Fintech, Pandemic, and the Financial System: Challenges and Opportunities: Volume 22

In this study, the authors use a country-level database covering 63 economies over the period 2014–2019 and employ a wide range of proxies to discuss new technological trends in finance, particularly in the banking sector. The authors also distinguish alternative technology-based business models that directly compete with banks [financial technology (fintech) and giant technology (bigtech) credit providers]. The results suggest that banks’ increased focus on technological innovation, as measured by market value and number of patents, is a possible response to the emerging technology-based nonbank competition, particularly from fintech and bigtech firms. Additionally, the results indicate that the emergence of financial innovation contributes negatively to the average value of bank patent, indicating significant competitive pressure on banks in the technological race. Thus, banks are countering the challenge of fintech and bigtech competition in the financial market by increasing their technology projects and patenting activities. These trends are crucial and may change the stability and sustainability perspectives of banks.

Although COVID-19 has caused a global slowdown, the magnitude of GDP losses appears to vary across countries. This study considers the question: could digital finance help to mitigate the adverse impact of COVID-19 on GDP? Countries with higher levels of digital financial inclusion are found to experience less fall in GDP, whereas countries relying more on cash transactions experience a greater GDP decline. These results suggest that digital financial inclusion might play a key role in mitigating the adverse impact of COVID-19 on GDP.

The relationship between borrowers and lenders can reveal a lot of information regarding loan pricing, information costs, and competition. In this study, the authors investigate the impact of FinTech lenders on Paycheck Protection Program (PPP) loan disbursement. Specifically, the authors investigate financial technology companies’ ability to provide loans at greater distances, expanding the available resources for businesses struggling during the Covid-19 pandemic. The authors find that not only were FinTechs able to lend at greater distances, but also they provided loans to firms that were younger and had less bank competition in their headquarters’ zip codes. The results remain consistent and are generalizable to the complete population of PPP loans.

This study examines whether fintech lending further enhances or mitigates the gender-based differences in consumer loan performance in an emerging market. Using a proprietary dataset of over 5.5 million consumer loans offered by the fifth-largest bank in Turkey and its fintech subsidiary, the authors first document a significant gender gap in average loan performances. In line with the previous empirical findings, men are more likely to default on their debt. The average difference in loan performance is around 10 basis points, indicating a statistically and economically significant magnitude even after controlling for an exhaustive list of demographic and credit characteristics. Next, the authors show that the gender gap in loan performance is more pronounced in areas where women have more outside options in terms of social and economic opportunities. Specifically, the authors observe that gender-based differences are predominantly evident in cities with higher divorce rates, lower young and elderly dependence, smaller household sizes, and higher labor force participation of women. Since the child and elderly care duties disproportionately influence women’s ability to participate in economic life, their ability to find resources to pay their loans in a timely manner improves more in comparison to men in areas where women face fewer restrictions to seek local economic opportunities outside the household. Finally, the authors document that fintech loans partially mitigate the gender-based differences in consumer loan performance in those cities. This result suggests that the developments in financial technology can reduce the inefficiencies associated with human involvement in credit decisions, narrowing the gender gap in loan outcomes to the extent that these gaps are attributable to the supply-side factors that involve human judgment and biases.

The authors consider a variety of cryptocurrency and equity risk factors as potential forces that drive cryptocurrency returns and carry risk premiums. In a cross-section of 2,000 biggest cryptocurrencies during 2014–2020, only downside market risk, cryptocurrency size and cryptocurrency policy uncertainty factors are systematically priced with significant premiums. Cryptocurrencies, which have greater exposures to these factors, yield higher returns subsequently. Equity market risk, particularly equity downside market risk, appears to be more important than cryptocurrency market risk, suggesting greater linkages between cryptocurrency and equity markets than we used to think. Global and the US equity factors are more relevant for the cryptocurrency market than local factors from other markets. However, there is no evidence that exposure to momentum, volatility and Fama–French factors is compensated by higher returns.

Should we include cryptocurrency in risky portfolio investing? Bitcoin, given its status as the leader of cryptocurrencies and a speculative asset due to its non-dividend-paying trait and high volatility as well as high returns, poses an interesting question whether it can also be beneficial in a portfolio of risky assets. In order to find an answer, we revisit the conventional dual objective of minimizing risk and maximizing expected return for risky assets. Various models are tested to analyze the risk-return trade-off of risky portfolios including Bitcoin. Given an initial budget for a finite portfolio, the cumulative filtration yields the expected return and the covariance matrix. With the addition of Bitcoin, we compare the performance of the portfolio generated from the optimization models and technical analysis. The main implications are follows: (1) risk tolerance and diversification constraints are the key factors in portfolio optimization; (2) including cryptocurrency enhances portfolio returns; and (3) the Markowitz model (Kataoka’s and conditional value-at-risk models) recommends to fully weigh (unload) Bitcoin in (from) the portfolio.

Cryptoassets have recently attracted the attention of national and international financial regulators. Since the mid-2010s blockchains have increasingly been adapted to automate and replace many aspects of financial intermediation, and by 2015 Ethereum had created the smart contract language that underpins the digitization of real assets as asset-backed tokens (ABTs). Those were initially issued by FinTech companies, but more recently banks active on international capital and financial markets, and even central banks, for example, the Bank of Thailand, have developed their own digital platforms and blockchains. A wide variety of real and financial assets underpins ABTs, viz., real-estate, art, corporate and sovereign bonds, and equity. Consequently, owing to the significant market capitalization of cryptocurrencies, the Basel Committee on Banking Supervision (BCBS) published two consultative papers delineating its approach on cryptoasset regulation. In this study, the authors analyze the mechanics of ABTs and their potential risks, relying on case studies of recent issuance of tokens in equity, real-estate, and debt markets, to highlight their main characteristics. The authors also investigate the consequences of the increasingly oligopolistic structure of blockchain mining pools and Bitcoin exchanges for the integrity and security of unregulated distributed ledgers. Finally, the authors analyze the BCBS’ regulatory proposals, and discuss the reaction of international financial institutions and cryptocurrency interest groups. The main findings are, firstly, that most ABTs are akin to asset-backed securities. Secondly, nearly all ABTs are “off-chain/on-chain,” that is, the underlying is a traditional asset that exists off-chain and is subsequently digitized. The main exception is the World Bank’s bond-i that is genuinely native to the blockchain created by the Commonwealth Bank of Australia, and has no existence outside it. Thirdly, all ABTs are issued on permissioned blockchains, where anti-money laundering/anti-terrorist funding and know-your-customer regulations are enforced. From a prudential regulatory perspective, ABTs do not appear to pose serious systemic risks to international financial markets. This may account for the often negative reactions of banks, banking associations, and cryptocurrency interest groups to the BCBS’ 2021 proposals for risk-weighted capital provisions for cryptoassets, which are viewed as excessive. Finally, we found that issuance of ABTS and other smart contracts on permissionless blockchains such as Bitcoin and Ethereum could potentially generate financial instability. A precedent involving Ethereum and The DAO in 2016 shows that (i) there is a significant accountability gap in permissionless blockchains, and (ii) the core developers of blockchains and smart contract technology, and Bitcoin mining pools, exercise an unexpectedly high- and completely unregulated-amount of power in what is supposedly a decentralized network.

A growing number of central banks are considering the issuance of central bank digital currencies (CBDCs). CBDCs for the general public (“retail CBDCs”) would constitute a central bank liability and a form of digital cash. To the public, they would be an alternative to central bank issued cash and private money, such as traditional bank deposits. The evolution of payments plays a pivotal role in developing CBDCs. Given the declining role of cash in some jurisdictions, CBDCs as a new form of central bank money may contribute to safeguarding trust in the public currency and improve financial inclusion outcomes. CBDCs have the potential to encourage competition and efficiency in an otherwise oligopolistic market for payment services, increasingly dominated by BigTechs, and increase overall resilience in payment markets of the future. Upon their introduction and depending on their exact design, CBDCs may have considerable consequences for policy makers and the general public. This chapter sets out four of the main motivations for issuing CBDCs, all while acknowledging considerable divergences across jurisdictions.

Technology has changed the future of money. The need to foster innovation in banking has been instigated by a shift from traditional finance provided by incumbents to fintech companies, such as challenger banks and decentralized platforms, offering new forms of money and payments services. The Bank of England has responded to this shift with the exploration of a Central Bank Digital Currency (CBDC), which in its retail form, would give the public the opportunity for the first time to directly hold state central bank money. This CBDC proposal emerges in a landscape where private money such as cryptocurrencies are increasing in capacity of coins and in trading volume; in a crypto economy with an expanding market capital. This competition opens the possibilities to reform banking to adapt to new payments platforms such as blockchains with advanced features such as smart contracts. The proposed design of a CBDC can either compete or complement such innovations which is evaluated in this review chapter. The author argues that the plethora of public and private currencies on the market, once reached legal maturity in terms of governance, can provide the element of choice to consumers in an open, innovative, and competitive free market. The author put forward that the Bank of England must act to introduce a CBDC that is interoperable with innovative payment platforms including blockchains, accompanied by a user centric design, to participate in the ever adapting fintech economy.

The digital euro is not a monolithic project. On the contrary, the application fields are broad, and possible solutions are diverse. This chapter provides an overview of use cases, application domains, and infrastructures for the digital euro that differ significantly. A comparison with solutions for the digital dollar and the digital yuan leads to the conclusion that, in the most extreme case, the euro could become a regional currency for Europe. The main reason for this argument is the design and prioritization of current approaches within Europe as well as the European Central Bank’s digital euro project, and that stablecoin approaches seem to be neglected as solutions for the digital euro.

The authors examine the factors that impact the growth of exchange traded funds (ETFs) from 1990 to 2020. The authors show the first-mover and winner-takes-all effects from top ETF issuers. Besides the longer history and larger asset under management (AUM), the ETFs being managed by top issuers have exhibited lower risks and higher trading volume. Delisted ETFs on the contrary has a shorter history, lower AUM, higher risks, and lower trading volume. For zombie ETFs, the authors find longer history, lower risks but lower AUM and trading volume, controlled for total expense ratio, return, volatility, Amihud (2002) illiquidity, bid-ask spread, turnover ratio, as well as year, issuer, asset class and region fixed effects. The authors further study the ETFs’ AUM and trading activities over the 2008 Global Financial Crisis (GFC) and COVID-19 pandemic crisis, and find that the GFC has a significant negative impact while the COVID-19 has a positive impact on the ETFs’ popularity. The significant increase in AUM of ETF relative to common stocks during the COVID-19 is associated with retail investors’ holdings, as the authors document a significant reduction of institutional holdings at the aggregate level.

We examine a large sample of some 100 economies worldwide to study the impact of financial sector size expansion on labor market performance. Simple linear dynamic panel data models inspired by the well-developed finance-growth literature suggest that (on average) a larger financial sector is beneficial for the labor market as it reduces unemployment rates. However, estimating country- and period-specific benchmark levels of financial sector size, we document that the relative contribution of finance vanishes with excessive levels of finance, and excessive levels of credit may actually be detrimental to employment. These non-linearities in the finance-unemployment nexus are more pronounced within developed economies. Overall, our study sheds new light on the ongoing controversy about the impact of the financial sector on societal well-being and highlights the importance of monitoring the expansion of the financial sector, in particular when it comes to credit markets.

The authors evaluate financial stability and capital flows management objectives of capital controls in the context of four capital control events: removing or imposing controls on capital inflows and removing or imposing controls on capital outflows. The authors use synthetic control method to solve the endogeneity problem stemmed from the timing of capital control implementation. The authors find new evidence that capital controls are not consistently effective in reaching financial stability outcomes but are consistent in reaching capital flows management outcomes. The authors compare our results to estimates using difference-in-difference (DID) and carry out placebo analysis. Finally, we use synthetic DID to correct for the parallel trend bias and show that the results still hold.

The development of financial markets as well as a country’s overall financial system plays a crucial role in the evolution of the world’s real economy. In developed countries like the USA, UK, Japan, and European nations, the world’s financial centers are located for exchanging huge capital flows with well-established functioning. However, laying the foundation for a financial center can be a big challenge to developing markets whose financial systems are still in the early stages, since the formation of financial centers is determined by multiple factors. Motivated by that reason, this book chapter provides a comprehensive review of critical determinants in the formation of international financial centers, including (i) economic growth; (ii) governance and business environment; (iii) financial development; (iv) labor force; (v) infrastructure accessibility; and (vi) the country’s reputation and stability. In line with the reviewed literature, the study particularly highlights the recent political and technological developments in the world and their impacts on the future of different financial centers worldwide.