Author: Dr Joachim Nagel

President of the Deutsche Bundesbank, Member of the Governing Council of the European Central Bank

The role of central banks in the digital transformation of financial markets

Digital transformation is taking place at a rapid pace, and its consequences for society and the economy are very much in evidence. Virtual meetings, instant messaging and online shopping have become part of our daily life.
The role of central banks in the digital transformation of financial markets

Dr Joachim Nagel, President of the Deutsche Bundesbank (Foto Nils Thies)

Many governments are actively promoting digital transformation through strategic measures and the necessary investment. Poland is a leading example of this and is pursuing its digital agenda with great enthusiasm and commitment. This is reflected, amongst other things, in Poland’s DESI (Digital Economy and Society Index), a score that monitors the digital performance and digital competitiveness of European countries, which has been rising steadily in recent years.

Clearly, digital transformation affects the economy at large. However, the effects on the financial sector are even more pronounced, because most, if not all, typical financial services can be digitalised. Online banking, online trading, and online loans are just a few examples. This process has only started in the last few years and will accelerate in the years to come. Nonetheless, it has already fundamentally changed the structure of financial markets. For instance, a series of new players have entered the financial market, in particular, fintech and bigtech companies. They have introduced innovative products and developed new channels to enter the financial market. Established financial institutions have also adapted their product portfolios. Today, most banking services and financial transactions can be managed remotely using a mobile device such as a smartphone or tablet. This is to the benefit of the consumer who can send money around the world while drinking a cup of coffee on the couch. Finally, decentralised finance (de-fi) increasingly allows direct access to financial products on a decentralised network. As an example, financial assets can be stored and transferred using a secured wallet, without relying on intermediaries such as brokers, exchanges or banks. The bottom line is that the landscape of the financial market has changed dramatically over the last few years.

The developments outlined above open up myriad opportunities for financial institutions. They can, for example, digitalise existing business models or create new ones using advanced technology such as robotics, artificial intelligence, blockchain or cloud services. An illustrative example are robo advisors that provide financial advice and investment management services based on algorithms and with minimal human intervention. However, digital transformation also entails risks. Some of them are particularly relevant for central banks, because they have the potential to impair financial stability. For example, the substitution of classic banking services through non-banks could affect the soundness of financial institutions or the banking system as a whole as it has adverse effects on profitability and refinancing conditions. In addition, digitalisation can sometimes stifle competition because platform markets established by bigtechs tend towards market concentration. This creates barriers for new market entrants and can lead to monopolies. Finally, it is unclear how all these changes will influence the transmission of monetary policy.

Without doubt, digital transformation affects central banks in many areas, and we need to define the right strategic approach. On the one hand, central banks must provide an infrastructure that allows innovation from the private sector to emerge in the first place, in particular innovation in the realm of new business models and digital payment services. On the other hand, central banks also need to engage in the discussion about whether the current regulatory framework fits the financial industry of tomorrow. Financial stability, data privacy and consumer protection are just some of the topics up for discussion, and good solutions require close co-operation between the different stakeholders. It is not entirely clear what the future will bring, but as central banks we have the expertise to enrich the discussion about what a sensible path into a digital financial future might look like.

Digitalisation can also be used as a helpful tool for central banks in dealing with the increasingly pressing issue of climate change. Central banks need to embed climate-related risks in their analyses to gain a full understanding of the repercussions that climate change will have on the financial system as a whole and on central banks’ balance sheets in particular. Data availability and disclosure have to be improved, analytical and forecasting toolkits have to be updated. Digital technologies such as artificial intelligence or process automation can help achieve these goals, because they allow the relevant data to be gathered and analysed in a cost-efficient way. Digital innovation is consequently very useful when it comes to identifying and understanding climate-related risks in the financial system.

That said, digitalisation is more than just a technological phenomenon. It also has an array of social aspects, and it changes the way we live and work. Therefore, central banks need to consider not only the technical consequences of digitalisation in relation to the duties they carry out in line with their mandate. They also need to review organisational structures because digital transformation brings about fundamental changes in working modes and affects day-to-day work within central banks. Technology influences the way in which central banks interact and communicate with stakeholders, for example with the banks they supervise. Moreover, central bank staff are increasingly using digital tools to free up time that would otherwise be spent on routine and repetitive tasks for analytical tasks. In order to make the most of new technologies, we thus need to keep up with the pace of digitalisation in the financial sector and the broader economy. I am convinced that the aforementioned challenges can only be tackled if central banks themselves exploit technological opportunities by digitalising their processes. Finally, a digital approach to central banking is necessary to remain attractive for current and prospective employees.

The next decade has much potential, but we also need to monitor the risks carefully. The whole financial system needs to embrace digitalisation if the benefits for society as a whole are to be maximised. This includes both private and public elements – including central banks, supervisory authorities and regulatory bodies. In that context, close liaison among central banks is crucial. This is why I very much appreciate the close cooperation and the constant exchange with Narodowy Bank Polski, as a partner within the European System of Central Banks. Cooperation and exchange are the foundation upon which we will build Europe’s digital future – and our future in general.

Dr Joachim Nagel, President of the Deutsche Bundesbank, Member of the Governing Council of the European Central Bank

 

With the article by Joachim Nagel, the President of Deutsche Bundesbank, we begin a series of articles in Obserwator Finansowy written by governors of central banks and distinguished economists. The series is under the special patronage of the Governor of Narodowy Bank Polski, Professor Adam Glapiński. The authors of the articles have agreed to waive their fees for writing the texts, and in exchange NBP shall donate the amount equivalent to the fees onto the account of the National Bank of Ukraine in order to support the NBU during the war. Below is a foreword by the Governor of NBP to the whole series:

On 24 February a huge tragedy occurred, in the face of which it is impossible to simply move on as if nothing had happened.

Nobody can remain indifferent to the misfortune that has befallen the Ukrainian nation.

All of us are shocked by the press reports, and particularly by what we see in the mass media.

Fighting Ukraine is not only its brave soldiers, but also an army of thousands of civilians trying to preserve normality in a country stricken by Russian aggression.

This army includes the staff of the National Bank of Ukraine, with whom NBP is in constant contact.

Aware of our Ukrainian colleagues’ needs, we have invited several central bank governors and eminent economists to share their knowledge on the economic processes taking place around the world.

It is rare for such a distinguished group of authors to feature in Obserwator Finansowy, which is published by NBP. It is also worth underlining that all the authors have waived the fees for their articles in order to donate them to meet the needs of our colleagues working in the National Bank of Ukraine.

I believe that you will find the series of these articles interesting, especially since they not only share the knowledge and experience of their authors, but also express goodwill towards the war-afflicted NBU.

                                                                           Prof. Adam Glapiński, Governor of NBP

Dr Joachim Nagel, President of the Deutsche Bundesbank (Foto Nils Thies)

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