When: 3 December 2019
Where: Paris
Chair of the Trustees Erkki Liikanen delivered a keynote speech at L’Agefi’s 10th Meeting of the Financial Industry in which he tackled the question of whether big tech is a threat to financial stability.
Thank you for your invitation. Can I start with a special remark? Next Tuesday the Nobel ceremony will be held in Stockholm. The Nobel Memorial Prize will be given to Abhijit Banerjee, Esther Duflo and Michael Kremer. Esther Duflo is the youngest ever and only the second woman to become Nobel Laureate in Economics.
The news came while I was flying to New York in October for the IFRS Foundation Trustees meeting. So, I Googled to learn that Banerjee and Duflo are coming out with a book called Good Economics for Hard Times. I ordered it.
At dinner in New York we noted that this is the second Nobel for French economists in five years. Jean Tirole got his well-deserved Nobel in 2014.
But this is not all. Two years later, Tirole wrote Économie du bien commun, which in 2017 was translated into English as Economics for the Common Good. Tirole writes that he was inspired by people: After he received the prize, people on the street regularly asked him about the nature of economic research and what it contributes to our well-being. In the book, Tirole explains that economics is not a science of the aims but is a science of the means. For non-economists, the book explains where economics can be useful. Tirole, as a world class economist, is also exceptionally modest; he gave—respecting other colleagues—a global view of state of economics. It was one of the best, if not the best book of economics that year.
Duflo´s and Banerjee´s new book, in the same field as Tirole’s, arrived by mail two weeks ago. They tell where cutting-edge research can help us understand and find solutions to today’s urgent issues, such as immigration and inequality; globalisation and technological disruption; slowing growth and climate change. A great intellectual achievement. I completed this book last weekend. Top quality research is enormously important for decision-making. I want to pay tribute to these great economists; I also want to highlight their contributions to policy preparation and discussion.
To today’s theme.
The global financial crisis demonstrated the importance of keeping financial stability as priority of the agenda in the global economy. It was financial innovation in the form of regulatory arbitrage, exotic financial instruments such as credit default swaps, and highly leveraged mortgage-backed securities—ran far ahead of the supervisory system that was meant to keep risks in check. At the time, many argued that financial innovation had dispersed risk among a variety of actors, and thus increased the stability and resilience of the global financial system.
But some disagreed with this complacent view. One of the most prominent critics was Raghuram Rajan, then the chief economist the IMF, in his comment at the 2005 Jackson Hole Economic Symposium. His title was: Has Financial Development Made the World Riskier? Contrary to the general thinking at the time, he replied three times yes.
Now, with the benefit of hindsight, we all know the consequences of the attempt to disperse risk was in fact to allow risk to build up unchecked, often outside the purview of supervisors.
Learning those painful lessons meant a decade of regulatory catch-up. Here in Europe, we had to created finally the banking union with common supervisor, the Single Supervisory Mechanism and a resolution mechanism. Internationally, we created the Basel III financial stability system as well as IFRS 9 Financial Instruments for accounting.
Today, a major push for innovation in global finance is coming from ‘big techs’. Big tech companies are dominant platform providers that offer ubiquitous digital services:
The Bank of International Settlements summarised the impact of the big techs in its annual report:
There are aspects of our financial system are inefficient and even outdated. The new entrants—big tech and fintech—represent an opportunity to energise the market for payment services, credit provision and insurance, among other services.
Ladies and gentlemen, the European Parliament confirmed its new Commission led by Ursula von der Leyen last week.
Two commissioners have direct responsibilities for financial markets and also a third one through digitalisation. Valdis Dombrovskis continues to be responsible for financial market including the Capital Market Union program and Marianne Vestager for competition.
The third is Thierry Breton, who is responsible for the digital single market and digital sovereignty of Europe, among other things. roles. I got to know Breton well when he was heading Orange. I was then the EU commissioner for Enterprise and Information Society.
I’ll start with Capital Market Union. The IMF, still then led by Christine Lagarde, published a paper on Capital Market Union (CMU) in September. The paper emphasizes that by lowering barriers to capital markets, a CMU would offer the prospect of powerful macroeconomic benefits. Vibrant EU equity markets and truly diversified cross-border debt markets would complement traditional bank lending by fostering risk-taking and investment.
A well-functioning CMU would also complement the banking union by providing channels to mobilize the large pool of savings in EU banks towards financing the economy. In the European Monetary Union, more integrated capital markets can also help to cushion shocks to parts of the euro area, thereby enhancing the resilience of the euro area as a whole.
For companies, cross-border ownership would mean that they have a wider pool of investors and potentially more stable sources of capital available for their investments. For investors, diversified portfolios would help them hedge against country-specific risks. Cross-border capital markets and banks would thus provide the level of private risk-sharing we need to ensure the long-term resilience of the euro area.
Has there been any progress for the CMU? Yes, we are seeing some changes in the structure of financial markets. The non-bank sector is playing an increasing role in providing a stable source of funding to the European economy. Another positive is the role European investment funds are playing in cross-border integration.
While many initiatives under the CMU action plan are on the path to completion, a ‘CMU effect’ on the cross-border integration of capital markets is yet to be seen. One reason is that progress in addressing barriers to further integration has been slow. Furthermore, some proposals will not deliver their full potential because the complexity of the products, when key elements are left to discretion of EU member states.
It is important to take advantage of the synergies between CMU and the banking union. More efficient markets could complement the banking union by offering ways to mobilize EU savings to finance young and innovative firms. Fostering equity investment by addressing the debt-equity bias would support the development of an equity culture and increase households’ return on their savings, for example. It could furthermore enhance financial stability through the reduction of leverage in the corporate system.
Let me conclude on the CMU: convincing investors and companies to venture outside their borders requires certainty about and homogeneity of the cross-border regulatory conditions. National policies need to be further harmonized and consistently implemented.
I already spoke about the BIS contribution to the discussion on the role big techs. Professor Hyun Song Shin, economic adviser and head of research for the BIS, sets out both the opportunities and risks associated with big tech in finance. In his ‘regulatory compass', the menu of policy choices can be reflected to help policymakers navigate this complex landscape. Building on his ideas, let me offer three observations.
One view is that the entry of new firms in the banking sector is a good thing because it fosters competition. Big techs are often unhampered by legacy infrastructures or by the high costs typical of many incumbent financial institutions. Platforms can be scaled up to offer financing at a lower cost, while gigabytes of financial and consumer insights promise the opportunity of better and more informed lending decisions.
Empirical research by the BIS suggests that big techs’ credit scoring applied to small vendors outperforms models based on credit bureau ratings and traditional borrower characteristics. Moreover, once a loan has been advanced, e-commerce patterns provide big techs an early warning system into future credit difficulties. So big techs can create efficiency gains and can enhance financial inclusion.
At the same time they create a major challenge to regulators, which need ensure to a level playing field between big techs and banks. The big techs have a benefit of wide customer base, access to information. Their business models are also wide ranging. It makes cross-subsidisation possible.
Big techs' entry present new and challenging between financial stability, competition and data protection.
Moreover, the relationship between entry and effective competition is far from obvious. Big techs, in particular, ‘skim the cream’ by narrowly focusing on the most profitable aspects of banking, potentially undermining the universal banking model. For big techs, data accumulation lies at the heart of their business model, so unrestricted entry may not increase effective competition if these companies manage to entrench their market power through control of key digital platforms.
Big tech platforms generate their own data feedback loop. The more services provided, the greater the volume and quality of customer insights obtained, resulting in better targeted or priced products, and so on. Alternative providers that lack these deep data insights will find it difficult to compete, leading to the perverse outcome of more competition leading to less.
Thierry Philippon writes in his new book, The Great Reversal, on the areas where EU has a good track record in competition, such as Local Loop Unbundling. As to the big techs, Margrethe Vestager, who continues as the commissioner for competition, is well-known in the field.
Big techs’ entry into financial services requires cooperation of different regulators. These are questions that cannot be answered by a single regulator. Joined-up thinking is essential to achieving a regulatory environment fit for purpose.
An area, where Europe has a strong track record, is privacy. The European General Data Protection Regulations, or GDPR, have provided citizens with far greater control than they previously enjoyed over where and how their data is used. The ‘customer consent’ aspect of GDPR has helped limit the unfettered use of data by big techs, while the ‘right to portability’ of data opens up an array of possibilities based on a citizen’s access to his or her data.
And within financial services, the EU has also shown the lead in a number of areas, not least in helping to establish IFRS Standards as the de facto global language of financial reporting.
For the reasons I have set out, the EU is placed to play a leading role in setting boundaries on these new financial players.
Such developments underscore the importance of cross-border cooperation and of formulating policy internationally. In the depths of the financial crisis, the G20 repeatedly called for a global response to a global issue. The same is true for developing a balanced approach to the regulation of big techs.
This is a theme echoed by recent paper published by the G7 Working Group on Stablecoins, chaired by Benoit Cœuré. The authors call for public authorities to ensure a globally consistent response to mitigating risks, while noting that various initiatives by international organisations and standard-setters are already underway. I was happy to learn that Benoit Cœuré, my colleague for many years in the ECB Governing Council, will head the BIS Innovation Hub, which aims to identify and develop in-depth insights into critical trends in financial technology, from January.
Among the initiatives in the field is the work by the IFRS Foundation to consider the accounting for crypto assets under IFRS Standards.
Innovation is here to stay, and it will bring benefits and it will bring challenges. We need a balanced approach, where we reap the benefits of financial inclusion and efficiency and ensure a level playing field between big techs and banks.