Disruption Index – Page 3 – Digital Finance Analytics (DFA) Blog

Central banks and digital currencies

In a speech delivered at the London School of Economics, Ben Broadbent outlines the importance of innovations in digital currencies – and what the economic implications of central banks introducing their own might be.

Ben explains that digital currencies like Bitcoin are, in themselves, extremely unlikely to become widely used alternative units of account, displacing the dollar or pound. Rather, the interesting aspect of these digital currencies is the settlement technology that underpins them, the so-called “distributed ledger”. This system allows transfers to be verified and recorded without the need for a trusted third party: the role that central banks currently perform for commercial banks.

Ben argues that, while clearing payments through a distributed ledger rather than a central bank may not have any significant macroeconomic effects in and of itself, what would prove significant is how the technology could be used to widen access to the central bank’s balance sheet beyond the commercial banks it currently serves.

Ben states: “That might mean adding only a narrow set of counterparties – non-bank financial companies, say. It might mean something more dramatic: in the limiting case, everyone – including individuals – would be able to hold such balances.”
The potential that distributed ledgers offer to expand access to central bank balance sheets encapsulate the distinction between ‘private’ digital currencies – which essentially seek to substitute central banks as settlement agents – and ‘central bank digital currencies’, which could result in central banks expanding their role as trusted third parties.

The macroeconomic impact of central bank digital currencies would depend on their precise design and the degree to which they competed with the main form of money in the economy currently: commercial bank deposits. As Ben notes, the public is already able to hold claims on the central bank through cash – and if all a central bank digital currency did was to offer a substitute for paper currency, it’s not clear the macroeconomic effects would be that substantial.

Even then, however, Ben argues you would expect to see some drain from commercial banks. This drain would be greater the more closely a central bank digital currency resembled a genuine bank account. Notably, flows into central bank digital currencies, and out of commercial banks, would pick up at times whenever people were concerned about the strength of the financial system.

Any such shift towards a relatively widely accessible central bank digital currency would therefore have two important implications: “On the one hand, it would probably make [commercial banks] safer. Currently, deposits are backed mainly by illiquid loans, assets that can’t be sold on open markets; if we all tried simultaneously to close our accounts, banks wouldn’t have the liquid resources to meet the demand. The central bank, by contrast, holds only liquid assets on its balance sheet. The central bank can’t run out of cash and therefore can’t suffer a “run”.

Ben adds: “On the other hand, taking deposits away from banks could impair their ability to make the loans in the first place. Banks would be more reliant on wholesale markets, a source of funding that didn’t prove particularly stable during the crisis, and could reduce their lending to the real economy as a result.”

Ben reflects that, in many ways, this debate on the future of digital currencies is resurrecting some of the older arguments in economics. Some admirers of private digital currencies like Bitcoin see them as a means of bypassing central banks altogether – a campaign recognisable to advocates of “free banking” in the 19th century. If it were a close substitute for bank deposits, on the other hand, a central bank digital currency would mean a more prominent role for the central bank; it would also represent a shift towards a “narrower” banking system, another argument with a long history.

Ben notes that while some have suggested that central banks will have to issue digital currencies to meet the “competitive threat” posed by private sector rivals. However, for Ben, “the more important issue for central banks considering such a move will be what it might mean for the funding of banks and the supply of credit”.

Connecting everyone to the internet won’t solve the world’s development problems

From The Conversation.

By 9.30am today I will have skyped Malawi, emailed Ghana, Facebooked Nepal, paid a bill online and used the satnav on my mobile phone. It feels a long time since we first got colour TV at home and, years later, when I accessed the internet using a dial-up modem. When I recalled these moments to my son he yawned. Aged, 19, he doesn’t remember a time before ubiquitous connectivity.

According to a new report from the World Bank, more than 40% of the global population now has internet access. On average, eight in ten people in the developing world own a mobile phone. Even in the poorest 20% of households this number is nearly seven in ten, making cellphones more prevalent than toilets or clean water.

Digital technologies are spreading rapidly in developing countries. Digital Dividends Report

There is no doubt that the world is experiencing a revolution of information and communication technology, bringing about rapid change on a massive scale. But despite great expectations for the power of digital technologies to transform lives around the world it has fallen short and is unevenly distributed, with the most advantages going, as ever, to the wealthy. The World Bank argues that increasing connectivity alone is not going to solve this problem.

Digital dividends

Around the world, digital investments bring growth, jobs and services. They help businesses become more productive, people to find better life opportunities and governments to deliver stronger public services. At their best, the report finds that inclusive, effective digital technologies provide choice, convenience, access and opportunity to millions, including the poor and disadvantaged.

For example, in the Indian state of Kerala the community action project Kudumbashree outsources information technology services to cooperatives of women from poor families – 90% of whom had not previously worked outside the home. The project, which supports micro-credit, entrepreneurship and empowerment, now covers more than half the households in the state.

The World Bank also emphasises that the poorest individuals can benefit from digital technologies even without mobile phones and computers. Digital Green, an NGO working with partners in India, Ethiopia, Afghanistan, Ghana, Niger and Tanzania, trains farmers using community-produced and screened videos.

Many governments are using the most of positive digital dividends to empower their citizens. In countries with historically poor birth registration, for example, a digital ID can provide millions of people with their first official identity. This increases their access to a host of public and private services, such as voting, medical care and bank accounts, enabling them to exercise their basic democratic and human rights.

Digital divides

For every person connected to high-speed broadband, five are not. Worldwide, around four billion people do not have any internet access, nearly two billion do not use a mobile phone, and almost half a billion live outside areas with any mobile signal. Divides persist across gender, geography, age and income.

Across Africa the digital divide within demographic groups remains considerable Digital Dividends Report

Those who are not connected are clearly being left behind. Yet many of the benefits of being online are also offset by new risks.

The poor record of many e-government initiatives points to high failure of technology and communications projects. Where processes are already inefficient, putting them online amplifies those inefficiencies. In Uganda, according to the World Bank, electronic tax return forms were more complicated than manual ones, and both had to be filed. As a result, the time needed to prepare and pay taxes actually increased. The report cites the risk that states and corporations could use digital technologies to control citizens, not to empower them.

The general disruption of technology in the workforce is complex and yet to be fully understood, but it seems to be contributing to a “hollowing out” of labour markets.

The labour market is becoming more polarised in many countries. Digital Dividends Report

Technology augments higher skills while replacing routine jobs, forcing more workers to compete for low-skilled work. This trend is happening around the world, in countries of all incomes, demonstrated by rising shares in high and low-skilled occupations as middle-skilled employment drops. The World Bank notes that:

The digital revolution can give rise to new business models that would benefit consumers, but not when incumbents control market entry. Technology can make workers more productive, but not when they lack the know-how to use it. Digital technologies can help monitor teacher attendance and improve learning outcomes, but not when the education system lacks accountability

Not surprisingly, the better educated, well connected, and more capable have received most of the benefits —- circumscribing the gains from the digital revolution.

A tremendous challenge

The report emphasises that investment in connectivity itself is not enough. In order to achieve the full development benefits of digital investment, it is essential to protect internet users from cybercrime, privacy violations and online censorship, and to provide a full set of “analogue complements” alongside. These include:

Regulations, to support innovation and competition

Improved skills, to enable access to digital opportunities

Accountable institutions, to respond to citizens’ needs and demands

Ultimately, while the World Bank continues to champion connectivity for all as a crucial goal, it also recognises the tremendous challenge in achieving the essential conditions needed for technology to be effective.

In my privileged home, digital technology brings me choice and convenience. It will be a long time before the digital revolution brings similar returns for everyone, everywhere.

Author: Anna Childs, Academic Director for International Development, The Open University

Is The Rise of Electronic Trading in Fixed Income Markets Risky?

Electronic trading has become an increasingly important part of the fixed income market landscape in recent years. As a result there are a number of risks to consider and regulatory issues to address, according to a newly released report from the Bank For International Settlements Markets Committee.

The growth in electronic trading as, according to the report, contributed to changes in the market structure, the process of price discovery and the nature of liquidity provision. The rise of electronic trading has enabled a greater use of automated trading (including algorithmic and high-frequency trading) in fixed income futures and parts of cash bond markets.

The term “electronic trading” covers a variety of activities that are part of the life cycle of a trade. In this report, electronic trading refers to the transfer of ownership of a financial instrument whereby the matching of the two counterparties in the negotiation or execution phase of the trade occurs through an electronic system.

Electronic trading broadly covers: trades conducted in systems such as electronic quote requests, electronic communications networks or dealer platforms; alternative electronic platforms such as dark pools; the quotation of prices or the dissemination of trade requests electronically; and settlement and reporting mechanisms that are electronic. For example, this includes both high-frequency trading on exchanges and trades negotiated by voice but executed and settled electronically.

The electronification of all these aspects of fixed income trading has been steadily increasing. There are now a variety of electronic trading platforms (ETPs), systems that match buyers with sellers, that differ in terms of the composition of their clients and their trading protocols.

Innovative trading venues and protocols (reinforced by changes in the nature of intermediation) have proliferated, and new market participants have emerged. For some fixed income securities, “electronification” has reached a level similar to that in equity and foreign exchange markets, but for other instruments the take-up is lagging.

Electronic trading in fixed income markets has been growing steadily. In many jurisdictions, it has supplanted voice trading as the new standard for many fixed income asset classes. Electronification, ie the rising use of electronic trading technology, has been driven by a combination of factors. These include: (i) advances in technology; (ii) changes in regulation; and (iii) changes in the structure and liquidity characteristics of specific markets. For some fixed income securities, electronification has reached a level similar to that in equity and foreign exchange markets. US Treasury markets are a prime example of a highly electronic fixed income market, in which a high proportion of trading in benchmark securities is done using automated trading. However, fixed income markets still lag developments in other asset classes due to their greater heterogeneity and complexity.

The report highlights two specific areas of rapid evolution in fixed income markets. First, trading is becoming more automated in the most liquid and standardised parts of fixed income markets, often importing technology developed in other asset classes. Traditional dealers too are using technology to improve the efficiency of their market-making. And non-bank liquidity providers are searching for ways to trade directly with end investors using direct electronic connections. Second, electronic trading platforms are experimenting with new protocols to bring together buyers and sellers.

Advances in technology and regulatory changes have impacted the economics of intermediation in fixed income markets. Technology improvements have enabled dealers to substitute capital for labour. They are able to reduce costs by automating quoting and hedging of certain trades. Dealers are also able to better monitor the trading behaviour of their customers and how their order flow changes in response to news. Dealers are internalising flows more efficiently across trading desks, providing greater economies of scale for trading in securities where volumes are particularly high. But the growth in electronic trading is posing a number of challenges for traditional dealers. It has allowed new competitors with lower marginal costs to reduce margins and force efficiency gains, and it has required a large investment in information technology at a time when traditional dealers are cutting costs.

Electronification is also changing the behaviour of buy-side investors. They are deepening their use of execution strategies, in particular complex algorithms. Large asset managers are further internalising flows within their fund family. And a number of asset managers are supporting different competing platform initiatives that are attempting to source pools of liquidity using new trading protocols. Electronic trading tends to have a positive impact in terms of market quality, but there are exceptions. There is relatively little research specific to fixed income markets, but lessons can be drawn from other asset classes. Evidence predominantly suggests that electronic trading platforms bring advantages to investors by lowering transaction costs. They improve market quality for assets that were already liquid by increasing competition, broadening market access and reducing the dependence on traditional market-makers. But platforms are not the appropriate solution for all securities, particularly for illiquid securities for which the risks from information leakage are high. For these securities, there is still a role for bilateral dealer-client relationships.

The impact of automated and high-frequency trading is a matter of considerable debate. Studies suggest that automation results in faster price discovery and an overall drop in transaction costs (at least for small trade sizes). The entrance of principal trading firms with lower marginal costs than traditional market-makers has intensified competition. It remains to be seen whether the benefits of automation observed in normal trading periods also prevail during periods of stress, when the benefits of immediacy are particularly high. Competition over speed might displace traditional broker-dealers who may be more willing to bear risks over longer horizons. There is a risk that liquidity may have become less robust and prices more sensitive to order flow imbalances. Some recent episodes covered in this document shed some light on these issues. These episodes highlight that multiple drivers are likely to be at play, rather than conclusive evidence pointing to a predominant impact of automated trading alone. Electronic trading, and in particular automated trading, poses a number of challenges to policymakers. The appropriate response may differ across jurisdictions because of the heterogeneous nature of fixed income markets as well as the varying degrees of electronification.

The report identifies four core areas for further policy assessment:

First, the steady advance of electronic trading needs to be appropriately monitored. Access to better data is required. A supplement to better monitoring is to establish regular dialogue between regulatory bodies and industry participants.
Second, further investigation is required to gauge the impact of automated trading on market quality. While there has been an improvement in certain metrics, liquidity may have become more fragile during stress episodes. More sophisticated measures need to be used to capture the multiple dimensions of market quality.
Third, electronification has created additional challenges for risk management at market-makers, platform providers and end investors. Algorithm developers should follow guidelines for best practices. Policymakers should be conscious of the growing dependence on critical electronic trading infrastructures.
Fourth, regulation and best practice guidelines should be living documents. They should be repeatedly reviewed and adapted as markets evolve. It may also be worth considering whether current regulatory requirements contribute to a level playing field amid the changing market structure and/or whether, for example, a code of conduct applicable to all significant market participants may be appropriate, when warranted by the specific circumstances.

When responding to these challenges, regulators should strike a balance between prescription and room for healthy innovation in market design. A flexible approach can enable platforms to compete to discover new ways to increase efficiency and integrity.

Four in Five Retailers Say Mobile Is Having a Major Effect

Mobile’s importance is becoming undeniable according to eMarketer.

Mobile still accounts for a fairly small share of total retail sales, and, in many markets, even of digital retail sales. But retailers are feeling the impact of mobile devices.

In 2014, a little over half (57%) of retailers worldwide surveyed by payment solutions provider Payvision reported experiencing major growth in mcommerce sales. Among the total, 33% strongly agreed that growth was significant—already a sizeable share.

But by 2015 the evidence in favor of mcommerce was overwhelming. Nearly half of respondents were now in the “strongly agree” group, with an additional 34% agreeing more generally. Overall, 79% of retailers worldwide were undergoing major mcommerce growth this year.

More retailers around the world are getting into omnichannel as a result. This year, 91% of respondents said they offered customers the option to shop and pay across multiple devices. That was up from 84% last year.

Nearly three in four respondents reported this year that such an option had boosted sales via digital devices. In addition, 71% of retailers surveyed said they were focused on offering seamless shopping across multiple devices as well as offline sales channels.

eMarketer estimates that in 2015, US consumers bought $74.93 billion worth of goods and services via mobile devices, up 32.2% over 2014 spending levels. This year, mobile accounted for 22.0% of all retail ecommerce sales in the US, up 3 points since last year. It still made up a tiny portion of total retail sales, however, at just 1.6%.

In some other world markets, mcommerce is a bigger part of the picture. In South Korea, for example, mcommerce sales made up 46.0% of retail ecommerce sales and 5.1% of total retail sales this year, according to eMarketer estimates. In China, 49.7% of retail ecommerce sales and 7.9% of all retail sales occurred via mobile devices in 2015.

Broker group launches app to shake up real estate industry

From Australian Broker.

Award-winning interstate broker group, N1 Finance, has partnered with online real estate portal, Seekahome, to create a new app to shake up the real estate market.

The DIY property renting app, Snailapp, aims to connect landlords directly with potential tenants by allowing them to create and post rental listings for free on the platform. It has also been built with a messenger service to initiate instant conversations between the tenant and landlord.

According to the latest census data compiled by the Australian Bureau of Statistics (ABS) in 2011, approximately 2.3 million occupied private dwellings, or 29.4%, were rented. With average weekly rents currently sitting at $483, according to data from Corelogic RP Data, and average property management fees at 5%, Ren Wong, director of N1 Finance says the market for DIY rental apps is huge.

“We know many landlords are happy with their existing property agents. This app targets those landlords looking for a quick, free and simple alternative to existing channels to source tenants. The unique selling point for the app is it facilitates communication easily between landlord and tenant as Snailapp is likely to be used by the landlord, not the agent,” Wong said.

The app has already received positive feedback, according to Wong, so he expects it to grow substantially over the coming year.

“We expect to have matched hundreds of tenants and landlords in the first 12 months and there has already been some positive feedback from current users,” he said.

“Once the platform hits scale, we believe there is a great opportunity to take on the established platforms, and this is part of our value-adding service to our existing investor clientele.”

Brokers not immune to fintech disruption

From Australian Broker.

A new index tracking the rate of change within financial services industry has revealed that emerging fintech companies are rapidly changing the face of financial services – and brokers are not immune.

The Disruption Index, a joint initiative from online SME lender Moula and research firm Digital Finance Analytics (DFA), tracks important leading indicators, such as smart device penetration and use, online loan applications and service expectations in the SME sector. Between May and July 2015, the Index stood at 33.02. Between August and October 2015, the Index rose to 33.94. The higher the Index score, the greater the disruption of the industry.

Speaking to Australian Broker, Martin North, principal of DFA, said the SME sector has driven disruption in the financial services space.

“There are three things that have happened relatively recently which have fundamentally changed the game. The first thing is the Treasurer gave a 100% capital write-off to small businesses and they have gone out in their droves and bought smart devices. We have seen a very significant rise in the penetration of smart devices as the main device businesses are using for their interactions with their customers, suppliers and the banks.

“The second thing is this means that [businesses] now have a much higher expectation in terms of immediacy of access to information, products and services than they did before. This has created a big gap between where the banks currently are in terms of servicing small business customers and where small businesses want to be.

“The third thing is there are lots of new players coming in and essentially offering a different proposition… People are responding to the opportunity created by the disruptive environment.”

According to North, 2016 is likely to see more fintech businesses enter the market, however the major trend will be existing fintech businesses starting to gain serious momentum.

“I think we are going to see more momentum. I think the peer-to-peer players are going to very interesting and I think we will probably see some new players beginning to think about the wealth creation sector because I think that is an area which is ripe for fintech penetration and development,” North told Australian Broker.

Brokers are also likely to face significant disruption through more effective use of technology and data insights, say North.

“I think there is an opportunity particularly in the broker segment for a different way of handling the consumer and a different way of providing advice. This means we are likely to see some different types of broker models.

“In other words, we will see [brokers] using technology in a more thoroughbred way to perhaps provide better advice rather than the cheapest loan. Essentially, they will provide a more tailored proposition. I wouldn’t be surprised if we started to see some more intelligence coming through the broker sector.

“Let’s be honest, a lot of the conversations are price-led to find the cheapest loan but there are a whole bunch of other conversations which could be had if they had access to better data and better insights.”

Measuring Disruption in Small Business Lending

Launched today, the Financial Services Disruption Index, which has been jointly developed by Moula, the lender to the small business sector; and research and consulting firm Digital Finance Analytics (DFA) shows that Financial Services are undergoing disruptive change, thanks to customers moving to digital channels, the emergence of new business models, and changing competitive landscapes. Combing data from both organisations, we are able to track the waves of disruption, initially in the small business lending sector, and more widely across financial services later.

The index tracks a number of dimensions. From the DFA Small business surveys (26,000 each year), we measure SME service expectations for unsecured lending, their awareness of non-traditional funding options, their use of smart devices, their willingness to share electronic data in return for credit, and overall business confidence of those who are borrowing relative to those who are not.

Moula data includes SME conversion data, the type of data SMEs share, the average loan amount approved, application credit enquiries, and speed of application processing.

The index stood at 33.02 from May to July 2015, and rose to 33.94 in the August to October period. The higher the score, the greater the disruption. Of note SMEs are becoming more aware of non-traditional unsecured lending options, are becoming more demanding in terms of application processing times, are more willing to share data and are more likely to apply using a smart device. In addition, the loan values being written are rising, more businesses are willing to share richer data, and the confidence levels among borrowing SMEs is on the rise.

Overall, unsecured lending to the SME sector is being disrupted significantly, and we expect the index will continue to trend higher, as awareness of alternatives to traditional banking continues to rise, and more firms apply for credit.

The average expectation duration was down from 9.2 days in Q3 2015 to 7.5 days this quarter. SMEs continue to expect better service standards when applying for credit. Whilst they accept it may take a few days for an application to be processed, the survey data shows that many think a week should be enough to complete an unsecured loan and get money into their account, and they expect to receive regular progress reports and updates on the way through.
We see a rise in awareness among SMEs of the availability of alternative credit solutions and greater familiarly with the tag “Fintech”. This month 3.75% of businesses recognised the concept, up from 2.74% last month, and momentum is increasing.
More business owners are using smart devices to run their business. They expect access to a wider range of services this way, and more immediate responses. Last quarter 42.6% of businesses used a smart device, this time it was 44.6%, and the rate of adoption is increasing.

The index is featured in an SMH MySmallBusiness article today.