Thursday, March 9, 2017

Fed's Powell sees technology challenges for payments system

By Colleen M. Svelnis

Speaking about innovation, technology, and the payments system, Federal Reserve Board Governor Jerome H. Powell focused on three key areas where technological innovation is driving change: creating a real-time retail payments system; using distributed ledger technology (DLT) to develop new clearing and settlement services; and the issuance of digital currencies by central banks.

In his remarks at the Yale Law School Center for the Study of Corporate Law, Powell discussed the impact of new technology on the financial system and businesses. He warned that disruptive new technologies suggest that traditional financial service providers must innovate and adapt or be left behind.

Payments system. The Fed and other central banks have adopted broad public policy objectives to guide the development and oversight of the payments system. At the Fed, Powell states, they have identified efficiency and safety as the “most fundamental” objectives. The payments system must be innovative, while also addressing risks, supporting financial stability, and maintaining public confidence, according to Powell. He stated that “Safe payment systems are built from proven technology and operate reliably and with integrity.”

With regard to the development of real time retail payments, Powell stated that the Fed has been working with a wide range of stakeholders to improve the speed, efficiency, and safety of the U.S. payments system. Powell also discussed the work of the Faster Payments Task Force, which in 2017 will assess proposals covering innovative ways to deliver real-time payments against the task force criteria.

Distributed ledger technologies. Using blockchain technology—which employs a form of DLT—and an open architecture, Powell noted that Bitcoin allows for the transfer of value between participants connected to its ecosystem without reliance on banks or other trusted intermediaries.

Powell noted that some predict that DLT will eventually render parts of the banking and payments system obsolete, as the intermediation of funds through the banking system will become unnecessary. In contrast to Bitcoin’s open architecture, Powell stated that work by the financial industry has focused on the development of “permissioned” systems.
 
Issues include whether finality of settlement is to be determined by a central trusted party or by a majority of participants, and whether participants are able to view information on other parties’ transactions. Another issue, according to Powell, is the costs for upgrading and streamlining payment, clearing, settlement, and related functions with DLT. Technical issues including whether a particular version of DLT will work for the intended purpose are still being explored, stated Powell, and issues of reliability, scalability, and security remain. Powell also stated that governance and risk management is critical, as well as the legal issues surrounding and supporting DLT.

Digital currencies. Powell discussed the idea of a digital currency issued by a Central Bank. According to Powell, a digital currency issued by a central bank would be a global target for cyber attacks, cyber counterfeiting, and cyber theft, as well as a potential vehicle for global criminal activities, including money laundering. Central banks would have to balance trade-offs between strengthening security and enabling illegal activity. Privacy issues would also need to be considered, stated Powell. According to Powell, “private-sector products and systems already exist or are being developed that will fulfill demands that central-bank-issued digital currencies might otherwise seek to meet.”

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