Banks, Digital Banking Initiatives and the Financial Safety Net: Theory and Analytical Framework

Abstract

This report presents an analytical framework for exploring the implications of Fintech innovations for incumbent banks and for provision of the financial safety net. The focus is on “digital banking initiatives”, that is, on Fintech initiatives that provide retail financial services akin to those traditionally provided by banks. Banks perform a wide range of functions for individual and institutional customers that help facilitate large-scale economic activity. In fact, in most economies the system of financial intermediation centres on banks and relies on their core products and services for financing of the economy and the maintenance of liquidity. On account of the central role banks play in the financial system, along with concerns about potential systemic instability linked to the riskiness of their activities, these institutions have long been regarded as “special”, as reflected in their prudential regulation and coverage under the various provisions of the financial safety net. Recent developments raise questions about the special status of banks. Two sets of questions are addressed herein: To what extent do new digital banking initiatives change the role that incumbent banks play in the financial system and the way that they perform their functions? To what extent are some of the new digital banking initiatives securing the benefits of the financial safety net without paying the commensurate price? To help address these questions the report first revisits the literature on core functions of the financial system to provide a framework for analysing recent developments. Particular attention is paid in this context to banks and their products and services. The “special” role of banks is discussed, which links to the provisions of the traditional safety net. These overview sections are followed by evidence on Fintech innovations that overlap the core banking products. Based on an examination of the characteristics of these new initiatives, the study then touches on the issue of whether banks are still special and whether some of these initiatives are or should be covered by financial safety net provisions.