Partner & Managing Director, Milan
When Facebook revealed plans earlier this year to launch a global digital currency, many in financial services wondered what that would mean for the future of banking.
The currency, called Libra, grabbed significant media attention, with the Financial Times referring to it as a “full frontal assault on finance.” So what does this mean? Is it time for the banking industry to worry?
In our previous article about Blockchain, we proposed that while it has the very real potential to change our world by disrupting fundamental central authorities (for example, central banks), and while it can support innovative solutions across a broad range of applications, it has, to date at least, fallen short of reaching its potential to disrupt entire industries. For example, blockchain’s first application was cryptocurrency, specifically Bitcoin. However, cryptocurrencies have yet to displace any Fiat currency. So far, they have proven to be neither the store of value nor the superior payment system that was heralded. Regulators are increasingly focused on these assets as potential instruments of fraud or other misuse, and, the concentration of (or collusion amongst) miners could threaten the most fundamental advantages of blockchain: immutability, decentralization and un-hackability over time.
Libra faces similar challenges.
Regulatory intervention: Last call for regulators to protect their role?
One month after Libra’s announcement, the New York Department of Financial Services announced the creation of the Research and Innovation Division aiming to be the regulator of the future and adapt its ways to the undeniable shifts in the financial sector shaped by technological advancements. The timely intervention on the development of technologies is necessary if regulators are to continue to serve in their guardian role.
Meanwhile, in the UK, the Financial Conduct Authority offers the Sandbox testing platform where both FinTechs as well as established financial institutions can pre-test their innovative beta products to see if they fit the regulatory requirements before they are launched to the public. The Swiss regulator FINMA and the German regulator BaFin lead by example in this area and have issued a series of guidelines showing openness to innovations in the financial sector.
Despite this openness, the European space remains rather rigid in terms of regulatory requirements, which likely will be a key factor in whether Libra will succeed. Regulatory forces are with no doubt a decisive element of equilibrium for both Libra and the development of cryptocurrencies in general. Certain expectations are expressed by regulators when it comes to advancements in the financial industry, including data security.
As a result of this regulatory environment, we anticipate Libra could inherit Facebook’s controversial track record on data handling, as the social media giant faces current struggles with regulators and upcoming investigations (FTC and The US Department of Justice’s anti-trust investigation into the tech sector).
With many jurisdictions taking a close look at Libra, only time will tell if the project will prevail.
Banking the unbanked: Is it an achievable target for Libra?
Facebook asserts that the problem of large numbers of unbanked is caused by individuals’ lack of access to the financial system. However, the 2017 Global Findex survey (a World Bank Survey measuring financial inclusion and the fintech revolution) reports that two thirds of unbanked individuals do not have enough resources to bank, rather than the incapacity to access financial services overall. The survey counts 1.7 billion individuals as being unbanked across the globe, out of which 50 percent live in one of seven developing economies and account for the economically disadvantaged in Bangladesh, China, India, Indonesia, Mexico, Nigeria, and Pakistan. The share of the unbanked that state an inability to access financial infrastructure is at 25 percent only.
Moreover, young adults, the less educated, and the unemployed account for the largest share among the unbanked population with a limited access to bankable funds. While it is difficult to account for the less educated and the unemployed population across Facebook’s platforms, its young population is at approximately 30 percent of the total user base, making 25- to 34-year-olds the most common age demographic on the platform.
Limited access to bankable resources does at first question Libra usage in unbanked areas. Nonetheless, it opens up opportunities for remittances business, especially considering that internet access in China, India, and Nigeria does not represent an issue.
Anti-Money Laundering: The balance between freedom to innovate and keeping away fraudsters
An element of particular importance for regulatory forces in the context of financial innovations is to adapt and align anti-money laundering efforts. Cryptocurrencies trigger considerable concerns with regards to Know Your Customer principles, suspicious activity monitoring, and sanctions interdictions.
Due to its global presence, Facebook and its structure would need to ensure Libra would be compliant across jurisdictions. Regardless of Libra’s classification as a cryptocurrency or a classic payment instrument, it would be a product of high exposure to money laundering concerns.
Assuming Facebook manages to bank the unbanked within its target audience in developing countries, it is important to note that these areas are often classified as high-risk jurisdictions, often lagging behind in terms of implementing industry standards on anti-money laundering.
Potential partnerships with banks could allow Libra to leverage their anti-money laundering practices and bring advantages, but it would remain at Facebook’s responsibility to ensure a risk-based approach to its Libra’s infrastructure.
Cryptocurrency: Do we really need a meta-currency?
While banking the unbanked around the globe looks debatable, Libra’s cryptocurrency labeling was by far the most discussed element of the announcement. The core particularity behind cryptocurrencies is their political and architectural decentralization. Libra will be a product orchestrated and managed by the Libra Association and Facebook’s financial subsidiary Calibra. The association launched with members of some of the key telecommunication and payment players, and a $10-million-dollar investment pledge to participate. The intention to extend the network is planned after five years of the launch only. Moreover, Libra will be tied to a basket of different currencies and assets, making it a more stable coin than a cryptocurrency, both being nonetheless unregulated structures.
Given this environment, Libra could have the potential to significantly smoothen currency fluctuations, reducing impacts of monetary policies set by government in response to their strategies.
Despite notable opportunities, enabling millions of users to make payments and transfers on an unregulated structure entitles the regulated sector – including banks – to at least worry for the future of their business models. However, at present, we believe there are more important areas where banks should focus their attention.
Where banks should place their focus today
Banks have been challenged to review their business models ever since tech advancements begun gaining traction. While cryptocurrency struggles to win acceptance from regulators, it leaves banks with the opportunities to improve mechanisms that crypto lacks.
For example, banks could increase their transparency and bolster anti-money laundering processes that have been hurting the banking industry’s reputation. In addition, taking steps to guarantee an enhanced digital experience for customers, including state-of-the-art cybersecurity, and educating customers on investment options via their existing accounts could lead to a new era in banking.
Regardless of development areas for banking and money overall, the element of trust remains at core. Both banks and Libra will need to pass the trust test in order to ensure longevity.