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Digital Finance and Crisis

Julia Walker
Julia Walker
Head of Government & Industry Affairs, Refinitiv

The current COVID-19 coronavirus crisis is putting unprecedented strain on markets, governments, businesses and individuals. This executive briefing note, entitled ‘Digital Finance and the Crisis – Strategies and Tools for Addressing Economic and Financial Contagion’ operates at 2 levels:

  • Macro: Identifying areas of systemic risk ahead of policy coordination and action
  • Micro: Illustrating readily available digital finance tools to support businesses

The origins of the Global Financial Crisis of 2008 and the current crisis are different: 2008 was a financial crisis spilling over into the real economy. 2020 is a health and geopolitical crisis, spilling over simultaneously into financial markets and the real economy.

As such it requires different approaches.

Strategies to solve the economic and human crisis include: (1) ensuring sufficient liquidity to support market functioning and underpin demand; (2) intensifying information exchange on health and financial / economic matters in an effort to ensure accurate information despite forces that work against this; (3) heavy, temporary financial support for individuals, small, medium and large enterprises to avoid loss of infrastructure and to preserve the capacity for an orchestrated response (by avoiding mass insolvency) as well as potentially in some cases governments; (4) leveraging digital finance and payments to reduce human-to-human contact, while organizing support for the elderly and other digitally excluded people who would normally use physical channels; (5) establishing a well-funded Health Stability Board as a crisis management tool to ensure information exchange; (6)  directing financial resources to medical infrastructure and also to digital infrastructure as the latter will assist in supporting all other aspects of society and the economy; and (7) online facilitation of education and widespread work from home policies.

Employees use an Apple iPhone to demonstrate the Apple Pay service in Beijing

At the same time, the digitization of financial services in the last decade offers alternative and more direct means by which to stimulate the real economy, critical in mitigating the economic impacts and maintaining social cohesion. Examples include: (1) online cash distributions to all consumers of a given region; (2) invoice factoring to unlock trapped capital; (3) faster payments providing instant disbursement; (4) automatic data exchange on delivery chains and stocks of crucial supplies (through RegTech and distributed ledger technology); (5) digital managing of scarce medical goods according to a key determined regionally and globally (including pharmaceutical products, vaccines and protective equipment); and (6) digital identification systems allowing for personal health monitoring and verification in addition to serving as the basis of financial infrastructure.

These short-term strategies are expected to generate deeper structural changes long-term. For now, one cannot presuppose the new world that will emerge post crisis, but this will be an issue which will require deep attention going forward as the immediate situation comes eventually under control and recovery begins.

Addressing financial sector issues: Interrelationships between finance and the real economy

From a financial sector standpoint, the starting point is to understand the situation and on that basis to deploy appropriate strategies to prevent or mitigate financial crisis while minimizing damage to the real economy.

The 2008 Crisis originated with a financial crisis (particularly in wholesale inter-bank markets resulting from loss of trust and confidence among major institutional players as a result of widely spread credit losses due to securitization resulting in a liquidity and financial solvency crisis) which in turn impacted the real economy (as financial resources became unavailable to support economic activity as a result of the financial crisis). This damage to the real economy in turn worsened financial sector issues (through both liquidity and solvency channels) causing a dangerous spiral (including spillovers to various governments around the world).

In 2020, the triggering events are different. The situation appears to be primarily the result of two shocks:

  • Health crisis: The COVID-19 coronavirus pandemic which started late Q4 of 2019
  • Geopolitical crisis: Oil price shocks, starting at the turn of 2020 and worsening towards end of Q1 2020

While the most significant impact of the pandemic is human, the immediate consequences of individual quarantine measures and lockdowns are felt through supply chains (ie reduced operation of factories and logistic networks), and increasingly and more severely through demand channels (ie individual and business appetite for consumption, and prohibitions on certain services such as travel and hospitality services) globally and locally. What is more, the level of uncertainties in terms of human casualties (COVID-19) and economic damage (COVID-19 and oil prices) is severely reducing trust within and between economic actors. The virus spreads within society, the loss of trust spreads within markets. In both cases, limitation of interaction, in the form of social distancing or reduced economic trade respectively, seems to be the short term result.

Unlike 2008, this crisis has not originated in the financial sector, but for the financial sector to operate efficiently it requires trust between actors and certainty in economic outlook. Both of these elements are now being challenged given the economic and human impact of this crisis.

Trust and certainty are the transmission mechanism between the real economy and the financial markets. Companies, governments and individuals face potentially second order challenges, and these will impact the financial sectors. In turn a weakened financial sector will not be able to perform well its role of financing the real economy, in turn worsening the business and human situation, and potentially thereby starting a vicious downward spiral.

Intervention to avert such an outcome needs to be targeted. We identify four levels of intervention, from Macro (infrastructure strain) to Micro (financial health).

The first level, from the standpoint of the financial sector, focuses on the infrastructure of the financial system, particularly payment systems and securities markets (for both companies and governments). In the context of extreme volatility, one of the greatest concerns is failure in this core infrastructure, which is almost entirely digital. This digital plumbing is at the core of any financial system, domestic or international.

To the extent this digital financial infrastructure functions as intended, it provides a basis for the financial sector to perform its key functions of liquidity management and financial resource allocation, which are necessary to support economic activity and sustainable development. Authorities have hopefully placed considerable attention on these areas under normal circumstances in terms of regulation, supervision and contingency planning.

Monitoring and ensuring crisis resilience of these core infrastructures is essential, as the damage of failure in times of crisis can be devastating. For instance, not only medical and security personnel but also core IT staff and tools must be understood as crucial for the functioning of society and receive preferential medical treatment. At the same time, behavior patterns highlight that it may be necessary in some circumstances to call trading halts. These however should be done ideally within present parameters (e.g. in the case of stock exchanges) and for limited periods.

Illustration file picture shows a man typing on a computer keyboard in Warsaw

Cybersecurity is also a major source of operational risk and has recently risen up the list of concerns from the board. Before the pandemic it was seen as a much greater risk than credit and financial risk and one that most firms struggled to deal with. In the current situation where companies are rapidly moving staff from secure office or government networks to home networks, opportunities for potential breach points for malicious actors increase.

The second level, from the standpoint of liquidity, focuses on identifying where solvency problems in both the real economy (individuals, firms, governments) and the financial sector (bank runs etc) will emerge.

At the heart of any financial sector are wholesale electronic systems which must be carefully monitored for stress by domestic liquidity providers (generally the central bank). In times of crisis, expansive credit lines from major central banks and assistance from international organisations can be essential. This is particularly true if consumers follow rumours on the crisis’ impact on financial institutions and seek to retain (and withdraw) cash, prompting a banking crisis on top of a health and economic crisis.

Yet liquidity supply alone will not ensure demand in the real economy if choice of goods remains limited (as it will likely be increasingly due to state intervention). Where choice of goods is limited the over-liquidity will almost surely translate into higher prices for the few goods available. Where real goods are limited digitally created financial goods (by way of token offerings) or new digital services (eg entertainment and news) could partially consume the excess liquidity, but mis-selling and fraud will be likely. However, tokens, online banking and mobile money schemes could also be used to channel funds faster to consumers to kick-start economic activity.

The third level, from the standpoint of solvency of financial institutions, focuses on having closer to real-time reporting in order to coordinate timely responses. Batch reporting of financial data, for both listed and private companies, are retrospective and will fail to capture dynamic financial changes. This pertains, for instance, to all annual, quarterly or monthly reports required by financial regulation. These numbers are outdated and fairly useless for steering an economy through a crisis.

RegTech and SupTech systems could provide important tools in this context. In the present crisis, concerns are not emanating from financial institutions but rather from the potential impact of the crisis on governments, firms and individuals and the potential impact this may have on the financial sector. Given the very rapid change in economic conditions, systems for collecting and analysing data and its impact through RegTech and SupTech offer important tools as it provides more granular and real time information about financial health. Through the same infrastructure set up for longer periods regulators could require significant institutions to report core data. Regrettably, while RegTech and SupTech systems could provide essential tools in this respect, they unfortunately cannot be put in place quickly, and not in the context of a crisis.

The fourth level, from the standpoint of the financial health of individuals, businesses and governments, focuses on leveraging existing FinTech solutions. The increased reliance on grocery and food delivery services has provided to be both a blessing and a curse. On the one had they enable social distancing and self-isolation opportunities, however when these food delivery systems fail – panic buying in physical supermarkets can prevail. Communication technology in the form of online learning, tutoring, education and marketing is increasing and will likely to continue.

Men pose with Samsung Galaxy S3 Nokia Lumia 820 and iPhone 4 smartphones in photo illustration in Zenica

Economic Impact: Maximizing Digital Channels

Digital finance offers potentially important tools in directing resources quickly and efficiently to the stakeholders that need it the most.  In particular we focus on the strategies and solutions available to mitigate economic and human impact.

In the present situation, economic impact results from short-term factors (but this could, at some point, turn into structural factors, which would in turn require different strategies).

In addressing economic impact, the starting point is to identify those groups most likely to be impacted and to seek to design targeted programs to address issues relating to liquidity (temporary loss of income, business etc) as well as solvency.

At this stage, impact is widespread across individuals, SMEs, larger firms and public institutions (such as hospitals). Impact on governments and the financial sector is so far limited but can be expected to increase in both cases dramatically the longer the crisis continues (given that tax revenues will fall).

In addition to mechanisms of monitoring financial and economic conditions, digital finance offers the potential to directly target financial resources rapidly to those experiencing the greatest impact.

A combination of digital identity frameworks combined with widespread availability of financial and mobile money accounts provides the greatest potential for delivering resources directly to consumers. In countries where such systems have been put in place, they should provide the foundations for the design of appropriate programs and delivery of financial resources using algorithms prioritizing different factors such as age, health, social commitment, professional qualifications, and others.

Governments, NGOs and international organizations should seek to work with payment, financial and telecommunications providers to use whatever resources are available in terms of rapid targeted delivery. Cheques mailed over a period of months are really unlikely to have the desired level of effectiveness.

For SMEs, short term tools include the capacity to unlock future income by looking at invoice factoring solutions. However, this requires digitization of invoices, which might not be commonplace in developing markets. And in developed countries, many businesses have lost all future income due to the cessation of orders from their clients these days. Another tech approach could include cash injections to maintain the organization of businesses as such, to avoid mass unemployment and loss of infrastructure and prepare for the rapid kickstart of the economy as soon as the health crises wanes. For instance, states could rely on tax authorities to trigger reverse transactions based on the last VAT, corporate tax and income / salary tax records. Certain types of businesses may also be suitable for crowdfunding, and states could support suitable campaigns by declaring officially its partial support.The true time for digitalization comes when for considers raising funds for support etc; individuals can invest excess capital using token-based or crowdfunding schemes directly into their local or super-regional economy to provide local boost and also to get higher yield given the interest rate situation.

A man explains how a digital currency mining operation works while pointing at the necessary hardware during the Inside Bitcoins: The Future of Virtual Currency Conference in New York

Human Impact: Continuity Mechanism in time of disruption

Digital finance is not at the core of addressing health and human impact in a pandemic. It does however play a central role in addressing financial and economic impact. It also provides important tools to support health and human impact strategies and policies.

In particular, digital finance provides tools for monitoring potential epidemic outbreaks. It also provides mechanisms to direct financial resources to individuals, health care providers and others that are necessary for them to provide their major functions and provides other potential mechanisms to finance responses, particularly in developing countries but also in other contexts.

Use of telecoms and search data in particular can be valuable. Beyond this, the ability to mobilize medical services and advice remotely (‘tele-medicine’) relates directly to the availability of communications infrastructure (particularly internet and mobile but also fixed line) and of electronic payment mechanisms, from the government, individuals, businesses, etc.

And of course, e-tokens could be used for disseminating scarce goods to those with the greatest needs, substituting for recipes being transmitted by postal delivery services where the delivery man or woman is both significantly exposed to the risk of being infected and a significant risk to those receiving deliveries.

In addition, from the standpoint of social distancing, e-commerce is vital. This has been widely available so far in the countries worst hit by this crisis, but will be far less common in developing countries going forward. Even where e-commerce is present, it will be crucial to use technology for facilitating delivery on the last mile to avoid human contact between delivery service provider and recipient.Digital finance brings important tools which can be very valuable but also bring new forms of risk. In particular there are increasing concerns about the robustness of fundamental digital infrastructure – the internet and communications systems – in addition to those about digital financial infrastructure. The more people work remotely and separately, the greater the stress on these systems, in particular on the internet generally and on the security of VPN and other systems. In addition to these, the increasing ubiquity of digital finance raises cyber risks in addition to digital infrastructure risks, whether of payments, securities, cloud or the internet. Finally, digital brings increasing risks of crime, with the most rapidly growing area of crime being digital crime.

Conclusion

A crisis is not the time to try to implement entirely new digital and tech solutions. It is the time to use the digital infrastructure already in place to far greater and potentially new effects, and the best way to do this may well be for governments to convene (electronic) gatherings of financial sector and FinTech experts to explore what can be done in each country.

Mobile money and other payment infrastructures can be used to direct targeted payments to the people and small businesses most in need. These digital payment infrastructures offer speed and traceability. Trust and certainty need to be preserved and enhanced. Rapidly effected support payments going to those who need them most work to achieve both ends.

Arner, Douglas W. and Barberis, Janos Nathan and Walker, Julia and Buckley, Ross P. and Zetzsche, Dirk Andreas, Digital Finance & Crisis (March 22, 2020). Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3558889


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