Thanks, Chris, and thanks for the invitation to talk to you at this time concerning the alternatives and dangers of innovation. For the needs of our dialogue at this time, I shall be specializing in monetary innovation supported by new applied sciences, or fintech.1 Within the fall of 2017, we managed to get Chris to just accept an invite to talk at a fintech convention in Ann Arbor, so it is about time that I returned the favor. Since then, we’ve continued to see main modifications in applied sciences and the monetary companies and merchandise they assist. In trying over the supplies for that convention, nevertheless, I am struck by how the important thing themes have remained fixed over, not solely the final 5 years, however arguably for hundreds of years. Monetary innovation has all the time introduced promise and threat, and the pressing must get regulation proper. In 1610, when Dutch retailers and bankers had been in any other case busy creating international finance, a collection of destabilizing financial institution runs additionally moved them to determine a ban on short-selling. Most of the points we grapple with at this time aren’t as new as we predict.
Supporting Innovation with Acceptable Regulation
First, let’s begin with the promise. Daily, all of us have numerous interactions with the monetary system—depositing our paychecks, shopping for groceries, paying hire, borrowing, saving, and insuring towards vital dangers. The promise of fintech is that it will probably make monetary services higher, sooner, cheaper, and extra accessible. Monetary innovation supported by new applied sciences can disrupt conventional suppliers by spurring competitors, creating merchandise that higher meet buyer wants, and increasing the attain of monetary companies and merchandise to these usually underserved.
To understand the advantages of innovation, we have to handle related dangers. Now we have seen by means of historical past that pleasure over revolutionary monetary merchandise can result in a tempo of adoption that overwhelms our capability to evaluate and handle underlying vulnerabilities. As we noticed within the lead as much as the International Monetary Disaster, revolutionary monetary merchandise can masks rising dangers, leading to important harms to companies and households and finally undermining monetary stability. These merchandise can go away shoppers weak if they aren’t coupled with significant disclosures and primary protections towards abusive practices. Innovation can result in disruptions of present markets, which can be helpful, however might also generate new systemic dangers.
Guarding towards these dangers is likely one of the jobs of monetary regulation and supervision, and I will speak by means of a couple of examples of how we’re working to take action now. However I’d be aware with some humility that hanging the correct steadiness between creating an enabling surroundings that helps innovation and managing associated dangers to companies, households, and the steadiness of the monetary system isn’t any straightforward process. When rules are too prescriptive or regulators too cautious, they run the danger of stifling innovation and locking available in the market energy of dominant members in methods that may elevate prices and restrict entry. When regulation is lax or behind the curve, it will probably facilitate risk-taking and a race to the underside that places shoppers, companies, and the financial system at risk and discredits new services with shoppers and traders. I imagine everybody has a stake in getting the regulatory steadiness proper.
Hanging the Proper Stability for Crypto-Asset Exercise
Crypto-assets have grown quickly within the final a number of years, each in market capitalization and in attain. However current fissures in these markets have proven that some crypto-assets are rife with dangers, together with fraud, theft, manipulation, and even publicity to money-laundering actions. Crypto-asset-related exercise, each inside and outside supervised banks, requires oversight that features safeguards to make sure that crypto service suppliers are topic to comparable rules as different monetary companies suppliers. We proceed to work on this situation from the overriding precept that the identical kind of exercise must be regulated in the identical approach. This precept holds even when the exercise might look totally different from the everyday actions we regulate, or when it includes an thrilling new expertise or a brand new approach to supply conventional monetary companies.
The Board is working with our colleagues on the Workplace of the Comptroller of the Forex (OCC) and the Federal Deposit Insurance coverage Company (FDIC) to make sure that crypto-asset-related actions banks might turn into concerned in are effectively regulated and supervised, to guard each clients and the monetary system.2 Many of those actions pose novel dangers, and it’s important for banks to make sure that any crypto-asset-related actions they conduct are legally permissible and that banks have applicable measures in place to handle these dangers. In August, the Board issued supervisory steerage that outlines the steps Federal Reserve-supervised banks ought to take previous to partaking in crypto-asset-related actions.3
The current volatility in crypto markets has demonstrated the extent of centralization and interconnectedness amongst crypto-asset firms, which contributes to amplified stress. Whereas banks weren’t immediately uncovered to losses from these occasions, these episodes have highlighted potential dangers for banking organizations. When a financial institution’s deposits are concentrated in deposits from the crypto-asset business or from crypto-asset firms which can be extremely interconnected or share comparable threat profiles, banks might expertise deposit fluctuations which can be correlated and intently linked to broader developments in crypto-asset markets. As well as, misrepresentations relating to deposit insurance coverage by crypto-asset firms could cause buyer confusion and result in elevated withdrawals at banks offering deposit companies to crypto-asset corporations and their clients throughout instances of stress.
The Fed is working with the OCC and the FDIC on these points and highlighting them to supervised establishments. For instance, it is necessary for banks to grasp a few of the heightened liquidity dangers they might face from sure kinds of deposits from crypto-asset firms. This effort is just not supposed to discourage banks from offering entry to banking services to companies related to crypto-assets. Our work on this space is concentrated on making certain dangers are appropriately managed. Wanting forward, there are extra kinds of crypto-asset-related actions the place the Fed may have to supply steerage to the banking sector within the coming months and years.
As a result of crypto-assets have proved to be so unstable, they’re unlikely to develop into cash substitutes and turn into a viable means to pay for transactions. Nevertheless, stablecoins, which purport to take care of a steady worth, have higher capability to operate as privately issued cash. For that reason, they pose particular, and well-understood dangers, just like different kinds of money-like property. Historical past has proven that money-like property are topic to runs that may threaten monetary stability. Stablecoins linked to the greenback are of explicit curiosity to the Federal Reserve. As Chair Powell stated the opposite day, a central financial institution is and can all the time be the primary supply of belief behind cash. Stablecoins borrow that belief, so we’ve an abiding curiosity in a powerful federal prudential framework for his or her use.
Over time, stablecoins might pose a threat to monetary stability, and you will need to get the regulatory framework proper earlier than they do. Right here too, the Fed is working with different regulatory businesses. The President’s Working Group report on stablecoins that got here out a few 12 months in the past referred to as upon Congress to take the mandatory motion to make sure that stablecoins, notably those who function a method of fee, are topic to prudential regulation.4 Congress ought to take motion to supply a powerful federal framework for prudential oversight, and regulators should additionally use present authorities.
Recognizing the Dangers of Tokenizing Financial institution Liabilities
We’re seeing banks discover quite a lot of totally different fashions to situation dollar-denominated tokens on distributed ledger networks. The proposals vary from issuance of tokens on non-public, managed networks to facilitate funds inside or amongst banks, to proposals that discover issuance of freely circulating tokens on open, permissionless networks. As banks discover totally different choices to faucet into the potential of the expertise, you will need to determine and assess the novel dangers inherent in these fashions and whether or not these dangers are surmountable. As an example, with some fashions which can be being explored, the financial institution might not be capable to observe who’s holding its tokenized legal responsibility, or whether or not its token is being utilized in dangerous or criminality. Whereas there’s work underway on technical options for managing these dangers, it stays an open query whether or not banks can have interaction in such preparations in a fashion according to protected and sound banking and in compliance with related regulation. Given these open questions, banks trying to experiment with these new applied sciences ought to accomplish that solely in a managed and restricted method. As banks experiment, I invite them to have interaction with their regulators early and sometimes to debate the advantages and dangers of latest use instances, making certain they’re according to banking actions performed in a protected, sound, and legally permissible method.
Advancing Buyer Autonomy
Let me point out an instance of the place I believe regulators might play a extra energetic function in shaping how innovation is altering the monetary merchandise panorama. Over the previous decade, digitization of monetary companies has led to the creation of huge quantities of buyer knowledge. Development in applied sciences now facilitates higher connectivity and safe knowledge sharing between banks and nonbanks. This has served as the muse for open banking and the event of latest kinds of monetary services that supply shoppers higher customization and an end-user expertise with much less friction, in comparison with conventional banking.
Jurisdictions around the globe have taken totally different approaches to open banking. Some, resembling Australia, Britain, and the European Union have adopted a regulatory strategy to facilitate open banking by implementing particular regulatory frameworks which can be constructed upon the ideas of shopper knowledge rights, knowledge privateness, and competitors. Up to now, the US has taken extra of a market-driven strategy to open banking. The Shopper Monetary Safety Bureau is charged with implementing rules to offer shoppers entry to their monetary knowledge, pursuant to Part 1033 of the Dodd-Frank Act. Whereas this isn’t an “open banking” rule, it would set the stage for shoppers to achieve higher management on the subject of sharing their knowledge with potential suppliers. The purpose of this effort is to advance shopper autonomy, improve competitors for monetary companies, and to supply simpler portability of account info from financial institution to financial institution in addition to nonbank suppliers. I sit up for listening to extra on this from the CFPB.
Offering Public Sector Help for Cost Innovation
So let me now flip to how the Federal Reserve is taking proactive steps to work with the non-public sector to assist innovation. The Federal Reserve has been engaged on modernizing our fee system for a couple of years now, and we’re within the closing phases of making the FedNow Service, a brand new platform for digital funds that can safely, effectively, and instantaneously transfer cash. FedNow will enhance safeguards on prompt funds, making the monetary system safer. And it’ll enhance entry to the monetary system by lowering fee delays and the excessive prices related to these delays. As I’ve mentioned extensively in my writings and speeches, these prices are notably borne by these least in a position to afford them.5
Banks and repair suppliers will be capable to construct revolutionary monetary merchandise utilizing FedNow’s real-time, low price, protected fee rails, benefiting households and companies. We plan to launch FedNow between Could and July subsequent 12 months.6 It can assist to decrease prices, prolong entry, and enhance safety for shoppers and security for the monetary system.
No dialog about funds innovation is full with out point out of central financial institution digital currencies (CBDC). The Federal Reserve has not made any selections about whether or not to situation a CBDC, and if we imagine it is sensible to take action, we might need the assist of Congress and the Administration. Within the meantime, we’re doing the work of understanding the technological necessities of such a system, deepening our understanding of potential coverage tradeoffs, and having a look at how different nations are serious about and experimenting with CBDCs.
Let me finish the place I started: We have to get the guardrails proper to efficiently assist a dynamic market of revolutionary monetary services. Now we have a duty to make sure that regulation and supervision foster improvements that enhance entry to monetary companies, whereas on the identical time safeguarding shoppers, monetary establishments, and monetary stability. Thanks.
1. I’m grateful to Christine Graham, Laura Lipscomb, and John Maggs of the Federal Reserve Board for his or her help in making ready this textual content. The views expressed listed below are my very own and don’t essentially replicate these of the Federal Reserve Board or the Federal Open Market Committee. Return to text
2. Board of Governors of the Federal Reserve System, Federal Deposit Insurance coverage Company, and Workplace of the Comptroller of the Forex, “Joint Statement on Crypto-Asset Policy Sprint Initiative and Next Steps,” (PDF) joint press release, November 23, 2021. Return to text
3. Board of Governors of the Federal Reserve System, SR Letter 22-6/CA-22-6: Engagement in Crypto-Asset-Related Activities by Federal Reserve-Supervised Banking Organizations, August 16, 2022. Return to text
4. See the President’s Working Group on Monetary Markets, Federal Deposit Insurance coverage Company, and Workplace of the Comptroller of the Forex, Report on Stablecoins (PDF) (Washington: PWG, FDIC, and OCC, November 2021). Return to text
6. Board of Governors of the Federal Reserve System, “Federal Reserve updates FedNow Service timing to mid-2023, marks beginning of full-scale pilot testing,” news release, August 29, 2022. Return to text