Remarks by Professor Amir Yaron, the Governor of the Bank of Israel, at the Banking Supervision Department Conference held today
- One of the risks in the expanded concept of money is money fragmentation. As of today, the central bank’s money is to be found and is honored in all parts of the economy. However, as new types of money develop, there is concern that anyone who issues money will honor only “its” money.
- To the extent that means of payment are developed that are not linked to the central bank’s money, the ability of the central bank to determine monetary policy will likely be hindered. Therefore, one of the main functions of central banks is to prevent fragmentation and to ensure that the payment systems become even more uniform and efficient. One of the ways to accomplish this is by means of a CBDC.
- In view of these trends, the Bank of Israel has decided to accelerate the investigation, research and preparation prior to the possible issue of a digital currency in the future, while providing an appropriate response to the various risks involved. It is important to emphasize that as in the case of many other central banks, the Bank of Israel has not yet decided whether to issue a digital currency and we are still examining the issue. We are committed to remaining at the forefront of economic and technological knowledge in this context.
- The Bank of Israel has in recent years worked to remove the barriers to entry for new banks and to modify the regulations that apply to them, with the goal of increasing the number of competitors in the economy. As a result of this process, private entrepreneurs have established a digital bank, in close coordination with the Bank of Israel. This technological innovation will facilitate the creation of new banks with a leaner structure of expenditure, which will contribute to competition.
- The lack of clarity as to the characterization of technology companies entering the financial system is liable to create a concern of regulatory arbitrage, which may lead to problems in the domain of money laundering and the war on terror. We must therefore guarantee that new companies operate according to the existing standards in the international financial industry.
- There is still no repo market in Israel and there is almost no interbank credit activity, which is attributable to the high level of liquidity. As a result, there is no market interest rate that can act as the overnight rate and which will constitute an alternative to the Telbor. Therefore, we are working to replace the Telbor interest rate, on the basis of which derivatives transactions are carried out, with an interest rate declared by the Bank of Israel. In parallel, we are working to develop the repo market.
First, I would like to commend the Banking Supervision Department for organizing this conference and to welcome those attending.
Innovation in the financial system is a focus of many regulators both in Israel and worldwide. Advancing this system has been at the top of the Bank of Israel’s agenda in recent years, and that is no coincidence because financial innovation—when carried out wisely—has many positive effects on all parts of the economy.
I will open with a short description of the importance of the financial system to the economy. I will then present the recent trends in the financial world and the steps being taken by the Bank of Israel in this context. I will conclude with some thoughts on the future of the financial world, with emphasis on the role of financial regulators.
The financial system constitutes the “lubricant” of the real economy. Many studies have demonstrated the connection between the level of financial development and both strong growth and investment. In an economy with a developed capital market, the allocation of sources and the flow of credit to finance real activity will be more efficient, will lead to a broader dispersion of risk and will result in lower costs of financing.
The development of the financial markets has in recent years been supported by, among other things, the integration of advanced technologies. The increasing innovation in financial technology has wide-ranging effects on the financial sector and more generally on the entire economy. The progress in this domain offers new and important opportunities. For example:
Technological progress facilities the development of new financial competitors and products. These increase competition in the financial world, which reduces prices, increases diversity and improves the quality of financial products, alongside greater customization and increased access to credit for small businesses and households.
The assimilation of financial technologies can serve as an important axis for strengthening financial inclusion. Using advanced technologies, it is possible to bypass existing barriers and to introduce advanced financial tools among populations that are currently marginalized in the financial system. Increased financial inclusion will contribute to inclusive growth, a reduction in inequality and the minimization of the unreported economy.
In view of these and other opportunities, financial regulators must continue to support these processes and the accelerated introduction of financial technology, by means of: the removal of existing regulatory obstacles; the implementation of new regulation in a smart and streamlined manner; encouragement of innovation-supporting infrastructure; and support of cooperation between the traditional financial system and hi-tech companies.
Alongside the opportunities being created by financial innovation, there are a number of challenges that need to be considered. Thus, alongside the desire for accelerated growth, regulators have a crucial role to play in maintaining security and responsibility in the financial system, alongside the careful management of risk.
In particular, the protection of the consumer deserves special attention. For a number of decades, the traditional financial system has been implementing comprehensive regulatory directives that apply in this domain. The imposition of this regulatory framework on high tech companies is not a given and may require modifications and changes. The consumer deserves regulatory protection when using a financial product and from the consumer’s perspective it shouldn’t matter what type of financial body is providing the product. Yet at the same time, overly burdensome regulation may deter high tech companies from becoming directly involved in financial transactions.
The issue of consumer protection and information brings up two additional challenges:
First, the protection of privacy: The financial bodies and high tech companies gather prodigious amounts of information, which leads to a number of important questions: Should regulators limit the gathering of this information? Or perhaps they should only supervise the way it is stored and the uses it can be put to?
Second, the use of information and data may have far-reaching implications for the structure of competition and for concentration in the financial sector. For example, the use of information gathered by a particular service provider to provide a different type of service may create monopolistic market power. This is an important issue that calls for the correct balance between stability and competition.
Another challenge created by financial innovation is in the cyber domain. The growing use of technological means and digitization of financial services increases the exposure to potential attacks. This exposure is exacerbated by the connectedness between the various entities operating in the financial system. A problem in one company is likely to create systemic risk to all players.
The lack of clarity with respect to the characterization of high tech companies entering the financial system is liable to create concern regarding regulatory arbitrage, which can lead to problems in the area of money laundering and the war on terror. We must guarantee that the new companies operate according to existing standards in the international financial industry.
I would now like to devote a few words to steps taken by the Bank of Israel to create a more advanced financial system.
The Bank of Israel has in recent years worked to remove barriers to entry for new banks and to modify regulations accordingly, a process that is meant to increase the number of competitors in the market. This process has led to the creation of a digital bank by private entrepreneurs, in close collaboration with the Bank of Israel. Technological progress makes it possible to create new banks with a leaner cost structure, which will contribute to competition.
Another step taken is the open banking reform which enables banks’ customers to share their financial information with third parties. This process can create value for the financial customer in a variety of ways. For example, the customers will be able to compare the services being offered by a variety of competitors and to choose the best-suited and most worthwhile according to their needs. This reform will encourage competition among the banks and between them and bodies outside the banking system.
If a customer wishes to accept the offer of a competitor—we have taken care of that as well: the “transfer with a click” reform that we introduced in recent years will allow the customer to switch banks quickly and efficiently and completely online.
As an aside, I would mention a point that I have repeated many times: The implementation of the reform only within the banking system is liable to create a situation in which a company specializing in investment advice will offer a portfolio to a customer that appears to be exactly suited to his characteristics—but only on the basis of the bank savings to which it has access, without taking into consideration assets held in provident funds, investment funds, pension savings, etc., which may lead to more harm than good.
Therefore, in order to allow the customer and the service provider to obtain a full financial picture, an open finance infrastructure that includes all financial entities is needed in Israel, and not just an open banking infrastructure.
Another step taken by the Bank of Israel relates to the Telbor interest rates and the development of the repo market. The Telbor interest rate is an interbank benchmark determined for various time periods according to quotes from a number of banks and is parallel to the IBOR interest rate that exists in many countries. This benchmark interest rate is a critical anchor for a large number of contracts and financial activities in the capital market.
In view of the problems that have emerged, many countries have switched from IBOR interest rates to riskless overnight interest rates that are based on transactions in the repo market or in the interbank market.
In Israel, and primarily in view of the high level of liquidity, there is still no repo market and there is almost no interbank credit activity. Therefore, there is no market interest rate that can serve as an overnight interest rate and as an alternative to the Telbor.
As a result, we are working to replace the Telbor interest rate—on the basis of which derivatives transactions are carried out—with an interest rate declared by the Bank of Israel, and at the same time we are working to develop the repo market.
The Bank of Israel is investing a great of effort to upgrade the existing payments system in Israel. Convenient, efficient, secure and stable payments systems are an important component of an advanced economy.
The assimilation of the EMV standard constitutes an important step in the introduction of advanced payment technologies and the entry of additional players, both domestic and foreign. In the past year, most of the businesses in Israel have adopted this standard and Israelis are paying by means of a private code (Tap and Pay) in the case of large amounts. This is in addition to the fact that many of us already leave our wallets at home because we are able to pay at many points of sale by means of a smartphone – thanks to this standard.
The Bank of Israel is promoting the shift to a fast payments infrastructure, which will make it possible to expand the variety of payment options in the payments system and to execute direct payments from the customer’s account. This will reduce transaction costs since there is no need for credit until settlement and will increase the liquidity of businesses, and if connected to the international infrastructure, it will also allow for more efficient cross-border settlement.
Though not yet implemented, another vehicle that we are working to introduce, together with all of the relevant players, is the securitization market. While the securitization market in other countries is of a similar size to the conventional bond market, in Israel it is still tiny. A robust securitization market will accelerate the development of a non-bank credit market, will enrich sources of financing, will expand the investment channels of institutional investors and will facilitate the freeing of capital and the management of duration in the banking system. Unfortunately, this area has not been developed as it should have been in my view—I am hopeful that this will soon be rectified.
From a broader perspective, financial innovation—beyond its natural effect on the world of banking and payments—is liable to have an even more direct effect on monetary policy. The technology brings about a situation in which new players—private entities that are not part of the conventional financial system—claim to be offering new types of money. For example, crypto currencies, which are issued by computer programs, do not have any intrinsic value and their value is highly volatile. So far, they have not been used as a means of payment, but only as an investment asset. There are also stablecoins that are meant to be backed by stable assets and therefore to have a stable value; however, they are issued by private bodies and there still remains a question of transparency with regard to their composition and ownership.
Both of these, and the latter in particular, may challenge monetary policy. We must thoroughly understand the dramatic changes in this domain as well and to prepare ourselves for the challenges of tomorrow.
As every freshman student in economics knows, money has three basic functions: a means of payment, a unit of measurement and a store of value. New technologies are challenging all three.
One of the risks in expanding the concept of money is money fragmentation. Currently the money of the central bank is to be found and is honored in all parts of the economy. However, as new types of money are developed, there is a concern that each issuer will honor only “its” money.
To the extent that means of payment are developed which are not linked to the central bank’s money, the ability of the central bank to steer monetary policy will be hindered.
Therefore, central banks have a central role to play in preventing money fragmentation and ensuring that the payment system becomes even more uniform and efficient. One of the ways of doing this is by means of a Central Bank Digital Currency (CBDC).
So what is a CBDC? It is a digital means of payment that is based on the commitment of the central bank to its holder.
There are a number of motivations for the Bank of Israel to issue a digital currency of its own: creation of an efficient, advanced and secure alternative to the existing new means of payment in the digital age; creation of an innovative infrastructure that will ensure the compatibility of the payments system to the needs of the future digital economy; the ensuring of redundancy in the payments system and its normal functioning during an emergency or breakdown; creation of an efficient and cheap cross-border payment infrastructure; supporting the public’s option to use a digital means of payment while maintaining their privacy; and support of government policy to reduce the use of cash.
It is important to mention that the issuing of a digital currency—and certainly if is not carefully designed—is liable to involve significant risk. The main risk is the possible harm as a result of bank disintermediation. If the public chooses to replace a significant portion of its deposits with the digital shekel, the ability of the banks to fulfil their basic role, namely intermediation between savers and borrowers and the provision of credit, is liable to be compromised and in a way that will cause significant economic harm.
The digital shekel is also liable to have an effect on monetary transmission. A poorly thought-out design of the system may generate cyber risk, risks to privacy and risk to the reputation of the central bank.
In view of these developments, the Bank of Israel has decided to accelerate the process of investigation, research and preparation prior to the possible issuing of a future digital currency, while providing a suitable solution to the various risks. It is important to emphasize that, like many other central banks, the Bank of Israel has not yet decided whether to issue a digital currency and we are still examining the issue. We are committed to being at the forefront of economic and technological knowledge in this area.
I would like to conclude the lecture with some thoughts about the basic characteristics that the new financial system should have, with emphasis on the role of the Bank of Israel as a leading regulator of the financial system and the role of financial regulators in general.
First, the resilience and trust of money and the payments system should not be harmed. Money and the payment system should be stable enough to endure economic crises and they should be convenient to use and resistant to technical breakdowns and intentional attacks.
Second, the future world of money must protect privacy and maintain the sovereignty of the consumer over his information, while complying with the rules of money laundering and the war on terror and the tax regulations. New electronic forms of money will force us to define the boundary between maintaining the privacy of the consumer and the ability of government authorities to access information when necessary.
In this context, it is worth mentioning the issue of international standardization that is meant to prevent corporate migration to “regulatory havens” where regulation is less stringent. Moreover, standardization is also highly important in order to develop the financial system’s ability to assimilate new technology and its connectedness with international bodies.
In addition, the financial system must be inclusive and open to all segments of the population.
Policy makers around the world are examining and discussing the effect of financial technology and innovation on the economy and on society as a whole, the modifications and adaptions in regulation that are called for and the correct division of labor between the private and public sectors in the design and management of the new financial system.
We will continue to work, alongside our partners in the public sector, the private sector, the central banks and international organizations, in order to shape the future financial system in a way that will exploit technology for the benefit of the public.
Thank you and I hope you will enjoy and benefit from the rest of the conference.