Member of the Board of Bank of Finland
Chair of the Finnish Financial Supervisory Authority (FIN-FSA)
FIN-FSA’s annual seminar on financial services
Helsinki, 22 November 2017
Digital transformation in the financial industry: what’s good for the society?
Ladies and Gentlemen,
Welcome also on my behalf to the financial services seminar of Finanssivalvonta (Fiva), the Finnish Financial Supervisory Authority. This time our over-arching subject is the digital transformation in the financial industry, which I believe is about as topical a theme as it can get in this field.
We are not at Fiva however taking purely a technology- or institution-driven view. Instead, we want to look at the digital transformation in the financial industry from the citizens’ point of view, i.e. from the standpoint of what is good for the society and for the citizen, be she a consumer, client or investor.
Today, there is much excitement and even hype around e.g. cryptocurrencies and initial coin offerings that resembles – at least for a pre-middle-aged chap like me – the boom period of the new economy around the turn of the millennium.
Therefore, it is of paramount importance to try to identify what is real and in turn what is hype in the digital transformation of the financial industry. I will aim at doing precisely that today, based on the work done by the economists, regulators and other experts in 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 required in this brave or grave new world;
(2) those that should be watched, or even prevented, such as booms and busts related to the cryptocurrencies and initial coin offerings; and
(3) those that could and probably should be further developed, such as the blockchain or distributed ledger technology, even if for now the 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 dwelling deeper into these issues, let us look at how digitalization is brewing new business models and changing consumer behaviour.
Slide 2: Digitalisation creates new business models
Digitalisation is perhaps the single most significant force for change in the financial sector; the other two are regulation and consumer behaviour. This is creating a completely new competitive environment for the sector.
Financial services are increasingly shifting online and to mobile devices carried by their owners. In the future, they will be increasingly used wherever and whenever business is done, 24/7.
In the coming years, we will see many agile FinTech companies enter the market. Tens of FinTech start-ups have already entered the market with operating models different from incumbents. At the same time global big-tech companies [called GAFA: Google, Apple, Facebook, Amazon] are enlarging their foothold to new business areas, including payments.
Regulation is the second driver. The EU’s revised Payment Services Directive (PSD2) will clarify payment legislation so that it is better suited to a digitalising economy. The Directive will promote competition in the financial sector, and thereby the creation of better services and formation of lower prices. It will open the market to third parties, i.e. payment initiation service providers and account information service providers. Banks are obliged to open their interfaces to these service providers.
Its effects will gradually be visible in Finland in the coming years. This change is probably comparable to what happened in the telecom markets in the early 2000s. In banking, this means in practice that the user experience can be provided by some party other than the bank itself.
Consumer behaviour is the third factor shaping how financial services will look in 2022. Consumers are always online. They seek information from various sources, including social media. This puts the consumer at the core of the development of financial services. Future success stories are likely to be those that provide the best user experience and value for the consumer.
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 digital transformation currently most visible to the consumer? In the field of payments. As this business field is rapidly changing, we can ask, 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 payment and cash. Some examples of these are the instant payment systems Siirto and MobilePay, and the service launch by ST1 Finance. The latter is a company originating from an industry other than financial services and is proof of the blurring of industry boundaries. We have also seen international tech giants, such as Apple, Samsung and Alipay, entering the Finnish payments market.
All this might be just the beginning. In the coming years we are likely to see many new payment services. These new services will not be offered by incumbent actors, but also by FinTech companies. Some of the new services may also be provided by actors that we have not yet seen on the payments playing field. However these companies may be well known on their current playing field, such as retail trade and e-commerce.
All of these new payment services that we are going to see have three things in common. First of all, they are real-time. 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 usable 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, looks like a challenge to a banker.
Let me illustrate the importance of payments for the Finnish banking sector. The figures that I am presenting are calculated on the basis of published annual financial statements. In 2016, the net income from payments in Finland was a little over 0.5 Billion euro. In 2016, payments constituted 8 percent of total income and 19 percent of operating profit. These figures show that payments are profitable business for banks and make up a significant share of their revenue at the moment.
I am not going to make any speculations on the share of payment transactions that will in the coming years be carried out by actors other than incumbent banks. I do, however, want to demonstrate what it would mean if half of the income received from payments today were to vanish while business models remain as they are.
This would mean a four percent loss in total income. But as payments are a very profitable business area, it would require a 10 percent increase in net interest income to compensate for the losses. It would be quite an uphill struggle to compensate the losses with current business models, taking into account the current interest levels. This is certainly thought-provoking.
Slide 5: Importance of the FinTech ecosystem
Finland has the potential to be a leader in this transformation. We have strong skills in digital technology and financial services. We adopted digital banking already in the late 1990s. Next, Finland can be a FinTech nation.
FinTechs are key drivers of change and can offer consumers enhanced user experience through innovative services. They have agile product development processes and can quickly develop new services for their customers. We have already seen banks working with the FinTech ecosystem. Partnerships between FinTechs and incumbents are being built.
I encourage all of you to engage more in this type of cooperation. Fiva is supporting this work e.g. through our Innovation Help-Desk for FinTech companies, which I encourage you to use in case you work in the field.
Cooperation across national borders is important. The Nordic region is the second largest FinTech community in Europe [after the UK]. In the past two years all Nordics have established several Fintech hubs and initiatives. Last week a cooperation agreement was signed between Nordic Fintech initiatives for sharing knowledge and helping FinTech start-ups to scale.
I am glad that Finnish universities have become active in both Fintech-related teaching and research. Let me give you some concrete examples: Aalto University has begun its research and teaching in FinTech with a seminar series this autumn; Hanken together with Arcada are offering courses in FinTech; the University of Applied Sciences in Oulu is holding an AppLab programme to train future Fintech professionals.
I would also encourage Finnish FinTech start-ups to think globally. Last week the Monetary Authority of Singapore (MAS) organised its FinTech festival. This is the largest FinTech event in the world, with 25 000 people from all over the world visiting. Sweden and Denmark both took part in the event with a delegation between 20 and 30 people. The delegations consisted of FinTech start-ups, representatives of FinTech hubs, regulators and organizations that are helping companies grow internationally.
Slide 6: Nordea’s relocation => banking sector 400% of GDP
There is another factor of positive dynamism in the Finnish financial industry. That is Nordea’s recent decision to relocate its headquarters – and balance sheet – to Helsinki. This decision, which Nordea obviously took for its own reasons, is a vote of confidence for the Eurozone banking union, and also strengthens the future perspectives of Finnish financial industry, and FinTechs.
While Nordea’s balance sheet has been evaluated as healthy in recent stress tests, we naturally analyzed the risks it could carry for Finland. The banking sector will soon be 400% of Finnish GDP, well above the EU average.
Our conclusion is that the risks to our country are manageable, thanks to the rules and tools of the banking union. In a possible crisis, any systemically important financial institution, like Nordea, would in the Eurozone be dealt with by the resolution and bail-in rules of the banking union. Moreover, completing the banking union with a common deposit guarantee scheme would be important for a country like Finland with a large banking sector. And needless to say, Nordea’s relocation will mean that new prudential resources are needed for the Fin-FSA, which we are taking care of.
Slide 7: Importance of digital skills and financial literacy
Digitalisation, in general and in the financial industry, creates the need for a new type of skills. For instance, every citizen needs at least the basic knowledge of cyber security and data protection. People need to understand the importance of protecting their devices and identifying attempts at online fraud [such as phishing, when a website that resembles a real service provider is trying to get the users' credentials to access their accounts].
Citizens should also understand their rights as data subjects. It will become more common to use one's personal data when paying for the use of financial services. Families, schools, authorities and financial service providers have an important role in increasing public awareness of these issues.
Account transfers are gradually changing to real-time. Payments are also disappearing into the background and becoming part of the customer experience. This makes financial management more challenging for households and underlines the need to promote financial literacy. Adequate financial literacy skills are a necessity in the digital age.
Financial literacy is nowadays promoted by many different parties: financial service providers, authorities and third sector players. It is of the utmost importance that these different parties cooperate. This is the only way to ensure adequate financial literacy throughout the whole of society.
We also see that a positive credit register would be a useful tool in financial management and would help prevent households’ over-indebtedness.
Slide 8: ICOs and cryptocurrencies price bubble
Cryptocurrencies are digital payment instruments that circulate from one holder to another without a centralised accounting system. Today the most known cryptocurrency among consumers is Bitcoin. It was originally developed as a means of payment, but its use for this purpose is very limited.
Currently, it appears that bitcoin and other cryptocurrencies interest people more as investments rather than as means of payment. They are purely speculative investment objects. The value of a bitcoin is not guaranteed by anyone, nor does it give any actual return, such as a dividend or interest. Any return is based solely on the expectation that the cryptocurrency can be sold later at a higher price. Such investment always involves major risks.
The European Banking Authority (EBA) has already in December 2013 issued a warning on a series of risks deriving from buying, holding or trading cryptocurrencies. It is extremely important to acknowledge that consumers are not protected through regulation when using cryptocurrencies as a means of payment and may be at risk of losing their money.
An ICO [Initial coin offering] is a way of collecting risk financing. This refers to the pre-sale of a new cryptocurrency and is reminiscent of crowdfunding. From the perspective of those providing finance, an ICO is a similar kind of speculative investment to existing cryptocurrencies.
The European Securities Market Authority issued a warning on ICOs in early November to highlight ICO risks for investors and firms. Today, the Fin-FSA issued a warning on investing in cryptocurrencies and ICOs. The warning is aimed at enhancing consumer awareness of the risks. At the moment, the rise in the price levels of cryptocurrencies [like bitcoin in the picture] suggests there is a visible price bubble that resembles the historical Tulip Mania.
Slide 9: Blockchain vs. centralised payment systems
The technology underlying cryptocurrencies, called blockchain technology or distributed ledger, has potential for new applications, and versions of the technology have been developed that are more suitable for the financial sector’s use. Currently, promising financial sector areas of application include interbank international credit transfers and securities clearing and settlement operations. They are developed mainly by private actors and are good examples of the diversity of digitalization development in the financial sector.
At the Bank of Finland we have, together with other Eurosystem central banks, studied distributed ledger technology. In its present form, it does not yet meet the requirements required by the systems of central bank services. 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) this year and next. For the future, it is important that systems are compatible, and that they are standardized and harmonized.
Slide 10: Summary
Ladies and Gentlemen,
Let me conclude. Finland has sound, realistic chances of becoming a winner in the currently ongoing and accelerating digital transformation in the financial industry. If we proceed wisely, this can be turned to the benefit of the whole society.
This calls for encouraging innovation and building a flourishing FinTech ecosystem to Finland. And it calls for a dynamic and competitive financial industry that can turn the innovations to products and services that genuinely enhance our economic and social welfare.
But it also calls for confidence and trust, rock-solid financial stability and adequate consumer protection. This, in turn, is the core business of the Finnish Financial Supervisory Authority. We aim at ensuring the right balance between innovation and technology, on one hand, and customer protection and financial stability, on the other hand.
And as financial services are going more online, there is a growing need for digital skills and true financial literacy. Here, cooperation between all key players is most important.
I trust the financial industry and other stakeholders share these worthy goals, and we can work well together in reaching them.
In this spirit, let me wish you a stimulating, productive conference and most interesting discussions today.