Bank of Canada Deputy Governor: Cooperation is the key to advancing the development of distributed ledgers

Rage Review : Technological innovation in the financial sector can provide better and lower-cost services to everyone and businesses, while better controlling risks. Financial institutions that adopt new business models will survive. Payments Canada, the Bank of Canada and R3 are working together to test distributed ledger applications to achieve large-scale payment experiments to find the mechanisms, limitations and possibilities of blockchain. Clear supervision will promote the development of innovation, but it is also necessary to deal with the problems brought about by development. Cooperation between financial institutions, new market entrants and policymakers can modernize the financial sector and create the best environment for blockchain.

Translation: Nicole

Technological innovation in the financial sector can reform the current financial system. If it can provide better services at lower costs for people and businesses, while better controlling risks, this is a good thing.

Change is coming, and it’s becoming increasingly clear what consumers are demanding these days. They want financial services to be better integrated with their mobile devices and online activities. Large, well-funded companies like Apple and Google are starting to offer financial services. The combination of the current inefficient legacy systems and new technologies is opening the door to greater competition.

This makes people wonder how much impact this will have on changes in the financial sector.

It’s still early days and no one knows for sure. I think even if some technologies are revolutionary, their overall impact on the financial system will be incremental.

This is because the most transformative technologies, such as distributed ledger technology (DLT), still have many hurdles to clear, giving financial institutions ample time to transform into new service providers and join the financial system.

In the end, those financial institutions that adopt new business models will survive.

Deputy Governor of the Bank of Canada: Carolyn Wilkins

Change is coming

I know some readers are imagining a future where decentralized currencies replace national currencies. This is a poignant idea, but I think it is unlikely unless decentralized currencies can outperform national currencies as a store of value and medium of exchange. At the same time, national authorities will want to continue to implement an independent monetary policy.

Applications beyond digital currencies – payment methods, trade finance, etc. – appear more promising. In some cases, the benefits include increased efficiency, lower operating costs, reduced risk to both parties, freeing up funds for other use cases, and increased transparency.

That’s why the company is investing a lot of money and energy into blockchain technology. Since the Bank of Canada regulates the main financial market infrastructure and participants in the payment system, we can see the potential for change. Therefore, we are working with Payments Canada, the Bank of Canada and R3 to test the application of DLT for large-scale payments. Our current goal is to find out the mechanisms, limitations and possibilities of blockchain technology.

I can’t find a better way to understand blockchain technology than using it.

The road to innovation

There are many frameworks to work on and many hurdles to overcome before DLT systems are ready for prime time. Are they based on DLT or are they just interesting questions that exist on current technology? Financial innovation can solve some old problems, but it can also create some new ones. So, while I support innovation, we also have a responsibility to properly manage the risks it brings.

This is a difficult path, best undertaken in the private sector. That’s why our advisory services and partnerships are so important to us. Some countries, like the UK and Singapore, have regulatory sandboxes. We agree that a clear analytical framework is needed to understand and assess the benefits and challenges. Authorities will assess many aspects, including consumer protection, financial inclusion, market integration, competition policy, and financial stability. Because the Internet is global, regulation must also be global. If designed well, a clear and consistent regulatory framework will promote innovation.

Right now, many things are not about financial stability, and I am very worried that "excessive influence will cause failure" will emerge in new forms and exceed current regulatory boundaries.

Payments are a good example of a player that is currently not subject to regulatory control and is very important to the system, even if they do not take on the same risks as banks, such as maturity transformation or leverage, or have too much influence to be considered by the system. Increasing direct access means that even small players will create significant dependencies in the financial system, especially if they are directly connected to the core payment infrastructure.

This could lead to a moral hazard. When considering systemic importance, especially from a cyber risk perspective, authorities should at least take operational dependencies seriously.

Looking ahead

Over the past few years, our research has focused on new payment methods, adoption and competition of digital currencies, and the key benefits of private e-money. We are broadening our development projects to include DLT and peer-to-peer lending.

We also wonder how new financial technologies will address the dynamics that create demand for financial intermediaries.

Some think it’s possible, at least in theory, that new technologies could allow different structures to solve the same friction problems, eliminating the need for financial intermediaries altogether.

In fact, I don’t think that will happen. The name and the face can change, but I don’t think technology will change the need for trust, term changes, loan supervision, and the need for intermediaries between lenders and borrowers.

Now is the time for financial institutions, new market entrants and policymakers to collaborate to create the best environment for modernizing the financial sector while managing the risks that arise.

For those of us working at the Bank of Canada, the focus will be on protecting financial stability and maintaining the safety and sound operation of core financial market infrastructure.