20 September 2018

OMFIF: Christine Lagarde: A regulatory approach to fintech

The IMF Director Christine Lagarde explains why some enthusiasts say crypto assets may represent the beginning of a breakthrough similar to that of Alexander Graham Bell's telephone.

Crypto assets are just one example of how new technologies are being used to deliver financial services. Advances in artificial intelligence promise to extract more value from ever more abundant and ubiquitous data. Its applications in financial services include enhancing fraud protection and regulatory compliance, potentially expanding access to services and deepening financial inclusion.

Financial technology offers considerable promise, but it also poses risks. Consider distributed ledger technology, which underpins crypto assets. It can enable faster and cheaper transactions, store records securely and execute so-called smart contracts automatically. But the technology has also been used for illicit purposes.

Regulators face a difficult task. On the one hand, they must protect consumers and investors against fraud and combat tax evasion, money laundering and the financing of terrorism. They must also protect the integrity and stability of the financial system. On the other, they must beware of stifling innovation that benefits the public. By engaging with market participants at the centre of financial innovation, regulators can stay abreast of the benefits of new technologies and identify risks. Developing a forward-looking regulatory framework calls for creativity, flexibility, and new expertise.

The experience of the 2008 financial crisis and its aftermath yielded three important lessons:

• First, trust is the foundation of the financial system, but it is fragile and can be shaken easily.
• Second, risk accumulates in unexpected places. In the years before the crisis, financial instruments emerged that were poorly understood by investors, such as collateralised debt obligations. It is unclear whether a decentralised financial system will be more stable or less. There is a chance that emerging risks will go undetected as the role of traditional intermediaries diminishes.
• Third, in a globalised world, financial shocks quickly reverberate across borders. Responding to a crisis requires concerted action. And a global financial system may transmit shocks more quickly.

Christine Lagarde, Managing Director of the International Monetary Fund,concludes:

“We must understand innovative technologies, learn from them, and perhaps even adopt some of them to improve regulation, supervision and surveillance. In some cases, it will be enough to apply existing regulations. In others, new approaches may be required as risks emerge and as distinctions between entities and activities break down. One thing seems certain: we should not put off action until the answers become clear. Instead, we must begin to consider the regulatory framework of the future.

“We must do so in a manner attuned to the rapid pace of change, and with the awareness that unexpected new opportunities and risks may emerge. One approach, undertaken in Hong Kong, Abu Dhabi and elsewhere, is to establish regulatory sandboxes where new financial technologies can be tested in a closely supervised environment.

“Above all, we must keep an open mind about crypto assets and fintech, not only because of the risks they pose, but also because of their potential to improve our lives. When in doubt, think of Bell and his telephone.”

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