Dr, Deputy Governor, Bank of Finland
Digital transformation in the financial industry - potential and challenges
Second Annual Conference on FinTech and Digital Innovation: Regulation at the European Level and Beyond, Brussels, 27 February 2018
Digital transformation in the financial industry – potential and challenges
Ladies and Gentlemen,
Many thanks for the invitation to speak in this important conference. Europe has indeed plenty of potential – but also major challenges – in the field of FinTech and digital innovation. We have the technological competence, no doubt, and a big enough home market in the form of the euro area. But let’s face it, Europe at large has not been a forerunner in FinTech. Can this be turned around? And how?
Today, there is much excitement about many financial innovations, such as mobile banking, robo advisory, algorithmic trading, and peer-to-peer lending. There are also phenomena like cryptocurrencies and initial coin offerings that – at least for a pre-middle-aged chap like me – resemble the new economy boom around the turn of the millennium.
But we should not only take a technology-driven view on digitalization. Instead, we want to look at it from the citizens’ point of view, i.e. from the standpoint of what is good for society and for its citizens, whether they are consumers, clients or investors.
Therefore, it is of paramount importance to identify what is real and what is hype in the digital revolution of the financial industry. Both entrepreneurs, investors and authorities must face this problem. I will try to do that today, based on the work done by the economists, regulators and other experts at the Bank of Finland and the Finnish FSA.
I will divide the relevant issues and developments in three categories
(1) those that clearly increase societal welfare and should be benefitted from, such as mobile and real-time payments - as long as we take care of enhancing the financial literacy in this brave or grave new world;
(2) those that should be watched, or even prevented, such as booms and busts related to cryptocurrencies and initial coin offerings; and
(3) those that could be further developed, such as blockchain or distributed ledger technology, even if for now central banks are developing their operations by other means, such as the introduction of new systems enabling real-time payments, like the TIPS and T2S.
Before delving deeper into these issues, let us look at how digitalization is creating new business models and changing consumer behaviour.
Slide 2: Digitalisation creates new business models
Digitalisation is the single most significant force changing the financial sector today; the other two are regulation and consumer behaviour.
In the coming years, we will see many more agile FinTech companies enter the market. Hundreds of FinTech start-ups have already emerged, with business models that are very different from incumbents. At the same time, global big-tech companies [Google, Apple, Facebook, Amazon, Alibaba, Tencent] are enlarging their foothold to new business areas, including payments.
Partnerships between FinTechs and incumbents are being built around Europe. The Nordic region has the second largest FinTech community in Europe. All Nordics have set up several Fintech hubs and initiatives. Last year a cooperation agreement was signed between Nordic Fintech hubs for sharing knowledge and helping FinTech start-ups to scale.
Regulation is the second driver. The EU’s revised Payment Services Directive (PSD2) will promote competition in the financial sector, help create better services and boost lower prices. It will open the market to third parties, i.e. payment initiation service providers and account information service providers. Its effects will become gradually visible, not overnight. This change is probably comparable to what happened in the telecom markets in the early 2000s.
Consumer behaviour is the third factor shaping financial services in the future. Consumers are moving online, and once there, they will stay connected around the clock. They seek information from various sources, including social media. This puts the consumer centre-stage in digitalisation. Future success stories are likely to be those that provide the best user experience and value for the consumer – but remember: the first-mover advantages are also significant in this competition.
Slide 3: The playing field of payments is changing: is it an old game with new rules – or an entirely new game?
Where is the transformation most visible to the consumer? In the business of payments. Is it an old game with new rules – or an entirely new game?
More ways to pay have been born, as various mobile applications have emerged alongside card payments and cash. All of these new payment services have three things in common.
First of all, they are real-time and instant. Money is transferred from one person to another in seconds.
Secondly, there will be fragmentation. Consumers are using several methods of payment, just as they are now using for communication – phone calls, text messages, e-mail, Whatsapp, Skype, Snapchat etc.
Thirdly, payments will be seamless. They will be used in a simple way, for example by confirming payments with fingerprints or facial recognition. The payment action is disappearing from the foreground and becoming an integral part of the customer experience.
Slide 4: Importance of payments for Finnish banking sector
What is an opportunity for the consumer, is a challenge to a banker.
Let me illustrate the importance of payments for the Finnish banking sector. In 2016, payments made up 8 % of total income and 19 % of operating profit. These figures show that payments are profitable business for banks and make up a large share of their revenue today.
I will not speculate on the share of payment transactions that will in future be carried out by actors other than incumbent banks. Let’s however ask what it would mean if half of the income from payments today were to vanish while business models remain as they are.
This would mean a 4% loss in total income. But since payments are a very profitable business, it would require a 10% increase in net interest income to compensate for the losses. It might be an uphill struggle to compensate the losses with current business models, to say the least.
Slide 5: Importance of digital skills and financial literacy
Digitalisation, in general and in the financial industry, creates the need for new skills. For instance, every citizen needs at least basic knowledge of cyber security and data protection.
Citizens should also understand their rights as data subjects. Families, schools, authorities and financial service providers have an important role in increasing public awareness of these issues.
Instant payments, i.e. real-time account transfers, are just around the corner. Payments are disappearing into the background and becoming part of the customer experience. This makes financial management more challenging for households and underlines the need for financial literacy. Financial literacy skills are a necessity in the digital age.
Financial literacy is nowadays promoted by various actors: financial service providers, supervisory authorities and third sector players. It is crucially important that these different parties cooperate, to ensure adequate financial literacy throughout the whole of society. Responsible behaviour is expected from the service providers: the sustainable interest of their customers should be the primary focus.
Slide 6: Block-chain vs. centralised payment systems
Part of financial literacy is to understand new phenomena like cryptocurrencies. Bitcoin and other cryptocurrencies are now mostly used for speculation, but the technology underlying cryptocurrencies, called block-chain or distributed ledger technology, is actually quite promising. It allows to make certain processes faster, and suitable versions of the technology have been developed for the financial sector. They are mainly being developed by private actors and are good examples of the diversity of digital transformation in the financial sector.
At the Bank of Finland we have, with other Eurosystem central banks, studied distributed ledger technology. It does not yet meet the requirements of central banks. Central bank systems are being developed by other means, however, such as the introduction of new functions and systems enabling real-time payments (TIPS & T2S).
Slide 7: Summary
Ladies and Gentlemen,
Digital transformation in the financial sector is well underway and moving fast. Europe has realistic chances of succeeding well in this transformation with its many initiatives. If we can fully utilise our potential, this can be turned to the benefit of the whole society.
This calls for cooperation between small and large, old and new players, in order to build flourishing ecosystems. And it calls for a dynamic and competitive financial industry that can turn the innovations into services that genuinely enhance our economic and social welfare.
But it also calls for confidence and trust, rock-solid financial stability and good consumer protection. As financial services are moving online, there is a growing need for digital skills and financial literacy.
I trust the financial industry and other stakeholders share these worthy goals, and encourage you to work together in reaching them.