Bank of Canada

Fintech and blockchain technology have raised questions about whether the industrial organization of the financial system is ready for an overhaul.

But according to Bank of Canada staff — who recently penned a discussion paper titled, “Fintech: Is This Time Different? A Framework for Assessing Risks and Opportunities for Central Banks” — fintechs have incentives to join the regulated banking system in order to compete and scale up.

Over the long term, fintech has the potential to affect central banks’ responsibility in two main ways, the paper says.

First, it could shift the industrial organization of monetary policy, currency demand, financial stability and the need for a lender of last resort. Second, it could have broader effects on employment and productivity as the economy is digitized, affecting central banks’ ability to react to economic shifts or shocks.

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For instance, blockchain technologies like Bitcoin could disrupt the financial system by creating an alternative to using bank notes for retail transactions. Central banks around the world manufacture and distribute bank notes, the paper says, and new cryptocurrencies could “drastically change the composition of the balance sheet of central banks.”

Central banks, in turn, have incentive to bring the technology into its fold. The paper adds: “On the other hand, central banks might still choose to issue their own digital alternative to bank notes for retail transactions.”

But, the paper says the regulatory system can actually help fintechs compete and exploit economies of scale that are critical in the world of banking. Incumbent lenders have the scale to balance investors with borrowers, which can be a struggle for small players, the paper says. Incumbent financial institutions also have established access to existing payments and settlement infrastructure, as well as a stronger ability to authenticate customer identities and estimate risks like fraud.

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“That is why our analysis suggests that fintech entrants will have incentives to become regulated entities, accepting deposits, to be able to exploit the traditional economies of scope and liquidity transformation of banks. Factors including strong competitor concentration, high capital intensity, low growth prospects and limited product differentiation underlie the intense rivalry in the traditional lending industry, and the need to adopt similar practices,” the BoC discussion paper says.

The paper concludes: “Going forward, central banks and regulators will have to monitor whether these new technologies and business models are fundamentally changing money demand and the industrial organization of financial intermediation.”

Read the full paper here.

Also read: 

New ‘liquidity intelligence’ finds you bond liquidity

Investing in fintech? Firms cite regulatory as a barrier to evolving

Originally published on Advisor.ca
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