What impact does FinTech have on monetary policy?

By Puja Sharma

FinTech refers to 21st-century financial services that are characterised by a portmanteau of financial technologies. Several consumer and trade financial institutions were initially supported and recognized by the innovation process, which eventually evolved into creating digital currencies such as Bitcoin and altcoins.

According to the research gate report, the use of FinTech products can affect banking sales and speed up innovation, despite various negative concerns associated with cryptocurrencies. Several studies have examined how monetary policymaking and central banks are impacted by financial innovation (e.g. Bernanke and Blinder 1988; Arize 1990). After the collapse of the Bretton Woods system, central banks are supposed to play a major role in monetary policy because of the innovation process (Arize 1990). The central bank’s ability to implement monetary policy has a complex relationship with the availability of money or credit throughout the financial system.

Central banks have always been at the cutting edge of financial technology and innovation. In the past, the invention of the banknote, the processing of payments through debits and credits in book-entry accounts, and the successive transitions of interbank payment systems from the telegraph to internet protocols were all transformative innovations.

FinTech presents unique opportunities for central banks. The rapid changes in technology that are transforming the financial system will allow central banks to enhance the execution of various of their core functions, such as currency issuance and payment systems.1 But some aspects of fintech pose major challenges, as per the IMF report.

Today, however, central banks are facing new and unprecedented challenges: distributed ledger technology, new data analytics (artificial intelligence [AI] and machine learning), and cloud computing, along with a wider spread of mobile access and increased internet speed and bandwidth. As with previous health crises (for example, the 2003 SARS epidemic), the ongoing coronavirus disease (COVID-19) pandemic plays an accelerating role. Furthermore, building on their agile embrace of technological changes, the private sector reinvigorated its efforts to develop financial services and asset classes that can compete in the traditional domain of central banks.

FinTech will likely impact the implementation rather than the legal wording of the monetary policy function, in particular by exposing excessive constraints in the related legal powers. This function is typically broadly worded in the central bank law: “The central bank shall formulate and implement monetary policy.” In contrast, the legal powers authorizing financial transactions with eligible counterparties are often restricted. For instance, open markets and credit operations are only authorized by banks. This may pose two challenges:

First, if, due to FinTech, traditional monetary policy counterparties were to become less relevant in the new financial system and economy, this could limit the effectiveness of the central banks’ monetary policy tools. As one way to palliate this, central banks could consider enlarging the category of monetary policy counterparties. This may, in due course, require reform of the central bank law, for instance by granting more “guided flexibility” to the central bank’s decision-making bodies to determine the categories of eligible counterparties.

Some FinTech firms may seek a specific regulatory status (for example, as a “bank”) that offers access to monetary policy operations as a means to access an additional liquidity backstop, even though those firms do not engage in maturity transformation. This could eventually also push central banks to review their access policies and rules. Beyond the issue of enlarging monetary policy counterparties, central banks may also require new and explicit powers to charge interest on token-based CBDC.