Seppo Honkapohja Bank of Finland - bi.go.id · Bank of Finland Innovation in Retail Payments and...

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Bank of Finland

Innovation in Retail Payments and Its Impact on a Country's Economic Growth and Financial Stability

Presentation in Bank Indonesia Seminar and Workshop 13 November 2017

113.11.2017

Seppo Honkapohja

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Agenda

1. Effects of innovation at the level of whole economy

The big picture: Digitalisation, technological change, productivity, and well-being in the long run

Optimists and pessimists: how will digitalisation impact the economy and society as a whole

Widening use of digital technology and new opportunities

2. Effects of innovation in financial markets

The financial system and economic performance Payment systems and economic well-being Innovations in financial services and financial stability

3. Evolution of payment systems

Main drivers and trends: consumer expectations, fragmentation of the markets, real-time payments, “embedded payments”

Assessing the change: European situation (PSD2, PAD)

4. Conclusions and policy considerations Key areas and challenges for policy makers

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1. Effects of innovation at the level of whole economy

1.1 Long-term trends


Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted13.11.2017 Seppo Honkapohja 4

Why has our standard of living improved so much over last 150 year?

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted13.11.2017 Seppo Honkapohja 5


The rise in the standard of living 1860−2010



Labour productivity growth and improvement of living standard in Finland in 1860−2015



Technological development evident as waves of productivity growth



1.2 Debate about digitalization



What is digitalization? Digitization:

To convert, store, transfer, and process information in a format understood by computers

– Binary data– Digital information can be music, movies,

documents, maps, observational data etc.

Digitalization:Widespread economic and social transformation made possible by the development of information and communication technology

– A change that is visible in all sectors of the economy– Automation, robotization, digital platforms, artificial intelligence,

industrial internet, internet of things, digital government etc.

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Will digitalization cause a new wave of productivity growth which matches the previous technological revolutions?

Pessimists Computers are seen everywhere

except productivity statistics(Robert Solow)

Development has been limited to entertainment and communication(Robert Gordon)

The low-hanging fruits have already been picked (Tyler Cowen)

We’ve been waiting for accelerated growth for a long time now

Economic headwinds will dampen growth despite technological progress (Robert Gordon)

Optimists We ain’t seen nothin’ yet (Joel Mokyr) The second machine age

(Erik Brynjolfsson & Andrew McAfee) We tend to overestimate the effect of a

technology in the short run and underestimate the effect in the long run (Ray Amara)

The same pessimist arguments were made before the previous technological revolutions

The statistics do not tell all The rate of new innovations has not

slowed down



Prices of ICT equipment and services have fallen exponentially



Prevalence of ICT equipment and connections in households



Mobile data transfer volume in Finland, 2007−2016


Currently almost 10 times more data is transferred in one day than in year

2007 as a whole


Technological development, economic growth and the road ahead

1. Productivity growth derived from technological development is the main driver of improving living standards in the long run.

2. The future impact of digitalization on economic growth is uncertain, but signs of its potential are already clearly visible.

3. Digitalisation is bound to transform industries based information processing and communication − such as finance and payments.



2. Effects of innovation in financial markets

2.1 Financial systems and economic performance



Financial systems and economic performance

Source: Hartmann et al. (2007) “The role of financial markets and innovation in productivity and growth in Europe“13.11.2017 Seppo Honkapohja


Impact of finance on economic growth (1)

Question: Can there be too much finance?

Source: Cournède, B. and O. Denk (2015), “Finance and economic growth in OECD and G20 countries”, OECD Economics Department Working Papers, No. 1223, OECD Publishing, Paris.



Impact of finance on economic growth (2)

Other views also exist: For example, Durusu-Ciftci, Ispir & Yetkiner (2017)

find that by fostering the development of a country’s financial sector, economic growth will be accelerated. Journal of Policy Modelling, Vol. 39, Issue 2. (http://www.sciencedirect.com/science/article/pii/S0161893816300631)

For financial innovation both “bright and dark sides” exist: For a recent review on innovation-growth view and

innovation-fragility view, see e.g. Beck, Chen, Lin & Song (2016) “The bright and the dark sides” Journal of Banking and Finance, Volume 72, November 2016 (http://www.sciencedirect.com/science/article/pii/S0378426616301133)


http://www.sciencedirect.com/science/article/pii/S0161893816300631

http://www.sciencedirect.com/science/article/pii/S0378426616301133


2.2 Payment systems and economic well-being



On the relationship between retail payments development and economic performance


Source: “Efficient retail payments: An untapped source for reviving growth in Europe?”, Iftekhar Hasan & Tuomas Takalo, VoxEU, 24 January 2014


Some studies on payment systems and economic growth

DeRenzis et al (2012 & 2013): – Electronic payment instruments have overall a positive impact on

economic development

Tee and Ong (2016):– The impact of adopting cashless payment on economic growth

can only be significantly observed in the long run

Zandi et al. (2017):– Increasing use of electronic payments boosts consumption and

GDP, and the impact increases as penetration rises. Effect on the global level is 0,1% of GDP.

Ilyes & Varga (2016): – Utilise a DSGE model to study impacts on the performance of the

Hungarian economy if retail cash payments were substituted with card payments. Results show both positive indirect and direct effects.



2.3 Innovations in financial services and financial stability



Financial services and Fintech

Use of advanced technologies by financial services firms is not a new phenomenon:– Internal technological solutions to service provision and to

compliance with regulatory obligations.– Also outsourcing with external service providers has existed for

long time.

But the rise of FinTech is a recent phenomenon. It has led to

– Increased technological, especially IT, investments– Appearance of a whole array of different firms:

Incumbents specialized start-ups and global telecom/technology companies (“GAFAA”: Google,

Apple, Facebook, Amazon and Alibaba”).



FinTech: Opportunities and challenges for central banks and regulators

Opportunities: Financial inclusion; more people gain access to

financial services. More competition; leads to lower prices and better

services. More efficient processes and financial intermediation.Challenges: Financial stability Banking supervision Payment systems Transmission of monetary policy



Overview about regulation of FinTechactivities in Europe

Public authorities in the EU are investigating the impact of FinTech.– Impact of FinTech on the financial system and – on its the regulation and supervision thereof.

Recent European Banking Authority (EBA) survey of financial services, innovations by FinTech firms and their regulation. – See next slide

Significant percentage of services provision is not regulated.– Regulation practices are likely to vary from country to country.

However, stability problems with FinTech have not risen thus far.– Rapid growth of FinTech => Important to remain alert



European Fintech activity


Source: EBA (https://www.eba.europa.eu/-/eba-publishes-a-discussion-paper-on-its-approach-to-fintech)


3. Evolution of payment systems

3.1 General features



Payments play an important role in innovations in financial services



Main driver in retail payment developments: consumer expectations

In payments, there is a movement towards a 24/7 world.

Consumers expect instantaneous transactions as well as easy and handy payment applications.

These are not isolated trends but a paradigm shift in consumer behavior.

Consumers compare financial services to other services and expect the same usability and customer experience.



An example of one major driving force: mobile device penetration


Mobile devices play a growing role in the supply of financial services

Source: World Bank


Three trends in payment markets

1. Payment landscape has become fragmented.

2. Payments are becoming instant / real-time.

3. Payments are becoming embedded into the service.



Trend (1): Payment landscape has become fragmented

Several new payment applications Several new actors in the customer interface Open interfaces enable ecosystems to evolve


Source: Edgar, Dunn & Company


Trend (2): Payments are becoming instant / real-time

The world moving towards 24/7 services

Also in (retail) payments pressure to move from traditional t+1 towards “real-time” is growing

In some countries (e.g. UK, SE, DK, FI, PL, SG, MEX, etc.) national instant payment systems exist

In Europe, pan-European instant payment systems are being built



Trend (3): Payments are becoming embedded into the service

Payments become integrated into the buying process, game, social media or other user experience.

Payment details are submitted only once, but transactions can happen frequently.

Consumer is not necessarily aware of making payments. Makes individual financial management more demanding – there is

a need for better financial literacy.



A contrasting case: cross-border payments (1)

The area of cross-border (c-b) payments is ripe for major change.

c-b payments still feature long-chains of operations and multiple intermediaries. [See Figure in next slide]– Account-based systems with capturing, messaging, two-legged

settlement, and disbursement. These are handled by multiple intermediaries.

Transfers are costly, cumbersome and opaque.– Personal example: I had to cash a cheque from US.

It took at least five days and transaction cost was significant (about 9%).

– Operations involve substantial fixed and sunk costs as well as network effects. There can be market concentrations.



Contrasting case: cross-border payments (2)



On c-b payment innovations

Innovations are creating new and more efficient methods for making intra-country payments.

– DLT can in principle be used in different ways.– So far, the potential gains are ”can/would be”.

One area is speed, transparency and end-to-end tracking of c-b payments.

Costs of compliance can be reduced through KYC and digital identity procedures to share customer information.

– Privacy and security issues can arise.

New techniques like DLT can lead to new means of payment.

– E.g. hub-and-spoke payments network with digital wallets of virtual currencies. [See Figure in next slide]

– Possible concerns: erratic valuation of currencies, lack of trust, operability issues.



On Payment Innovations: virtual transactions


Fiat Money

Means of Exchange

Private Virtual Currencies

HUB SPOKESSPOKES

Digital Wallets

Means of Exchange

Fiat Money

VIRTUAL TRANSACTIONS

Hub-and-Spoke Network, Source: IMF (2017)

Digital Wallets


The Single Euro Payments Area (SEPA)as an example facilitating cross-border payments


Source: ECB; http://www.ecb.europa.eu/paym/retpaym/html/index.en.html

http://www.ecb.europa.eu/paym/retpaym/html/index.en.html


European regulation in the retail payments is evolving: Payment Services Directive (PSD2)

EU legislation for regulating payment services and payments service providers in Europe, has been part of national legislation since 2009.

PSD2 is an update to the directive and has to be implemented into national legislation by 13.1.2018.

PSD2 will enable bank customers to use third-party providersto access their payment accounts and to initiate payments on their behalf.

Banks are obliged to provide access to accounts to third-party providers through APIs.

– This allows third parties to develop their own services on top of the infrastructure and data owned by banks.

Through this legislation, the EU aims to increase innovation, improve consumer protection, and improve the security of payments.



On the potential effects of Payment Service Directive 2

Payment Services Directive 2 (PSD2) is not only about payments.

PSD2 forces banks to open their payment infrastructure to all third-party providers.

– Customers are free to choose.

For banks, payments are the most frequent touchpoint to their customers.

– losing this interaction would mean that banks risk fading into background.

Payments also provide data which can be used to analyze customer behavior

– Identifying profitable customer segments– Analyzing credit risk– Creating cross-selling opportunities

Also Payment Account Directive (PAD) 2014:– Basic banking services for everyone.



4. Conclusions and policy considerations



Conclusions and policy considerations (1)

Fintech has the potential to shape the financial industry.

– Startups and big IT-firms are entering the financial markets to compete with incumbents

Retail payments are an area where the new products and players have already entered.

– In Europe, the regulatory framework (e.g. PSD2) is also facilitating change in the playing field.

=> The supply side of financial services is changing

In this changing environment, authorities should focus to preserve security and reliability of financial services. => trust will remain the necessary precondition for financial services also in the future.



Conclusions and policy considerations (2)

Key focus areas for authorities: Competition

– Increased competition in services but further consolidation of financial infrastructures are to be expected.

Resilience– Digitalization holds promise of better resilience through

decentralization but can also lead to increased vulnerabilities

Integrity– Protection of sensitive customer data and legitimate privacy

Access and inclusivity– Certain financial services must be regarded as necessities



Thank you!


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