Financial Innovation and the Future of the Financial System · BRANDEIS INTERNATIONAL BUSINESS...

BRANDEIS INTERNATIONAL

BUSINESS SCHOOL

Financial Innovation and the

Future of the Financial System

Stephen G. Cecchetti

www.moneyandbanking.com

http://www.moneyandbanking.com/


BRANDEIS INTERNATIONAL BUSINESS SCHOOL

Cost of Financial Intermediation(as a percent of total assets intermediated)

2

Notes: The data are annual through 1944, and quarterly thereafter. The horizontal axis is expanded from 1945 to

make the data more visible. Source: Figure 3 in Thomas Philippon, The FinTech Opportunity, NBER Working Paper

22476, August 2016.

Cost is 1½ to 2%

Unchanged in 130 years!

https://ideas.repec.org/p/nbr/nberwo/22476.html


Global financial assets by sector

3

Source: Financial Stability Board (2019), monitoring dataset.

2007 to 2017:

Globally:

Banks 48% to 44%

Nonbanks 31% to 36%


Japanese financial assets by sector

4

2007 to 2017:

Japan:

Banks 60% to 62%

Nonbanks 40% to 38%

Source: Financial Stability Board (2019), monitoring dataset.


Technology

5

iPhone 8

1975 Cray-1

iPhone to scale

5000 times power =

= 44,000 times price ($42 million vs $950)

Efficiency +50% per year

Improves:Information collection, transmission & storage

Enhances:Service quality, speed, user experience


Technology

6

Reduces information costs

Improves credit evaluation

Enhances ability of lenders to collect

Lowers transactions costs

Increases convenience

Provides access


Technology

7

Money & Payments

Saving, Lending & Access

Securities Issuance & Venture Finance


Impact of Technology on Finance

8

Money & Payments



Diversification & Risk ManagementIncreases scope & improves efficiency

Safekeeping & Advising Reduces cost and operational risk, moderates behavioral biases



9

Money & Payments


Payments

11

Money is a combination of

Legal framework: government backed/widely accepted

Technology: metal/paper/book entries


Digital Money

12


Digital Fraction of Monetary Base & M2

13

Source: FRED, European Central Bank and Bank of Japan

Money is a combination of

Legal framework

Technology

Central bank money is digital!

Nearly all money is digital!


Digital Money

14

Cannot be anonymous

Must be in unlimited supply

Will be universally available

Has to pay interest

Would commercial banks survive?

What would the central bank become?


((Retail) Central Bank Digital Currency

15

Mobile payments

US: Apple Pay, Amazon Pay, Zelle… <1% of GDP

China: Alipay,Tencent… >30% of GDP(Run by nonbanks!)

Scale and scope economies providers become large


Payments

16

Mobile payments

US: Apple Pay, Amazon Pay, Zelle… <1% of GDP

China: Alipay,Tencent… >30% of GDP(Run by nonbanks!)

Economies of scale and scope become very large

Tech companies are changing payments.

Will they displace traditional banks?


Payments

17

Global volume of remittances (Billions of 2017 U.S. dollars), 1970-2017

18Note: Inflation-adjusted sum of country-specific remittance flows. Source: World Bank.

Average Cost of Sending US$200 Cross-Border (Percent of Total, 2008-17)

19Source: World Bank.

Costs have fallen.

But why do they remain so high?

Volumes increased dramatically

Prices remain high

Barriers to cost reduction:

Anti-Money Laundering (AML & KYC)

Preventing Terrorist Finance


Remittances

20

Volumes increased dramatically

Prices remain high

Barriers to cost reduction:

Anti-Money Laundering (AML & KYC)

Preventing Terrorist Finance

Costs will fall when personal identification

is inexpensive and widely accepted.


Remittances

21

Money & Payments

money unchanged, payments evolving,

risk to banks, some things remain expensive





22

Money & Payments





23


Saving & Lending

24


Banks vs Peer-to-Peer Finance

25

SaverSaverSaver Saver

Borrower Borrower BorrowerBorrower

SaverSaverSaver Saver

Borrower Borrower BorrowerBorrower

Peer-to-PeerBank


Share of Bank Credit in Total Credit

26

1999 to 2018

Japan:

56% to 70%

Euro Area:

66% to 55%

United States:

Unchanged (35%)


https://www.prosper.com/listings

Two challenges:1. Is a potential borrower creditworthy?

2. Will a borrower use resources as they claim?

Solutions:1. Screen and demand collateral

2. Monitor and require net worth


Saving & Lending

28

Two challenges:1. Is a potential borrower is creditworthy?

2. Will a borrower use resources as they claim?

Solutions:1. Screen and demand collateral

2. Monitor and require net worth

Banks are good at screening and monitoring.

Why hasn’t technology reduced costs?


Saving & Lending

29

Unbanked in 2017: 1.7 billion adults (31%)

Unbanked in Indonesia: > 51% adults

Unbanked in United States: 7% adults

(Only 2% of Japanese adults are unbanked)


Financial Access: Mobilizing Savings

30


Unbanked adults by country

and those with mobile phones (millions)

31

Note: Red diamonds indicate those with mobile phones. Source: World Bank Findex.

Numbers large

Everyone has a phone!

Population 15+ in 2014: With no bank account: 450 mn (47%)

With no formal savings: 780 min (85%)

Technology + Government Policy: Aadhaar: Biometric identification issued all adults

Pradhan Mantri Jan Dhan Yojana: no frills, no min balance(Prime Minister’s People’s Wealth Scheme)


Mobilize Savings: India

32


Banking India’s Unbanked

33

Source: Table 2.1, Dutta and Das, May 2017, and PMJDY website. Note: Absent data between March and September 2017

are linearly interpolated.

>300 million

in 3 years!

http://www.math.iitb.ac.in/~ashish/workshop/PMJDY_2017.pdf

https://pmjdy.gov.in/account

Population 15+ in 2014:

With no bank account: 450 mn (47%) now <200 mn.

With no formal savings: 780 mn (85%) now <550 mn.

Technology + Government Policy: Aadhaar: Biometric identification issued to all of adults

Pradhan Mantri Jan Dhan Yojana: no frills, no min balance(Prime Minister’s People’s Wealth Scheme)


Mobilize Savings: India

34

Money & Payments

Saving, Lending & AccessBanks are good at screening & monitoring

Governments can use technology to mobilize saving

Diversification & Risk Management



35

Money & Payments





36



37

Initial Public Offerings(Exploits Blockchain Mania)

Crowdfunding(Raises small amounts from

large number of people)

https://www.kickstarter.com/discover/recommended?ref=discovery_overlay


Examples from Kickstarter

38

Cheese maker

Investigative

Journalism

Donation: charitable giving

Equity: value tokens

Debt: peer-to-peer lending

Reward: pre-sell a product

Litigation: funds lawsuits (receive part of settlement)


Types of Crowdfunding

39

Donation: charitable giving

Equity: value tokens

Debt: peer-to-peer lending

Reward: pre-sell a product

Litigation: funds lawsuits (receive part of settlement)


Types of Crowdfunding

40

Requirements

Owner net worth

Collateral

Sources

Personal Assets (your own, family, friend)

Credit (credit cards, bank loans)

Equity (Angel investors, venture capitalists)

Nonprofits or Government (grants, guaranteed loans)

Traditional Venture Finance

41

Requirements

Owner net worth

Collateral

Sources

Personal Assets (your own, family, friend)

Credit (credit cards, bank loans)

Equity (Angel investors, venture capitalists)

Nonprofits or Government (grants, guaranteed loans)

Traditional Venture Finance

42


Tangible and intangible investment(United States, 1976 to 2017)

43

Source: Lee Branstetter and Daniel Sichel, “The Case for an American Productivity Revival,”

Peterson Institution for International Economics, Policy Brief 17-26, June 2017.

Big Shift

Tangible

Intangible

Investment in software, data, intellectual property, etc.

Intangibles more difficult to value, less useful as collateral

Less reliance on debt finance & public equity issuance


Changing Venture Finance

44


Number of Listed Domestic Companies

45

Source: World Bank Development database. For Japan, the jump of 1100 firms in 2013 is due to the

integration of the OSE cash market into the TSE,

U.S & Euro Area:

Dramatic Fall

Japan:

Moderate rise

Investment in software, data, intellectual property, etc.

Intangibles more difficult to value, less useful as collateral

Less reliance on debt finance & public equity issuance

Consequence of investment shifting to intangibles:

Rise in private equity

Increase in mergers & acquisitions

Fall in number of listed domestic companies


Changing Venture Finance

46

Money & Paymentsmoney unchanged, payments evolving,

risk to banks, some things remain expensive

Saving, Lending & Accessbanks are good at screening & monitoring,

governments can mobilize saving

Securities Issuance & Venture Financetraditional sources and methods endure,

but shift toward private equity



47


Cost of Financial Intermediation(as a percent of total assets intermediated)

48

Notes: The data are annual through 1944, and quarterly thereafter. The horizontal axis is expanded from 1945 to

make the data more visible. Source: Figure 3 in Thomas Philippon, The FinTech Opportunity, NBER Working Paper

22476, August 2016.

https://ideas.repec.org/p/nbr/nberwo/22476.html

BRANDEIS INTERNATIONAL

BUSINESS SCHOOL

Financial Innovation and the

Future of the Financial System

Stephen G. Cecchetti

www.moneyandbanking.com



Financial Innovation and the Future of the Financial System · BRANDEIS INTERNATIONAL BUSINESS...

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