Innovation in Retail Payments and Its Impact on a Country's - - PowerPoint PPT Presentation

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Bank of Finland

Innovation in Retail Payments and Its Impact on a Country's Economic Growth and Financial Stability

Presentation in Bank Indonesia Seminar and Workshop 13 November 2017

1 13.11.2017

Seppo Honkapohja

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Agenda

• 1. Effects of innovation at the level of whole economy
• The big picture: Digitalisation, technological change, productivity, and well-being in the

long run

• Optimists and pessimists: how will digitalisation impact the economy and society as a

whole

• Widening use of digital technology and new opportunities
• 2. Effects of innovation in financial markets
• The financial system and economic performance
• Payment systems and economic well-being
• Innovations in financial services and financial stability
• 3. Evolution of payment systems
• Main drivers and trends: consumer expectations, fragmentation of the markets, real-time

payments, “embedded payments”

• Assessing the change: European situation (PSD2, PAD)
• 4. Conclusions and policy considerations
• Key areas and challenges for policy makers

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

• 1. Effects of innovation at the

level of whole economy

1.1 Long-term trends

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted 13.11.2017 Seppo Honkapohja 4

Why has our standard of living improved so much over last 150 year?

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted 13.11.2017 Seppo Honkapohja 5

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

The rise in the standard of living 1860−2010

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Labour productivity growth and improvement

• f living standard in Finland in 1860−2015

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Technological development evident as waves of productivity growth

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

1.2 Debate about digitalization

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

What is digitalization?

• Digitization:

To convert, store, transfer, and process information in a format understood by computers

–

Binary data

–

Digital information can be music, movies, documents, maps, observational data etc.

• Digitalization:

Widespread economic and social transformation made possible by the development of information and communication technology

–

A change that is visible in all sectors of the economy

–

Automation, robotization, digital platforms, artificial intelligence, industrial internet, internet of things, digital government etc.

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”Suomen Pankki” = 01010011 01110101 01101111 01101101 01100101 01101110 00100000 01010000 01100001 01101110 01101011 01101011 01101001

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Will digitalization cause a new wave of productivity growth which matches the previous technological revolutions?

Pessimists

• Computers are seen everywhere

except productivity statistics (Robert Solow)

• Development has been limited to

entertainment and communication (Robert Gordon)

• The low-hanging fruits have already

been picked (Tyler Cowen)

• We’ve been waiting for accelerated

growth for a long time now

• Economic headwinds will dampen

growth despite technological progress (Robert Gordon)

Optimists

• We ain’t seen nothin’ yet (Joel Mokyr)
• The second machine age

(Erik Brynjolfsson & Andrew McAfee)

• We tend to overestimate the effect of a

technology in the short run and underestimate the effect in the long run (Ray Amara)

• The same pessimist arguments were

made before the previous technological revolutions

• The statistics do not tell all
• The rate of new innovations has not

slowed down

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Prices of ICT equipment and services have fallen exponentially

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Prevalence of ICT equipment and connections in households

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Mobile data transfer volume in Finland, 2007−2016

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Currently almost 10 times more data is transferred in one day than in year 2007 as a whole

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Technological development, economic growth and the road ahead

1.

Productivity growth derived from technological development is the main driver of improving living standards in the long run.

2.

The future impact of digitalization on economic growth is uncertain, but signs of its potential are already clearly visible.

3.

Digitalisation is bound to transform industries based information processing and communication − such as finance and payments.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

• 2. Effects of innovation in

financial markets

2.1 Financial systems and economic performance

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Financial systems and economic performance

Source: Hartmann et al. (2007) “The role of financial markets and innovation in productivity and growth in Europe“

13.11.2017 Seppo Honkapohja

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Impact of finance on economic growth (1)

Question: Can there be too much finance?

Source: Cournède, B. and O. Denk (2015), “Finance and economic growth in OECD and G20 countries”, OECD Economics Department Working Papers, No. 1223, OECD Publishing, Paris.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Impact of finance on economic growth (2)

Other views also exist:

• For example, Durusu-Ciftci, Ispir & Yetkiner (2017)

find that by fostering the development of a country’s financial sector, economic growth will be accelerated.

Journal of Policy Modelling, Vol. 39, Issue 2.

(http://www.sciencedirect.com/science/article/pii/S0161893816300631)

For financial innovation both “bright and dark sides” exist:

• For a recent review on innovation-growth view and

innovation-fragility view, see e.g. Beck, Chen, Lin & Song (2016) “The bright and the dark sides”

Journal of Banking and Finance, Volume 72, November 2016 (http://www.sciencedirect.com/science/article/pii/S0378426616301133)

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

2.2 Payment systems and economic well-being

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

On the relationship between retail payments development and economic performance

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Source: “Efficient retail payments: An untapped source for reviving growth in Europe?”, Iftekhar Hasan & Tuomas Takalo, VoxEU, 24 January 2014

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Some studies on payment systems and

economic growth

• DeRenzis et al (2012 & 2013):

–

Electronic payment instruments have overall a positive impact on economic development

• Tee and Ong (2016):

–

The impact of adopting cashless payment on economic growth can only be significantly observed in the long run

• Zandi et al. (2017):

–

Increasing use of electronic payments boosts consumption and GDP, and the impact increases as penetration rises. Effect on the global level is 0,1% of GDP.

• Ilyes & Varga (2016):

–

Utilise a DSGE model to study impacts on the performance of the Hungarian economy if retail cash payments were substituted with card payments. Results show both positive indirect and direct effects.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

2.3 Innovations in financial services and financial stability

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Financial services and Fintech

• Use of advanced technologies by financial services

firms is not a new phenomenon:

–

Internal technological solutions to service provision and to compliance with regulatory obligations.

–

Also outsourcing with external service providers has existed for long time.

• But the rise of FinTech is a recent phenomenon.
• It has led to

–

Increased technological, especially IT, investments

–

Appearance of a whole array of different firms:

• Incumbents
• specialized start-ups and
• global telecom/technology companies (“GAFAA”: Google,

Apple, Facebook, Amazon and Alibaba”).

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

FinTech: Opportunities and challenges for central banks and regulators

Opportunities:

• Financial inclusion; more people gain access to

financial services.

• More competition; leads to lower prices and better

services.

• More efficient processes and financial intermediation.

Challenges:

• Financial stability
• Banking supervision
• Payment systems
• Transmission of monetary policy

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Overview about regulation of FinTech activities in Europe

• Public authorities in the EU are investigating the

impact of FinTech.

–

Impact of FinTech on the financial system and

–

• n its the regulation and supervision thereof.
• Recent European Banking Authority (EBA) survey of

financial services, innovations by FinTech firms and their regulation.

–

See next slide

• Significant percentage of services provision is not

regulated.

–

Regulation practices are likely to vary from country to country.

• However, stability problems with FinTech have not

risen thus far.

–

Rapid growth of FinTech => Important to remain alert

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

European Fintech activity

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Source: EBA (https://www.eba.europa.eu/-/eba-publishes-a-discussion-paper-on-its-approach-to-fintech)

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

• 3. Evolution of payment

systems

3.1 General features

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Payments play an important role in innovations in financial services

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Main driver in retail payment developments: consumer expectations

• In payments, there is a movement towards a 24/7

world.

• Consumers expect instantaneous transactions as

well as easy and handy payment applications.

• These are not isolated trends but a paradigm shift

in consumer behavior.

• Consumers compare financial services to other

services and expect the same usability and customer experience.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

An example of one major driving force: mobile device penetration

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Mobile devices play a growing role in the supply of financial services

Source: World Bank

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Three trends in payment markets

1.

Payment landscape has become fragmented.

2.

Payments are becoming instant / real-time.

3.

Payments are becoming embedded into the service.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Trend (1): Payment landscape has become fragmented

• Several new payment applications
• Several new actors in the customer interface
• Open interfaces enable ecosystems to evolve

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Source: Edgar, Dunn & Company

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Trend (2): Payments are becoming instant / real-time

• The world moving towards 24/7 services
• Also in (retail) payments pressure to move from

traditional t+1 towards “real-time” is growing

• In some countries (e.g. UK, SE, DK, FI, PL, SG,

MEX, etc.) national instant payment systems exist

• In Europe, pan-European instant payment systems

are being built

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Trend (3): Payments are becoming embedded into the service

• Payments become integrated into the buying process, game,

social media or other user experience.

• Payment details are submitted only once, but transactions can

happen frequently.

• Consumer is not necessarily aware of making payments.
• Makes individual financial management more demanding – there is

a need for better financial literacy.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

A contrasting case: cross-border payments (1)

• The area of cross-border (c-b) payments is ripe for

major change.

• c-b payments still feature long-chains of operations

and multiple intermediaries. [See Figure in next slide]

–

Account-based systems with capturing, messaging, two-legged settlement, and disbursement.

• These are handled by multiple intermediaries.
• Transfers are costly, cumbersome and opaque.

–

Personal example: I had to cash a cheque from US.

• It took at least five days and transaction cost was significant

(about 9%).

–

Operations involve substantial fixed and sunk costs as well as network effects.

• There can be market concentrations.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Contrasting case: cross-border payments (2)

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

On c-b payment innovations

• Innovations are creating new and more efficient

methods for making intra-country payments.

–

DLT can in principle be used in different ways.

–

So far, the potential gains are ”can/would be”.

• One area is speed, transparency and end-to-end

tracking of c-b payments.

• Costs of compliance can be reduced through KYC and

digital identity procedures to share customer information.

–

Privacy and security issues can arise.

• New techniques like DLT can lead to new means of

payment.

–

E.g. hub-and-spoke payments network with digital wallets of virtual

• currencies. [See Figure in next slide]

–

Possible concerns: erratic valuation of currencies, lack of trust,

• perability issues.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

On Payment Innovations: virtual transactions

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Fiat Money Means of Exchange Private Virtual Currencies

HUB SPOKES SPOKES

Digital Wallets Means of Exchange Fiat Money

VIRTUAL TRANSACTIONS

Hub-and-Spoke Network, Source: IMF (2017)

Digital Wallets

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

The Single Euro Payments Area (SEPA) as an example facilitating cross-border payments

13.11.2017 Seppo Honkapohja 40 Source: ECB; http://www.ecb.europa.eu/paym/retpaym/html/index.en.html

Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

European regulation in the retail payments is evolving: Payment Services Directive (PSD2)

• EU legislation for regulating payment services and payments

service providers in Europe, has been part of national legislation since 2009.

• PSD2 is an update to the directive and has to be implemented into

national legislation by 13.1.2018.

• PSD2 will enable bank customers to use third-party providers

to access their payment accounts and to initiate payments on their behalf.

• Banks are obliged to provide access to accounts to third-party

providers through APIs.

–

This allows third parties to develop their own services on top of the infrastructure and data

• wned by banks.
• Through this legislation, the EU aims to increase innovation,

improve consumer protection, and improve the security of payments.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

On the potential effects of Payment Service Directive 2

• Payment Services Directive 2 (PSD2) is not only about

payments.

• PSD2 forces banks to open their payment infrastructure

to all third-party providers.

–

Customers are free to choose.

• For banks, payments are the most frequent touchpoint

to their customers.

–

losing this interaction would mean that banks risk fading into background.

• Payments also provide data which can be used to

analyze customer behavior

–

Identifying profitable customer segments

–

Analyzing credit risk

–

Creating cross-selling opportunities

• Also Payment Account Directive (PAD) 2014:

–

Basic banking services for everyone.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

• 4. Conclusions and policy

considerations

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Conclusions and policy considerations (1)

• Fintech has the potential to shape the financial

industry.

–

Startups and big IT-firms are entering the financial markets to compete with incumbents

• Retail payments are an area where the new products

and players have already entered.

–

In Europe, the regulatory framework (e.g. PSD2) is also facilitating change in the playing field.

=> The supply side of financial services is changing In this changing environment, authorities should focus to preserve security and reliability of financial services. => trust will remain the necessary precondition for financial services also in the future.

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Conclusions and policy considerations (2) Key focus areas for authorities:

• Competition

– Increased competition in services but further consolidation of

financial infrastructures are to be expected.

• Resilience

– Digitalization holds promise of better resilience through

decentralization but can also lead to increased vulnerabilities

• Integrity

– Protection of sensitive customer data and legitimate privacy

• Access and inclusivity

– Certain financial services must be regarded as necessities

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Suomen Pankki – Finlands Bank – Bank of Finland Unrestricted

Thank you!

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