, insurances pletely neutral and will neither favour and securities markets. Depending on nor discriminate against any market the specific business model, a dedicated participant. We are also strictly neutral ad-hoc team of experts answers the when it comes to technology: all tech- request as soon as possible. Our services nological approaches complying with understand that time is of the essence the law stand on an equal footing. and are thus committed to provide That being said, we are aware that speedy replies after having assessed the businesses with less legal knowledge request. In the following dialogue the

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obstacles to digitalisation contained in Online Identification Regulation3 which ments Directive (CRD) (2013/36/EU) the law as it reads today. Some regula- allows online identification of new cus- regrettably contains no provisions on tions still require users of financial ser- tomers inter alia under the following outsourcing, the FMA has submitted a vices to be physically present at the conditions: draft proposal to the European Com- business premises or to provide paper • The customer needs a video connec- mission regarding an amendment of the copies with handwritten signatures. tion with a specifically trained staff CRD to include provisions on outsourc- We believe that these requirements are of the service provider; ing a year ago. Our draft aims at creat- outdated and should be modernised. • The customer needs to show his/her ing a level-playing field for outsourcing We are inviting market participants as official ID or passport so that the ho- and efficient supervision. Therefore, well as other interested stakeholders lograms as security features and the we would welcome new and advanced like academics or NGOs to give us input document number can be checked; common European rules for outsourc- where regulation needs to be revised to • The financial service provider has to ing institutions and service-providers. allow for innovative digital solutions. perform the online identification in a Meanwhile we are eager to see more entrepreneur has a single point of con- dedicated room with access control guidance on the use of outsourcing and tact at the FMA to clarify all necessary 3 Regulatory change: online and has to stop the procedure if either in particular cloud computing services aspects of his/her business model. video identification the customer or his/her ID or pass- from the European Banking Authority We are perceiving intensifying activ- Whilst the FMA is committed to enabling port cannot be sufficiently verified. (EBA) and the European Central Bank ity on the Austrian FinTech market: useful innovation, financial stability (ECB). EBA recently published a con- After being set up in October 2016, in and investor protection have to be 4 Open regulatory questions: sultation setting out its guidance for the the first six months of operation the ensured. A case where the FMA and outsourcing of activities use of cloud service providers by finan- contact point already evaluated 30 cases the Ministry of Finance successfully With regard to online video identifica- cial institutions5. involving questions or business models amended the regulatory requirements tion the FMA was able to act immedi- related to FinTechs and provided regu- to allow a very useful FinTech solution ately, because EU legislation was flexible 5 FinTechs are an international latory feedback. We have held talks in the best interest of financial service enough – in some areas like payment and European affair with about 40 FinTech stakeholders providers and their clients is online services Union law is already “fit for FinTechs are high on the agenda of from companies which do not hold a video identification. Due to require- FinTechs”. However, there are exam- several European fora since 2016: see license from the FMA and we are con- ments for the prevention of money ples where important regulatory ques- for example the European Supervisory stantly in touch with the Austrian Eco- laundering and terrorism financing the tions are still to be answered: The use Authorities’ report on automation in nomic Chambers (WKO) and other Austrian Banking Act1 stated that every of cloud computing services in banking financial advice6 and discussion paper FinTech-interest-groups. Furthermore, new costumer had to be identified while is treated as an outsourcing of activi- on big data7, the European Securities the FMA organises serial FinTech net- she or he is physically present. Having ties, but to date the relevant European and Markets Authority’s (ESMA) report work events to spread knowledge and to be physically present at a bank’s legal framework contains only very on the distributed ledger technology raise awareness about FinTechs and premises can be quite cumbersome and high level guidance for credit institu- applied to securities markets8 and the their regulatory and supervisory envi- difficult for some clients. To find a tions: The existing outsourcing frame- EBA discussion paper on innovative ronment. The FMA FinTech Contact solution, the FMA was mandated to work is limited to the requirements of uses of consumer data by financial insti- Point cooperates closely with the Aus- develop a legally sound approach to allow the CEBS-Guidelines on Outsourcing tutions9. To represent FMA’s positions, trian central bank – the Oesterreichische a digital form of identification while from 2006.4 As the Capital Require- our staff participates in the relevant Nationalbank (OeNB). this process is fully compliant with the We do not believe that providing provisions for the prevention of money 3 Verordnung der Finanzmarktaufsichtsbehörde (FMA) über die videogestützte Online-Identifikation von Kunden guidance about the current legal frame- laundering and terrorism financing.2 (Online-Identifikationsverordnung – Online-IDV), Austrian Federal Law Gazette II 5/2017. work is enough. This is why the FMA The FMA has taken immediate reg- 4 https://www.eba.europa.eu/documents/10180/104404/GL02OutsourcingGuidelines.pdf.pdf. has launched a “Call for Input” to detect ulatory action and has enacted the new 5 https://www.eba.europa.eu/documents/10180/1848359/Draft+Recommendation+on+outsourcing+to+Cloud +Service++%28EBA-CP-2017-06%29.pdf. 6 https://esas-joint-committee.europa.eu/Publications/Reports/EBA%20BS%202016%20422%20(JC%20

1 SC%20CPFI%20Final%20Report%20on%20automated%20advice%20tools).pdf. Bundesgesetz über das Bankwesen (Bankwesengesetz – BWG), Austrian Federal Law Gazette I 532/1993 as 7 amended. https://esas-joint-committee.europa.eu/Publications/Discussion%20Paper/jc-2016-86_discussion_paper_ 2 th big_data.pdf. This was made possible because of the new Directive (EU) 2015/849 (4 AMLD), which is implemented in Austria 8 by the Financial Markets Anti-Money Laundering Act (Bundesgesetz zur Verhinderung der Geldwäscherei und https://www.esma.europa.eu/sites/default/files/library/dlt_report_-_esma50-1121423017-285.pdf Terrorismusfinanzierung im Finanzmarkt), Austrian Federal Law Gazette I 118/2016. 9 https://www.eba.europa.eu/documents/10180/1455508/EBA-DP-2016-01+DP+on+innovative+uses+of+co nsumer+data+by+financial+institutions.pdf.

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European working groups dealing with pean Commission launched a consulta- FinTech matters in particular at the tion “Fintech: A more competitive and ECB, ESMA, EBA and the European innovative European financial sector”.10 Insurance and Occupational Pensions The focus of the Commission was to Authority (EIOPA). We want to be part promote a more competitive and inno- of the European effort to promote in- vative European financial sector through novation through FinTechs and to keep FinTechs and we fully share this goal. the right balance with regards to investor protection and financial stability. 6 Conclusion Many new FinTech-related initia- Like every innovation, FinTechs bring tives are coming up – in 2018 the trans- risks and opportunities, the FMA is position of the Payment Services Direc- committed to ensure that financial tive (EU) 2015/2366 (PSD2) and of the markets can seize those business oppor- Directive on security of network and tunities and provide safe and sound ser- information systems (EU) 2016/1148 vices to their customers. The FMA wants (NIS-Directive) concerning measures to enable innovative solutions through for a high common level of security of new FinTechs as well as through exist- network and information systems are ing financial service providers and at due. More initiatives are in the regulatory the same time to safeguard investor pipeline concerning for example anti- protection and financial stability, mak- money laundering and cybersecurity. ing FinTech a success story – for busi- In order to formulate a comprehensive nesses, regulators and especially the European policy on FinTechs the Euro- users of financial services.

10 https://ec.europa.eu/info/finance-consultations-2017-fintech_en.

148 OESTERREICHISCHE NATIONALBANK Erkki Liikanen Is the post-crisis financial system more resilient? Governor Suomen Pankki What remains to be done?

This summer, it will be 10 years since Let us recollect the key causes and the first phase of the global financial lessons of the financial crisis. They will crisis started in August 2007. help us appreciate the value for national I have looked through reports from economies of the regulatory reforms. early 2007. In April 2007, the Interna- tional Monetary Fund (IMF) reported 1 Causes and lessons of the global that “ favourable global economic prospects financial crisis: a synthesis continue to serve as a strong foundation for The causes of the financial crisis can be global financial stability”. However, the divided into three closely entangled cat- report did include a scenario analysis egories: 1) underlying macroeconomic concerning subprime mortgages and factors, 2) deficient monetary and mac- financial stability. roprudential policies in the years lead- When discussing risks to the global ing up to the crisis and 3) problems of economy in June 2007, the Bank for financial market development, regula- International Settlements (BIS) noted that tion and supervision. “at least four sets of concerns can be raised, even if our capacity to calculate both their First explanation: Underlying probability and possible interdependence macroeconomic factors remains limited.” Later on BIS has been A key macroeconomic factor behind commended for issuing risk reminders the crisis was the current account on a regular basis ahead of the crisis. imbalances, especially between the But overall, neither the world nor econ- United States and China. The abundant omists were in a crisis mode back then supply of external capital pushed U.S. as these examples show. long-term interest rates down. The global financial crisis has had a In the environment of falling yields, profound impact on a range of issues. pressure was put on developing new high- Financial market regulation has been yield investment instruments, including stepped up in the advanced economies. subprime loans, which also enjoyed politi- Economics as a science has engaged in cal momentum in the United States. some serious introspection. We recognise today that macroeconomic models should be designed so as to better cap- ture severe financial market disruptions and their consequences for the real economy. The financial crisis has served as a reminder of the great losses of economic growth suffered during severe financial market disruptions. The stable functioning of the financial system is a precondition for sustainable economic growth. This should be borne in mind now amid all the criticism over the regulatory reforms.

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Another macroeconomic factor under- to burst the U.S. housing market bubble? Moreover, the large Wall Street invest- occasionally sweeps the financial mar- lying the crisis was the time of the so According to Jan Tinbergen’s famous ment banks that had traditionally oper- kets. The euphoria was also fuelled by called “Great Moderation”. This was largely principle, a certain number of policy ated as partnerships were converted into the aforementioned, seemingly benign ascribed to modern monetary policy. targets requires an equal number of limited companies one after the other. macroeconomic environment that pre- Ever since the stock market crash of policy instruments. More research on the role of these vailed before the crisis. 1987, we had also become used to the The challenge was that monetary regulatory and structural changes in The overheating was also fuelled by central banks stepping in with liquidity policy had one tool to offer, but there the development of the financial crisis confidence in the ability and incentives injections, where necessary, to restore were two objectives to meet, i.e. price would still be welcome, but it is quite of the major financial institutions to stability on the markets. stability and financial stability. There likely that they increased risk taking. manage their risks. Although positive as such, these were no macroprudential tools in place As is now well-known, one of the I witnessed an historic debate on the developments came with the downside for ensuring financial stability. changes that took place in banking in matter in Jackson Hole in 2005, as the of a false sense of security and a lower Banking regulation tools were, in the pre-crisis decade was the increas- then Chief Economist of the IMF, Pro- awareness of risk. principle, available, but decision-making ingly widespread use of the “originate fessor Raghuram Rajan, questioned the was impaired by the fragmentation of and distribute” business model. faith in self- regulating financial markets. Second explanation: Non-existent the U.S. regulatory framework. Ben This was justified by more efficient Professor Rajan analysed three macroprudential policies and Bernanke, Greenspan’s successor, also diversification of credit risks of bank problems: front-loaded bonuses gave deficient monetary policies addresses this issue in his memoirs. loans. Unfortunately, it also broke the incentives for higher risk-taking, too The second explanation for the finan- As Finnish Parliamentarians met traditional link between borrower and much confidence was placed in risk di- cial crisis relates to the non-existent with Bernanke during his last week in lender, which led to a loosening of lend- versification, and it was believed that macroprudential policies but, in hind- office in Washington in January 2014, ing criteria. there would be an endless amount of li- sight, also to deficient monetary poli- we asked him what was surprising or This business model made use of quidity available. He concluded that cies in the years leading up to the crisis. new about this crisis. His answer was the so called “off-balance sheet chan- these developments have not made the U.S. monetary policy had been that they knew that speedy interest rate nel” which also had another motive: it global financial system safer; they have relaxed in response to the September 11 cuts had to be made and a strong eco- enabled lower capital requirements, made it even riskier. He was criticised attacks and other millennium shocks. nomic stimulus introduced. But they within the regulatory rules in force at strongly, even called a Luddite. History The accommodative stance of mone- had not anticipated the complexity of that time, even though risks had remained has proven Professor Rajan right. tary policy was sustained by concerns international financial institutions. virtually unchanged. Finally, there was the problem of over deflationary trends. Housing mar- Tim Geithner, the first Treasury Secre- “too-big-to-fail”: financial institutions kets showed signs of overheating, but Third explanation: Imbalances in tary in Barack Obama’s administration, that had become too large and com- when the series of interest rate hikes financial market developments argues in his memoirs that the key plex, with potentially excessive risk- began, this did not, in retrospect, seem The third explanation for the financial cause for the crisis was the business taking incentives. to be effective enough. crisis thus relates to the liberalisation of model applied by investment and com- What has been done to prevent the Should more determined measures the global financial system, and prob- mercial banks, a model which was a recurrence of the problems? of monetary policy have been adopted lems relating to financial innovations combination of a low level of equity and and regulation. very short-term market funding. 2 Major changes in financial The liberalisation of the global finan Regulation also allowed banks to regulation and supervision cial markets and deregulation intensi- use low-quality capital to fulfil part of At least four reforms in particular de- fied in the 1980s. This was partly a nat- the capital requirements, which did not serve closer attention. ural consequence of developments in provide a buffer against losses. This • First, banks’ loss-absorption capacity information technology and the man- turned out to be a key mistake. has been significantly strengthened. agement of financial risks. An underly- There is a broad consensus on • Second, banks’ ability to withstand ing factor was also the growing empha- Geithner’s views on both sides of the liquidity crises has also been strength- sis on the virtues of free markets in all Atlantic. But what were the underlying ened. The global financial crisis b egan areas of economic activity. factors that led to banks’ excessive lever as a liquidity crisis when banks lost At the end of the 1990s, the Glass- age and an increase in short- term mar- their confidence in one another. Steagall Act was repealed in the United ket funding? Banks have also been required to States. The Act had separated investment According to one explanation, this reduce the share of short-term fund- and commercial banking activities. was a case of the typical euphoria that ing in their funding profile.

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• Third, no bank can be regarded as As a result of the establishment of This is when macroprudential tools The regulatory reforms have been “too-big-to-fail” any more. Supervi- the Banking Union, today we have the need to be deployed. considerable, but time has also been sion and capital requirements have Single Supervisory Mechanism (SSM) The financial industry is also under- granted for adapting to them. Mean- been strengthened the most for banks that has the mandate to ensure rigorous going change. The boundaries between while, the low interest rate environ- that are systemically important. Au- and consistent supervision of cross-bor- banking and other corporate activity ment may have presented challenges for thorities have been granted new pow- der banks. At the same time, it draws are blurring. profitability of some banks, depending on ers to resolve banks efficiently. In on the local expertise of national finan- In addition, banks are being chal- the interest rate linkages of their assets relation to that, requirements on banks’ cial supervisors. Secondly, the common lenged by new market participants har- and the composition of their own funding. total loss absorbing capacity have crisis resolution framework aims to nessing the latest technology. Digitali- However, it is essential that banks’ been introduced, especially in the ensure coordinated and orderly restruc- sation will bring benefits. Benefits also profitability cannot any longer be based form of debt that can be “bailed-in”. turing of failing multinational banks. include new risks, some of which are on their own funding being supported • Fourth, the global financial crisis There is some evidence that implicit still hard to identify. by public safety nets, which enables demonstrated that price stability-ori- government guarantees have recently On the other hand, in recent years, high leverage and, through that channel, ented monetary policy and supervi- declined. This means that markets have be- international financial activity has also a seeming improvement in profitability. sion that controls individual financial gun to take governments’ goals seriously. become simpler in a sound way. A few Owners and investors need to be pre- institutions’ capital adequacy and risk- However, the third element of the examples: (i) Banks are engaged in pared for bearing the risks: both profits taking do not automatically safeguard Banking Union, the common deposit short-term securities trading to a lesser and losses. The new bank recovery and financial stability. Authorities needed guarantee scheme, is still incomplete. I extent than in earlier years. (ii) Many resolution legislation offers tools for a a stronger mandate to ensure the sta- will return to that at the end of the pre- large international financial conglomer- genuine transfer of risks to bank own- bility of the financial system as a whole. sentation. ates have streamlined and simplified ers and investors in bank debt markets. Identification of risks alone is insuffi- their structures. (iii) The use of com- This may lead to bank owners and cient to prevent financial crises. The 3 Outlook for the future risks are plex, artificial financial instruments investors requiring higher risk premia authorities also need macroprudential changing producing no real added value has in the future. There is, however, no tools to react to financial system imbal- Have the regulatory reforms been effec declined. (iv) The markets for financial return to times of ineffective regulation ances. Examples of these tools include tive? There are good reasons to believe derivatives are more transparent. and the practice of taxpayers ultimately counter-cyclical capital buffers and loan- that global financial system has become Many of these changes have gone a bearing the risks involved. to-value constraints. more stable and safer post-crisis. long way in the direction suggested in Even so, the risks threatening sta- the High-Level Expert Group’s report “Shadow banking” Banking Union strengthens bility are like constantly mutating viruses. on banks’ structural reform, but not all An important question in the assessment supervision and crisis resolution in They often become more virulent when the way. of post-crisis regulation is whether Europe reacting to medication developed for revised bank regulation drives banking Although the seeds of the global finan- earlier diseases. Too much of a good thing? and its risks increasingly to “shadow cial crisis were sown in the United Expressed in ice hockey terminol- The following question has also been banks”. These are businesses that offer States, many European countries seri- ogy, the challenge of financial market raised: have post-financial crisis regula- financial services and are engaged in ously suffered from the financial crisis supervision is ‘to skate in the direction tory reforms gone too far in the sense activities resembling banking, but are and from the euro area sovereign debt where the puck will go next, not where that they have become an impediment subject to more relaxed regulation. crisis that came to a head thereafter. it is now’. to economic growth? Shadow banks had a significant role Experiences from the financial cri- Central banks have in recent years A recent study argues that the to play in the build-up of the financial sis revealed that it was unsustainable to kept their policy rates at exceptionally recovery of bank stock valuations fol- crisis, as part of banks’ actual risks did have integrated European banking and low levels. Expansionary monetary pol- lowing the global financial crisis and not appear on their own balance sheets, financial markets, on one hand, but icy has been indispensable in a world the European sovereign debt crisis has being hidden as off-balance-sheet items. nationally fragmented banking supervi- slowly recovering from the crisis. been slow compared with previous cri- Various views on the management sion and crisis resolution, on the other. As a side effect, low interest rates ses (in spite of the recent development). of risks in the shadow banking sector If large financial institutions are engaged can increase incentives for risk-taking The study suggests that the reason for have been put forward since the crisis. in significant cross-border activities, their and feed the elevation of asset prices. this could be regulation.1 Significant regulation of shadow banks supervision and crisis resolution must Lending in some countries has begun to also be based on a broader framework. grow at a potentially excessive pace. 1 Chousakos, K. and G. Gorton. 2017. Bank Health Post-Crisis. Paper prepared for the Banque de France Financial Stability Review.

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has not been introduced so far. Instead, would accrue to small and concentrated banks’ links with the shadow banking banking systems with correlated bank- sector are regulated more effectively. ing risks among different actors. This helps transform shadow banking The European financial system is into “resilient market-based finance”2 highly bank-based with a relatively lim- that can stand on its own, and will not ited role for market-based financing. transmit excessive risks to the banking This structural feature adds to the fra- sector via either direct financial links gility of the European financial system. or the fire sales-induced balance sheet For this reason, it is also important to channel. implement the Capital Markets Union, In the United States, the Dodd- which complements the Banking Union. Frank legislation adopted following the There are already signs of a recovery financial crisis allows authorities to put in risk capital investments in Europe. It under supervision a shadow bank that is vital that we continue work to ensure has become a system-level threat. This that the expansion of promising new possibility does not exist in Europe for businesses do not face unnecessary bar- the time being. riers created by bottlenecks in financing. SUERF and Suomen Pankki organ- ise in September this year a conference 5 Concluding remarks on shadow banks; this provides a forum The financial regulation and market for discussing the theme more closely. infrastructure reform agenda, initiated by G20 in the aftermath of the financial 4 Finalising the Banking Union crisis has been a great achievement. We A key remaining task for Europe is must not let regulatory “fatigue” bring finalising the Banking Union. As I it to a premature end. I share the view already discussed above, two pillars of of Mario Draghi from January when he the Banking Union, single banking emphasized commitment to the com- supervision and the bank recovery and pletion of Basel III, in his capacity as resolution framework, have largely been the chairman of The Group of Central implemented, but the third, single Bank Governors and Heads of Supervi- deposit protection, is unfinished. sion.4 At the same time, we need to be A single deposit guarantee scheme clear, to the extent possible, as regards has been a controversial issue, but I what remains to be done, in order to share the view that an insurance-type facilitate existing and new financial deposit protection implemented in an institutions’ planning for their future appropriate manner is a consistent ele- investments. ment of Banking Union.3 Most benefit I thank you for your attention.

2 See M. Carney. 2017. What a difference a decade makes. Bank of England speech. 3 See e. g. the report by a working group chaired by Dr. Antti Suvanto. Improving the resilience of Europe’s Economic and Monetary Union. Ministry of Finance Publications – 37b/2015. Finland. 4 Finalising Basel III reforms, Press release 3 January 2017. Basel Committee on Banking Supervision. www.bis. org/press/p170103.htm.

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Thomas Drozda head of the Foreign Research Division Thomas Drozda was sworn in as Federal of the Oesterreichische Nationalbank, Minister by President Heinz Fischer on and from 1995 to 1997, as an econo- 18th May 2016. He took office as Fed- mist in the Secretariat of the Foreign- eral Minister for Arts and Culture, Exchange Policy Sub-Committee at the Constitution and Media on 25 May European Monetary Institute (a fore- 2016. Born in 1965, Mr. Drozda earned runner of the European Central Bank). a degree in business administration and He is a former national expert in the economics from the University of Linz. Directorate General for Monetary and After completing his studies, he worked Financial Affairs at the European Com- as a general manager at „Trotzdem“, mission in Brussels, and a former invest the publishing house of the Austrian ment fund manager at Genossenschaft Socialist Youth organisation in Vienna; liche Zentralbank in Vienna. Ernest Gnan shortly thereafter, he worked in the received a master’s degree in commer- Economic Studies Division at the Aus- cial sciences and a Ph. D. in Economics trian central bank (Oesterreichische at the University of Economics and Busi Nationalbank). In 1993, Mr. Drozda ness Administration in Vienna. became an economic policy advisor in Federal Chancellor Franz Vranitzky’s Nikolaus Hautsch cabinet, where he was responsible for Nikolaus Hautsch is Professor of Finance budgetary, fiscal, social, youth and and Statistics at the Faculty of Business, family affairs; from 1996 onward, Mr. Economics and Statistics at the Univer- Drozda’s remit was expanded to include sity of Vienna. He was educated at the the field of arts and culture. From 1997 University of Konstanz (Master of Eco- to 1998, he continued his career as an nomics in 1998) where he also earned economic and cultural policy advisor to his Ph. D. (summa cum laude) in 2003. Federal Chancellor Viktor Klima. Mr. After several years of professional expe- Drozda went on to serve as the business rience as assistant professor and associate manager at Vienna’s Burgtheater from professor at the University of Copenha- 1998 to 2008, and from 2007 to 2014 gen, he became Professor of Economet- he was also a member of the Board of rics at Humboldt University in Berlin the Austrian Broadcasting Corporation from 2007 to 2013. Among other pro- (ORF) Foundation. In 2008, he became fessional activities, he served as Vice the Chief Executive Officer at V ereinigte Director of the Center of Applied Bühnen Wien, which operates three Statistics and Economics at Humboldt prominent theatre venues in Vienna. University and as Director of the Berlin Doctoral Program in Economics and Ernest Gnan Management Science. Mr. Hautsch is Ernest Gnan has been Head of the Eco- an honored Elected Fellow of the Soci- nomic Analysis Division of the Oester- ety for Financial Econometrics and reichische Nationalbank in Vienna since received the Dornier dissertation 1999. He is a member of the European research prize in 2004. His research Central Bank’s Monetary Policy Com- interest include among others financial mittee, and is also an adjunct professor econometrics and empirical finance at Webster University in Vienna, teach- including high-frequency finance. Pro- ing courses on economic analysis. Dur- fessor Hautsch is married and has two ing 1998, Ernest Gnan served as deputy children.

44th ECONOMICS CONFERENCE 2017 159 Contributors Contributors

Andreas Ittner ing the banking risk practice and then John Kay Michael taught economics at Stanford Andreas Ittner was appointed Vice later financial regulatory advice. She John Anderson Kay (born 1948) is a University from 1998 to 2004. He worked Governor of the Oesterreichische leads projects with the major banks British economist. Kay was educated at in corporate banking for Barclays Bank Nationalbank (OeNB) on July 11, 2013, globally on all the risk types as well as the Royal High School, Edinburgh Uni- from 1988 to 1993. His work has been and is responsible for the Executive Basel III and stress testing. She is also versity, and Nuffield College, Oxford. published by AER, JME, AEJ Macro, Directorate Financial Stability, Bank- increasingly involved in risk governance He is a visiting Professor of Economics JIE, JEDC, JMCB, EER and the Jour- ing Supervision and Statistics. Ittner issues including developing an approach at the London School of Economics and nal of Macroeconomics, among others. joined the OeNB in 1983. He was a to setting and embedding risk appetite has been a fellow of St John’s College, Dr. Kumhof is a citizen of Germany. member of the OeNB’s Governing Board and risk culture. Prior to this, she was Oxford, since 1970. After ten years as from September 2008 prior to his ap- the Head of the Financial Industry and a tutorial fellow in economics, he es- Klaus Kumpfmüller pointment to the post of Vice Governor. Regulation Division in the Bank of Eng- tablished the independent think tank, Klaus Kumpfmüller was born in Schärd- In his capacity as Vice Governor, Ittner land and represented the UK on the the Institute for Fiscal Studies. In 1986, ing, Upper Austria, on 29 November is the accompanying person of the Gov- Basel Committee for Banking Supervi- he became a Professor at the London 1969. He graduated in Business Admi ernor at meetings of the Governing sion for 7 years, leading the global QIS Business School and founded London nistration from the Vienna University Council of the European Central Bank studies and calibration of Basel II. She is Economics, a consultancy firm. He was of Economics and Business Administra- (ECB). In addition, Ittner holds numer- a Trustee of CEPR and on the Council the first director of Oxford’s Said Busi- tion and the Johannes Kepler Univer- ous national and international functions of SUERF. She is also an Adjunct Pro- ness School from 1997 to 1999. Mr. sity in Linz. From 1994 to 1995 he was related to banking supervision, e.g. in fessor at Imperial College. Ms. Jackson Kay has served as a director of Halifax a cabinet staff member of the State Sec- the General Board of the European Sys- has published a wide range of papers on plc and of several investment compa- retary at the Federal Ministry of Eco- temic Risk Board (ESRB), the Board of market and credit risk and bank capital. nies. In 2012, he presented a substantial nomic Affairs. He then changed to Supervisors of the European Banking She edited a book on Risk Culture and report to the British government on re- Raiffeisenlandesbank Oberösterreich AG Authority (EBA) and in the Supervi- Effective Risk Governance published form of the equity market. Kay was ap- in 1995, where he worked as Key sory Board of the Austrian Financial by Risk Books September 2014. pointed Commander of the Order of Account Manager for institutional cus- Market Authority (FMA). Previous posi- the British Empire (CBE) in the 2014 tomers. In 2002, he changed to HYPO tions at the OeNB include that of Clemens Jobst New Year Honours for services to eco- Oberösterreich to become Director of Director of the Financial Stability and Clemens Jobst is a Lead Economist at the nomics. Kay has also served as a mem- Key Account Services and, additionally, Bank Inspections Department. Oesterreichische Nationalbank (OeNB) ber of the Council of Economic Advis- Managing Director for several of the and Research Affiliate at CEPR London. ers to the First Minister of Scotland bank’s holding companies. In 2011, he After under-graduate studies at the from 2007 to 2011. became a Member of the Management University of Vienna and the University Board at the Austrian Federal Financ- of Illinois at Urbana-Champaign, he Michael Kumhof ing Agency (OeBFA), a position he held earned a doctorate at Sciences Po Paris Michael Kumhof is Senior Research until he joined the FMA. In 2013, the in 2007. He joined the OeNB as an eco Advisor in the Research Hub of the Federal President appointed Klaus nomist in 2007 and serves also as lec- Bank of England. He is responsible for Kumpfmüller as new member of FMA turer for monetary history at the Uni- co-leading this new unit, and for h elping Executive Board of the Financial Market versity of Vienna. His research interests to formulate and carry out key parts of Authority FMA for a term of office of include monetary policy implementation, its research agenda. His previous posi- five years. Klaus Kumpfmüller is mem- both past and present, and the history tion was Deputy Division Chief, Eco- ber of the Board of Supervisors and of central banking. His research has been nomic Modelling Division, IMF, where member of the Management Board of published in the Cambridge Journal of his responsibilities included the devel- the European Securities and Markets Regions, Economy and Societies, the opment of the IMF’s global DSGE sim- Authority (ESMA). Patricia Jackson Economic Journal, the European Review ulation model. His main research inter- Ms. Jackson is a Non-Executive Direc- of Economic History and the Journal of ests are the quantitative evaluation of Erkki Liikanen tor of the digital challenger bank Atom Economic History among others. In monetary reform proposals, modelling Mr. Erkki Liikanen MPolSc. (Econ.) and chairs the risk committee. She is 2016, he published a history volume of the role of banks in the macroeconomy, has been Governor of the Bank of also a Senior Adviser at EY and a member the Austrian central bank from its foun- the role of economic inequality in caus- Finland since 2004. He is currently of the global regulatory network. Patricia dation to the present day, which he has ing imbalances and crises, and the mac- serving his second 7-year term. Mr. joined EY in 2004 as the Partner lead- jointly authored with Hans Kernbauer. roeconomic effects of fossil fuel depletion. Liikanen, a former EU Commissioner,

160 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 161 Contributors Contributors

Ambassador and Minister of Finance is Finance, Peter Mooslechner held a Nowotny served on the supervisory one of the longest serving members of research position at the Austrian Insti- boards of several banks and corpora- the Governing Council of the Euro- tute of Economic Research (WIFO) tions and was a member of the OeNB’s pean Central Bank. He is Chairman of from 1981 to 1996, exploring currency-, General Council from 2007 to 2008. the ECB Audit Committee with a man- balance of payments- and money and Ewald Nowotny was born in Vienna, date to enhance the corporate gover- credit-related topics. In 1996, he joined Austria, in 1944. He studied law and nance of the ECB and the Eurosystem. the OeNB as Head of the OeNB’s Eco- political science at the University of He is also Governor of the International nomic Analysis Division. In 1999, he Vienna and economics at the Institute Monetary Fund for Finland. In 2012, was promoted to Director of the Eco- for Advanced Studies (IHS) in Vienna. Mr. Liikanen chaired a High-level Expert nomic Analysis and Research Depart- In 1967, he received his doctorate in law Group proposing structural reforms to ment. Peter Mooslechner represents from the University of Vienna. He served the EU banking sector. At the Euro- the OeNB in numerous national and in- as a professor at the University of Linz pean Commission, Mr. Liikanen was ternational bodies (e.g. on the Board of and at the Vienna University of Economics responsible for Enterprise and Informa- the Austrian Economic Association and Business, where he was also Vice- tion Society and earlier for Budget, (NOeG) and in the International Rela- Rector for Financial Affairs. Ewald (GSA), IG Immobilien Invest GmbH (IG) Personnel and Administration. In all, tions Committee (IRC) of the ECB). Nowotny was Vice President of the Aus- and Betriebs-Liegenschafts-Management Mr. Liikanen was a member of the Peter Mooslechner has taught econom- trian Economic Association and is a Mem- GmbH (BLM). European Commission for almost ten ics at a number of Austrian universities ber of the University Board of the Vienna years. In the early 1990s, Mr. Liikanen (Linz, Innsbruck, Salzburg and Vienna University of Economics and Business. Thomas Puschmann was head of the Finnish Mission to the University of Economics and Business) Mr. Puschmann is Head of Swiss Fin- European Union. Before commencing and has published extensively on a Kurt Pribil Tech Innovation Lab at the University his international career, Mr. Liikanen broad spectrum of economic policy is- Kurt Pribil was born in Vienna in 1957. of Zurich. The Swiss FinTech Innova- was Minister of Finance for Finland. sues. His recent research has dealt with He has been a Member of the Governing tion Lab is a cross-disciplinary research Mr. Liikanen is so far the youngest per- microeconomic aspects of household Board of the Oesterreichische National program on the global phenomenon of son ever to become a member of the wealth and debt, economic policy dur- bank (OeNB) since July 11, 2013. He innovation in the financial industry Finnish Parliament, starting his parlia- ing the financial crisis and monetary studied business administration at the induced by Financial Technology. The mentary career in 1971 at the age of 21. and exchange rate policy in Eastern and Vienna University of Economics and lab’s goal is to conduct research on the Mr. Liikanen is an economist by train- Southeastern Europe. Business and received a Ph. D. in 1983. topic of digitization in the financial ser- ing. He holds a master degree in Politi- In 1982, Pribil started his career in the vices industry together with participants cal Science (Economics) from the Ewald Nowotny OeNB’s International Division; from from the whole value chain, including University of Helsinki. He also holds Ewald Nowotny is the Governor of the 1988 to 1991, he acted as the OeNB’s banks, insurers, providers, regulators, honorary doctorates from the Univer- Oesterreichische Nationalbank (OeNB) representative in Brussels. From 1991 and various other organizations and sity of Technology, Finland (2003) and and a Member of the Governing Council to 1999, he served as economic adviser associations from the FinTech ecosys- Aalto University School of Economics, of the European Central Bank (ECB). to Wolfgang Schüssel during the lat- tem. Dr. Puschmann is also a visiting Finland (2011). Mr. Liikanen is mar- Before taking on his current position in ter’s terms as Federal Minister for Eco- scholar at the Massachusetts Institute of ried to Hanna-Liisa Liikanen Ph.D. September 2008, Ewald Nowotny held nomic Affairs and Vice Chancellor. Technology in Cambridge, USA. Previ- They have two daughters. a number of high-level positions in Shortly upon his return to the OeNB, ously, he was a member of the board of financial institutions. He was CEO of Kurt Pribil became Head of the For- ESPRIT Consulting and The Informa- Peter Mooslechner the Austrian BAWAG P.S.K. banking eign Research Division, a position he tion Management Group. Peter Mooslechner became a Member group from 2006 to 2007, served as held until 2001. He then joined the of the Governing Board of the Oester- Vice-President and Member of the Austrian Financial Market Authority Doris Ritzberger-Grünwald reichische Nationalbank on May 1, 2013. Management Committee of the Euro- (FMA) as member of the FMA Execu- Doris Ritzberger-Grünwald was born Born in Bruck an der Glocknerstraße pean Investment Bank (EIB) in Luxem- tive Board. Since 2013, Mr. Pribil has in Vienna (Austria) in 1961. She obtained (Salzburg) in 1954, he studied econom- bourg from 1999 to 2003, and, between chaired the supervisory boards of Casi- her Master’s degree in social and eco- ics at the Johannes Kepler University 1971 and 1979, was first a Member and nos Austria AG (CASAG), Oesterreich nomic sciences from the University of Linz (JKU), where he also received his then President of the Governing Board of ische Banknoten- und Sicherheitsdruck Vienna in 1985, completed the Pro- doctoral degree in 1981. After having Österreichische Postsparkasse (P.S.K.). GmbH (OeBS), Münze Österreich AG gram in Economics at the Institute for worked at the JKU’s Institute of Public Moreover, from 1992 to 2008, Ewald (MÖAG), Geldservice Austria GmbH Advanced Studies (IAS) in Vienna in

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Hans-Jörg Schelling of the London School of Economics in member of the steering committee of Hans Jörg Schelling is an Austrian entre- 2004. His research interests are bank- the G20 Financial Stability Board, and preneur and politician (ÖVP) and took ing regulation and systemic risk, finan- chaired its Committee on the Resolu- office as Minister of Finance of the Repub- cial stability and financial economics. tion of Cross-Border Banks. He is a lic of Austria on September 1, 2014. Af- Senior Fellow at Harvard Business ter graduation of the State Secondary Helmut Stix School (HBS) and a former Senior Fel- School in Feldkirch in 1972, he studied Helmut Stix is research economist at low at the Mossavar-Rahmani Center Business Administration at the Univer- the Oesterreichische Nationalbank. His for Business and Government at Har- sity of Linz, finishing his studies with a current research focuses on households’ vard Kennedy School. In 2014, Tucker doctoral degree in 1982. In 1981, Hans reaction to financial crises, as well as was granted a knighthood for his ser- Jörg Schelling started his professional on cash demand and payment innova- vices to central banking. In addition to career as assistant of the management tions. He has published in academic his work at Harvard, he currently of Leiner/Kika Group, becoming Man- journals on topics like consumer cash serves as a director at Swiss Re, a lead- aging Director in 1988. In addition, usage across countries, why people save ing global re-insurer, and was recently 1987 and obtained her Doctoral degree Mr. Schelling founded the Independent in cash, the choice and use of payment elected to the board of the Financial in social and economic sciences from Management Consultant Schelling instruments, trust in banks during nor- Services Volunteers Corps (FSVC). the University of Vienna in 1991. Fol- GesmbH that he managed until 2014. mal and crises times, the determinants lowing a period as research assistant at In 1992, he took over the management of financial dollarization, and inflation François Velde the IAS from 1987 to August 1988, she of XXXLutz GmbH. After a restruc- perceptions. He studied at the Univer- François Velde is a senior economist joined the Oesterreichische National- turing of the company, he became sity of Vienna, from where he received and research advisor in the economic bank in 1988, where she started as an Member of the Supervisory Board in his doctorate, and at the Institute for research department at the Federal economist in the Economic Analysis 2005. Amongst others, Mr. Schelling Advanced Studies (IHS, Vienna), where Reserve Bank of Chicago. Velde’s pri- Division and then moved to the Foreign was Managing Shareholder of the Big he completed a postgraduate program mary research on monetary history and Research Division. After an interim Deal Marken und Marketingberatungs in economics. From 1996 to 1999, he monetary theory has been published in position as assistant to a Member of the gesmbH (1999–2014) and Managing worked as a “Universitätsassistent” (assis numerous journals. His research topics Governing Board she returned to the Director, XLA GmbH Wels. Before be- tant professor) at the Department of Eco- include medieval currency debase- Foreign Research Division as special coming Minister of Finance, Hans Jörg nomics at the University of Vienna. In ments, the monetary history of the adviser, to be promoted in 2000 to the Schelling held several public positions 1999, he joined the Economics Studies United States, dollarization in Argen- post of Deputy Head of Division. From e. g. Vice President of the Austrian Fed- Division of the Oesterreichische National tina and the macroeconomics of the June 2002 to April 2013, she served as eral Economic Chamber, Member of the bank. He was research visitor at the French revolution. In 2002, Velde and Head of the Foreign Research Division. Austrian National Council, Chairman Department of Political Science at the Thomas Sargent co-authored the book In May 2013, she was appointed as the of the Managing Board of the Main University of Minnesota and at the Bank The Big Problem of Small Change OeNB’s chief economist (Director of Association of Austrian Social Security of Finland. (Princeton University Press), which the Economic Analysis and Research Institutions, Chairman of the Supervi- studies how monetary systems in West- Department). Her fields of policy-ori- sory Board of Volksbank AG, Chair- Sir Paul Tucker ern European economies evolved in ented research include monetary policy, man of the Supervisory Board of the Sir Paul Tucker joined The Systemic response to recurring shortages and economic growth, convergence issues, Austrian Social Security Pension Fund. Risk Council as Chair in December depreciation of small change. Prior to inflation, the enlargement of the Euro- 2015. He previously served as Deputy joining the Chicago Fed as an econo- pean Union and the European Monetary Martin Summer Governor at the Bank of England mist in 1997, Velde was an assistant Union, with a special focus on Central, Martin Summer is Head of the Eco- (2009–2013) and as a member of the professor of economics at Johns Hopkins Eastern and Southeastern European nomic Studies Division at the Oester- G20 Financial Stability Board’s Steer- University. He is currently a visiting Countries. She is a member of the Mon- reichische Nationalbank (OeNB). Before ing Group. During his time at the Bank lecturer at the University of Chicago. etary Policy Committee of the European joining the OeNB in 2000, he worked of England, Tucker was a member of Velde earned an undergraduate degree Central Bank and an Executive Board as a lecturer at the University of Vienna, the bank’s Monetary Policy Commit- at the École Polytechnique in France Member of the Joint Vienna Institute. the University of Birmingham and the tee, Financial Policy Committee (vice and a Ph. D. in economics at Stanford University of Regensburg. He also worked chair), Prudential Regulatory Author- University. as a visiting researcher at the Bank of ity Board (vice chair), and Court of England and the Financial Markets Group Directors. Internationally, he was a

164 OESTERREICHISCHE NATIONALBANK 44th ECONOMICS CONFERENCE 2017 165 Contributors

David Yermack areas include boards of directors, exec- David L. Yermack is the Albert Fingerhut utive compensation, and corporate fi- Professor of Finance and Business Trans nance. Professor Yermack has published formation at New York University Stern more than 25 articles in leading academic School of Business. He serves as Chair- journals in finance, accounting, econom- man of the Finance Department and ics, and law. He is a Faculty Research Director of the NYU Pollack Center Associate of the National Bureau of for Law and Business. Professor Yermack Economic Research and has been a teaches joint MBA – Law School Visiting Scholar at the U.S. Federal courses in Restructuring Firms & Indus- Reserve Bank. Professor Yermack re- tries and Bitcoin & Cryptocurrencies, ceived his Bachelor of Arts in Economics as well as Ph. D. research courses in (1985), Master of Business Administra- corporate governance, executive com- tion (1991), Juris Doctor (1991), Master pensation, and distress and restructuring. of Arts in Business Economics (1993) and Professor Yermack has been with NYU Doctor of Philosophy in Business Eco- Stern since 1994. His primary research nomics (1994) from Harvard University.

166 OESTERREICHISCHE NATIONALBANK The Economics Conference hosted by the OeNB is an international platform for exchanging views on monetary and economic policy as well as financial market issues. It convenes central bank representatives, economic policy decision makers, financial market players, academics and researchers.

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