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.