By Yoseph Eshetu Shibeshi
The next wave of disruption is currently sweeping through the world of finance, banking and currencies; up-ended by technology. We have seen how ride hailing services have completely changed the landscape of taxi and transport provision in many of the world’s countries with companies like UBER and other similar local and international solutions completely changing how traditional taxi hailing is conducted. The world of retail has also gone through the moves, being disrupted by companies like AMAZON, ALIBABA and other similar companies. Even traditional industries like print media, books, magazines and newspapers have also fallen victim to digital disruption and are increasingly adopting digitization. It appears that even sectors like finance are not immune to this wave of change, with FINTECH companies currently going toe-to-toe with well-established traditional commercial banks and other payment institutions through the provision of easy and fast payment solutions. More and more FINTECH companies are now growing and taking the next step in becoming full-fledged commercial banks, by increasingly getting into the space of providing more services traditionally dominated by commercial banks, and this is creating an existential threat to commercial banks. It is more than likely that we will see the role of commercial banks increasingly being diminished over the next decade, with some extreme views even challenging thoughts that whether we need conventional traditional banking at all. With companies like ALIPAY in China and WEPAY amassing huge powers and leverage through the services that they provide. This trend is not only threatening to commercial banks, but also challenging central-banks and the effectiveness of monitory policy in general.
To explain these two effects, we first need to look at how historically there exists an inter-dependence between central banks and commercial banks. First, it helps to understand that there are generally two parts to every economy, the REAL sector, where goods and services are produced, exchanged and consumed; and the MONETARY or financial sector, where the supply of money is controlled, and it is the interaction of these two sectors that ultimately defines the short and long run macro-economic stability of the individual economy, in very simple terms. Traditionally, central banks are the ultimate and final authority for each country or group of countries’ currencies, by taking accountability and building confidence in the financial system, and as the backers of currency as a medium of exchange with-in its borders, and this exclusive power is known as Monitory Sovereignty. In very simple terms, among other things, Central Banks use this power to effect monitory policies by varying the supply of money that circulates in the economy, and the price of money (interest rate). Each commercial bank is then required to deposit a certain proportion of the deposits that they mobilize from their customers, with the central bank, and lend out the rest and generate interest, and thereby their profits. This system, called FRACTIONAL RESERVE BANKING, started over 250 years ago with the bank of England, and ever since has been the main tool for creating money (by and large, it has evolved through the gold standard, but essentially, remaining the basic principle remaining unchanged). Whilst doing so, commercial banks inadvertently create credit with-in the economy, and it is this ability to create credit that ultimately leads to further deposits and further credit (you get the picture), and the effectiveness of monitory policy. By varying the amount of deposit requirements as well as the interest rate (the price of money), depending on what they want to do in the economy, central banks exert their influence through commercial banks, as an instrument of monetary policy. This is an oversimplified version of how money is created in the economy, and of-course we have only looked at one aspect of what central banks do, but it will suffice for the time being.
Money, in all its forms has three important functions, it provides a UNIT OF ACCOUNT, a MEDIUM OF EXCHANGE, and a STORE OF VALUE. So, with growing numbers of powerful FINTECH companies increasingly digitizing payments for transactions, and increasingly providing other services that have been traditionally been provided by commercial banks, like loans, it is no wonder that the next step for them would be to up-grade to a full-fledged commercial bank by applying for licenses. In-fact, this is exactly what seems to be happening. Grab and the ANT group are cases in point in Singapore. One big advantage that fintech companies have over commercial banks is the access to increasingly more and more data from their customers; so for instance, they will be able to learn the shopping habits of their customers, spending habits, earning history, risk appetite and all of this data gives them an unprecedented power in assessing each customer and their risk profile when it comes to evaluating who makes up a good (credit worthy) borrower, and amazingly, all of this can potentially happen instantly, supported by technology. This is a huge advantage that the FINTECH world has one over the commercial banks, as traditionally, this power of knowing whom to lend to, was a closely guarded knowledge base for commercial banks. So, if fintech companies can do a better job of assessing customer credit scores than commercial banks, and if they are adding more and more of the services that traditional commercial banks used to do, is it then possible for them to completely replace them, and potentially change the landscape of how the delicate balance of money creation is conducted? As such, policy makers are always concerned about questions on the future, and what type of customers they will end up serving. Paraphrasing Jean-Pierre Landau, the former deputy governor of the Banque De France (among many of his former influential roles), when it comes to today’s pre-teens who are well versed on the use of technology and mobile phones, and their likelihood of choice between conventional and digital banking, and we all know which one they will choose, and this is what keeps bankers like him awake at night.
Fintech companies are also threatening central banks by robbing them of the effectiveness of monitory policy, as well as the power of monitory sovereignty. A good example is the case of FACEBOOK, which created LIBRA, later re-named to DIEM. The project was originally intended to make up a digital currency backed by a group of major currencies, and imagine how this will give it a clear advantage, given its nearly 2.8 billion active facebook users worldwide; who will not have a problem of credibly accepting a “global currency” that will be effective everywhere. This obviously spooked governments and central banks worldwide, that it may effectively take-away their monetary sovereignty and the potential of opening a loop-hole for money laundering, effectively forcing many of its high-profile backers like Paypal to defect, which is why it has now scaled down from its global ambitions and trying to launch a one to one pegging to the US dollar, and only initially to be launched in the United States.
This takes us to the next risk posed by digital currencies and payment platforms from fintech, and that is the issue of PRIVACY and DATA PROTECTION, being left in the hands of private companies. As more and more of our activities going online using these platforms, the amount of data that gets in the hands of these private companies is huge, and the risks are too great to bear, calling for additional mitigating regulations on privacy and data protection. The western world is well ahead in this regard than developing countries like Ethiopia, but even they are having to look at enforcing additional controls; and what of us, that are only at the beginning of this journey? Could there be a way we could leap-frog some of this learning journey and jump straight to the solutions?
In between this, there is another innovation that is sweeping the world over again, and that is the subject of govcoins, or digital currencies issued by central banks directly. This is a system where, in effect, citizens can directly open accounts with the central bank, and effectively jump the entire middlemen of commercial banks. The BAHAMAS, with a population of less than 0.5m people happens to be the first country in the world to launch this, which is a form of CBDC (Central Bank Digital Currency). I should point out, so far, there are no clear definitions of CBDCs as yet, and there could be different variants of it, based on whether it is to be pegged to a fiat currency, if it is programmable, and other features. As it happens, at the moment, CBDC is also being experimented by 50 different governments through-out the world, experimenting with its effectiveness. According to the Economist, The Bank of International Settlements (which is a club of Central Bankers) predicts within three years, 20% of the world’s population will live in economies with CBDCs. China has issued its version for some 0.5m people, to use it and get a practical experience. The UK has also commissioned a task-force to study CBDCs in March this year. The United States is also studying the issuance of a digital dollar. Christine Lagarde, President of the European Central Bank predicts that it will take up-to 4 years to launch CBDCs, with all the controls and safeguards in place. CBDCs will of-course put back the power of monitory sovereignty and the effectiveness of monetary policies squarely back in the central banks’ hands. However, this will then put the power of data collection, and therefore, privacy and data protection in the government’s hands, and potentially a threat to individual freedoms and democracy. Some of these challenges can eventually be straightened out through regulation, to create a system that works for everyone. So at this time, the question of having CBDCs is a question of when not if.
And what of the white elephant in the room, which I am sure all of you are asking, regardless of the solutions coming from the private sector or CBDCs, will this not expose the system to crippling cyber-crime, where it becomes a victim to malicious malware to stop it in its tracks? All of these questions also need to be thought out and mitigation plans put in-place well ahead of launch.
Boldly borrowing a concept from the central limits theory of statistics, in the long run, there will be a tendency of “regression to the mean”, where all things will gravitate towards the average, the final outcome will most probably be a combination of the different solutions available.
In all of this, what implications are there for Ethiopia? Are there learnings we can take now, and things we can work on ahead of time, like privacy and data protection laws, protection against illicit finance and anti-money laundering, safeguards against cyber-crime? What are we doing to link individual identities with bank-accounts, and how do we start building credit history on the back of this? It is undeniable that Ethiopia is in a unique position when it comes to operating one of the largest telecom companies in Africa still being run by the government, and what implications of its privatization have on what the future is going to look like, in the sense that it provides an additional tool to leap-frog some of the processes that the rest of the world is going through right now? Already, great strides are being made through the launch of TELEBIRR and its significance to bring in the mass of unbanked population, into the financial system. Are we missing on any potential opportunities to of this unique position to make transition easier? Borrowing from the academic world, “the proof of it is left to the student as an exercise” I will leave these questions to the policy makers of our nation.