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Credit: The International Monetary Fund

Credit: The International Monetary Fund

IMF Deputy MD on challenges and opportunities in digitisation of money and finance

Recently, at a conference, International Monetary Fund (IMF) Deputy Managing Director Mr Tao Zhang spoke about the issues facing central banks and regulatory authorities in this era of technological advances in the field of finance.

Mr Zhang pointed out that the global economy is experiencing a “non-stop digital revolution” in which digital revolution and the explosion of data represent both technological benefits and potential dislocations.

The macroeconomic implications of this digital revolution are also worth looking into, as Mr Zhang cited latest IMF World Economic Outlook, a study that suggests automation may replace a lot of labour-intensive manufacturing that countries have used to climb the development ladder. Instead, jobs in these countries may migrate to the service sector.

According to Mr Zhang, one frontier of technology that is certain to have a major impact on our economy is the digitisation of money and finance. He discussed how financial services may be transformed by the adoption of financial technology, examined how crypto-assets rise may pose challenges to financial integrity and stability, spoke on how central banks and regulators can mitigate potential stability risks without impeding innovation, and highlighted the work the IMF is doing to help its 189 member countries address these challenges.

Technology and innovations: Implications for finance

The digitisation of finance has been spurred by the innovations encompassed in the term fintech. This includes artificial intelligence, big data, biometrics, and distributed ledger technologies such as blockchains. Fintech offers the promise of faster, cheaper, more transparent and user-friendly financial services. It raises the prospect of expanding financial inclusion, especially in developing countries.

“Companies working with artificial intelligence are exploring credit scoring based on payment data. Fintech startups in Latin America, Africa, and Asia are moving toward the use of peer-to-peer lending data, and information from mobile phone payments to build reliable credit databases,” said Mr Zhang.

Another area under development that he mentioned is smart contracts that could allow the more secure and faster settlement of financial market transactions. These contracts use software to enable automatic triggers that allow transactions without human intervention.

Although fintech could enable greater access to financing and investment opportunities, there are inevitably risks as well. One of the risks that Mr Zhang is concerned with is the impact of fintech on financial stability, which could be a result of disruptions to existing service providers and business models or unregulated sectors that create additional operational risks related to cybercrime and outsourcing. He also pointed out that new technologies and new forms of intermediation may upset the balance between transparency and privacy, underlining ethical concerns and the need for clear rules governing privacy and data ownership.

Rise of crypto-assets

On the development of crypto-assets in the financial landscape, Mr Zhang remarked that there has been a notable expansion of such assets in recent years, citing the IMF’s latest Global Financial Stability Report which estimates an increase in the market capitalisation of all crypto-assets to about US$600 billion this past December, a drastic increase from only about US$25 billion one year before.

“In truth, there are both opportunities and risks associated with crypto-assets. As an asset class, crypto-assets have not been correlated with other assets, and could provide diversification benefits to investors,” he said.

As Mr Zhang explained, some useful technology is being developed to improve market efficiency. For example, services have slashed from days to minutes the time it takes for cross-border payments to reach destinations. One of the examples of such cross-border payment services he gave was Western Union.

“As with other forms of fintech, crypto-assets also have the potential for criminal activities. They can mask identities, which makes them attractive for money laundering, terrorist financing, tax evasion and fraud. For now, crypto-assets are still relatively insignificant compared with conventional assets, and, so far, they do not pose a threat to macro-financial stability. However, this could change,” he cautioned.

He explained that when asset prices go up quickly, risks can accumulate, especially if market participants borrow to buy them. So, when leverage rises because of crypto-assets, vulnerabilities may emerge. The borderless nature of the underlying transaction mechanism and different national regulatory approaches would amplify the market disruptions caused by the expansion of the investor base and the lack of transparency in the crypto-markets.

The role of central banks and regulators

Given the implications of technology on finance and the rise of crypto-assets, how should regulators and central banks respond?

Around the world, regulators have begun to address these challenges with a variety of approaches including the clarifying the applicability of existing legislation to crypto-assets, issuing warnings to consumers, imposing licensing requirements on certain market participants, prohibiting financial institutions from dealing in crypto-assets, completely banning the use of crypto-assets, and prosecuting violators.

According to Mr Zhang, to maximise the full potential of new financial technologies, policymakers must strike a “sensible balance” which involves creating a supportive space for innovation, while maintaining a robust regulatory framework.

He also gave four key points on how trust can be maintained in an evolving financial system. They are:

(1) Regulators need to complement their focus on entities with increasing attention to activities. This responds to the reality that an increasingly diverse group of firms and market platforms are providing financial services.

(2) Governance needs to be strengthened. Rules and standards will need to be developed to ensure the integrity of data, algorithms, and platforms—in other words, to ensure that they operate in a manner that does not expose consumers or the financial system to undue risk.

(3) Policy options could be considered to support open networks, and licensing policies could be adjusted to help foster competition.

(4) Legal principles need to be modernized. Maintaining trust in financial services may also require the development of new legal frameworks to clarify rights and obligations within the new financial landscape.

“The bottom line is that policymaking will need to be nimble, innovative, and cooperative,” he said.

The role of the IMF

“It will take a coordinated effort among multilateral organizations, the private sector and governments. This includes the IMF,” said Mr Zhang.

He stated that the IMF can help advance the agenda on Fintech regulation by offering advice and by serving as a forum for collaboration. It can work with governments and international standards setters on a consistent regulatory approach.

According to him, immediate action is needed in three key areas: to close data gaps that are inhibiting effective monitoring of potential risks and their links to the core financial system; to support systemic risk assessment and timely policy responses; and to protect consumers, investors, and market integrity.

“It is important to get the balance right. National regulatory authorities and central banks will need to calibrate the regulation of fintech in a manner that appropriately addresses the risks without stifling innovation. During the process efficient and stable payment and settlement systems, and financial stability need to be continuously and constantly protected. In other words, if we adopt the right policy responses, something good can come out of this wave of technological innovations—more efficient and accessible financial services, and better money and monetary policy,” he concluded.

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