Our future lies with central banks’ digital money

In a rapidly digitalizing world, the value of tangible assets is declining while the service industry’s role is becoming increasingly prominent. Services are also changing and becoming more standardized – in almost no time, consumers will stop being aware which company they actually used because the speed and ease of getting the service will be the things that matter. This definitely applies to banking, which is going through a tremendous transformation now due to the increasingly fast implementation of digital products. Invest Foresight has discussed the challenges for the banking industry, the future of cash and the risks of using big data with Konstantin Korishchenko, professor at RANEPA Department of Stock Markets and Financial Engineering.

Credit: Vladimir Trefilov | RIAN

Banks cease to be money intermediaries

What risks is digitalization posing to banks?

— Specifically for banks, digitalization entails the loss of two huge advantages they have enjoyed for years. Just consider this – for centuries, a bank was the main trusted center that handled money. Few people would risk entrusting their money to a vegetable shop or a neighbor; they took their time choosing a bank that could be trusted to keep their money safe. Today, money can be safely deposited with almost any bank, especially if it offers high interest – the client is no longer interested in a particular bank, and with the Deposit Insurance System in place, one does not even have to think about risks, and even less so when they want a loan.

Furthermore, banks used to have an unconditional right to make payments: customers had to establish long-term relationships with a particular bank simply to be able to pay their bills. Today, one still needs a bank account to make a payment, but money can be easily transferred to another bank in seconds. Customers can use various payment and card systems, and even make payments with their mobile phones – the Bank of Russia’s Faster Payments System (FPS) enables instant transfers using only a mobile phone number. Those are the most basic services Russians have been using ever since the inception of the banking system.

— How will these changes transform the role of a conventional bank?

— As a result, the bank loses its functionality as a money intermediary. Indeed, the bank has always acted as a “gateway to money” – something you used to have access to your money. This is what is changing now. And how will things change if central banks issue their own digital money? Indeed, according to the latest survey by the Bank for International Settlements (BIS), central banks of more than 10 countries are planning to do just that in the next two to three years; China has already announced the project. If (or rather, when) this process begins, people will directly handle their Central Bank’s money, and commercial banks will fall out of this chain.

Does this mean banks will no longer be needed?

— Banks will retain the extremely important functionality as lenders. Indeed, economically, when renting a house or a car, you inevitably enter into a credit relationship.

Transition from the ownership economy to the rental economy means a drastic surge in the scope of credit relations across all types of assets. If banks maintain the competence of a credit institution and develop it, this could be a significant area for work. By the way, banks are already trying to shift away from the competition based on loan rates and loan periods to the competition based on end products. To do so, they are creating their own ecosystems.

Banks are moving beyond the boundaries of ordinary lending by offering consumer or investment products rather than simple loans. This means that a bank’s credit functionality is simply integrated with numerous products. Sberbank is an example of this trend and many other, especially major, banks are trying to follow it. An alternative format is marketplace or a platform where consumers choose services (e.g. loans, deposits, insurance) and vendors (banks, insurance companies, etc.) sell them.

Therefore, there are two vectors: a quasi-monopoly and a quasi-exchange. These trends in the banking industry are competing with each other right now. Which of them will be a path of choice for the banking businesses, we will see soon.

Big Data for banks

— Banks are obtaining increasingly more data on their customers. What is new in this area?

— There are several standard solutions available in the world today. Creating an independent identification system is one of the global trends. In Russia, it is represented by the Unified Biometric System and the Unified Identification and Authentication System. In this case, the state provides a reliable identification system and allows all citizens to use it.

But at the same time, all kinds of procedures associated with the banking business are outsourced to partners, large or small specialist organizations. It can be customer data verification, transaction verification, foreign exchange legislation compliance, etc. Customers of financial services go through numerous checks after which end operations – such as loan issuance, payments and money transfers – are performed by the bank almost automatically. This approach can be implemented as both an ecosystem and a marketplace. As indicated by experience and cooperation development, these specialist companies are more efficient and make it possible for banks to cut costs.

— Is it possible to make access to data as difficult as possible, for their security?

— Of course, protection of customer personal data is an increasingly more important aspect. However, in order to get necessary services fast, banks will have to provide access to the data storage to various fintech companies. I am talking about an open API that will, regardless of whether the entity storing your data wants it or not, open access to the data – with your consent, of course. Europe and the United States are already enforcing such requirements while Russia is also considering them. I can surely say that Revolut was able to grow as a business in the UK mainly because this country has an open banking and API regulation.

— Will Big Data be helpful or bring new risks?

— Any process has both positive and negative consequences. When you sharpen a kitchen knife, it is a good or a bad thing? Big Data can help determine your needs even if you don’t know about them yourself. In this sense, Big Data is a very valuable thing, including for credit and finance: it allows for assessing the client in a prompt way. But risks of information leaks are also growing and this information can be used not in the interests of a concrete person like it is happening with China’s social credit system. What’s most important, the quality of Big Data is still a problem. There is much talk of how much it is possible to learn about a person from their social network accounts. But this information is often low-quality, distorted and controversial, so the attempts to use it are doomed from the very beginning. Therefore, there is a big question that remains unanswered: which data should be used?

— Will Big Data change our lives?

— Yes, Big Data is a very important phenomenon. However, Big Data, artificial intelligence and machine learning are also very overestimated processes. It doesn’t mean that they are useless or bad. It’s just in the 1980s, when I was a student at the computational mathematics and cybernetics department, they said that artificial intelligence would change everything in 5-10 years. Forty years have passed and we are still waiting for this change. We should not overestimate the importance of such things as chatbots, for instance. They can help save money on call centers and help with many communication tasks, but in their current form they are rather funny or annoying, and do not solve any real business problems.

— Does digitalization of the banking industry reduce demand for cash?

— The main advantage of cash is that the transactions are anonymous. They do not have to be criminal though. Therefore, there is a constant demand for cash and it is even bigger today. But the other side, the issuer, has other motives such as seignorage or the ability of the Central Bank to receive income from issuing banknotes. By the way, Russia receives some 1% of GDP from emitting cash, it is almost a world record. Another important demand factor is negative or near-zero interest rates that have been adopted by many countries in the past few years. In this situation, cash is a very good investment. The cost of storage, maintenance and transportation of cash is between 0.5% and 1%, and if the rates go below -1%, everyone will transition to cash. Central banks understand that.

— Is there a solution?

— For instance, cash can be abandoned completely. There are such discussions already. Members of the Better Than Cash Alliance, both government agencies and private companies, suggest that cash should be eliminated. But what’s interesting is that against this backdrop there is an idea to launch a radically new kind of money that can replace both cash and cashless payments. This is the idea of ‘digital money,’ which was initially implemented in the format of private cryptocurrencies – yet all of them, including bitcoin and ether, are prototypes rather than actual economic systems. Stablecoin seems more promising, including the Libra and Gram projects. Apparently, there is a new type of money emerging, with central banks preparing to issue their digital currencies, which are highly likely to become our future monetary system. Ten countries are currently testing this option, and I believe that some of them will launch it within the next three years.

Will it have a dramatic effect on our lives?

— This will drastically affect people’s lives. This is not going to be simply a new electronic money format but money designed for a different class of users: machine, not man. Today, the watch on my wrist, the smartphone in my pocket, the telemetric device in my car and the coffeemaker in the office – they all can gather and transfer information and provide services. This is in many cases free so far; yet, given these operations’ economic effect, they should be paid for.     

For instance, speaking of keeping your home at a particular temperature, there is a device that can do this; the only thing to do is make it able to pay to the corresponding organization. The sum will be charged from your account – and it takes no effort. Switching the device on and off can be done over and over and for short periods of time, with payment automatically made for each operation. Payment versus delivery is a principle of autonomous devices’ safe performance. A program for conducting these actions could be written even now; however, payment sums could be small and may involve fractional numbers – maybe, fractions of a kopeck. The current accounting system rounds them off, which can result in accumulation of substantial rounding-off errors; this means the new currency should have a precision of 8-20 digits to provide calculation accuracy.             

What role will man play in this world?

— It is hard to say; speaking of monetary transactions, people will be consumers of products and services rather than participants in financial transactions. This is not about the immediate future, but we will eventually get there. It is possible that in the long run people will work by the hours to receive necessary goods and services, while money will be used solely for settlements between mediation machines.

Efforts are probably underway to test this system in certain countries; this will involve the universal basic income format, with the government providing a guaranteed set of goods or services to citizens, who will work in accordance with their abilities. In a society like this, time may become the scarcest resource; it may even become sort of quasi-foreign currency as we will eventually abandon monetary relations.      

By Olga Blinova

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