It’s time to build: three priorities to reset the financial system

How should finance change in response to the pandemic and support the recovery? Alice Law and Huw van Steenis suggest three ideas – around climate, small businesses and encouraging resilient innovation

14 Jan 2021

Originally published by the World Economic Forum (WEF)

Huw van Steenis

Huw is Chair of the sustainable finance committee at UBS, former adviser to Bank of England governor Mark Carney, and a member of the World Economic Forum’s Global Future Council on Financial and Monetary Systems.

Alice Law

Alice is Managing Director, Mandatory Provident Fund Schemes Authority

The pandemic has exposed how unprepared many institutions were for one of the greatest global challenges in generations. Yet it’s also catalysed a wartime footing of speed and ingenuity in response. Now we must bring those qualities to how we shape the post-pandemic global financial system.

Unlike in 2008, the financial system has responded well. Financial firms have been resilient, not amplified risks and worked with policy makers to disburse emergency lending or offer forbearance. There have been some stand out examples of firms which have innovated swiftly.

During the initial stages of the pandemic, Marc Andreessen, co-founder Andreessen Horrowitz, argued "It's time to build.” His call to build new infrastructure applies just as much to financial infrastructure. Here are a few steps we can take to build the financial infrastructure we need, drawn from our discussions in the WEF’s Responsive Financial System’s council:

1) Turbocharge the transition to a low-carbon economy

The pandemic has sharpened the understanding that climate change, like the pandemic, could upend the financial system. The biggest shock to the energy sector in 70 years demands a new paradigm for financing assets. We cannot turbocharge a sustainable recovery without trusted, comprehensive, real-time data argues Refinitiv CEO David Craig. We are still some way from having the comprehensive, up to date and consistent data investors and financiers need.

Energy transition is a huge opportunity for public and private market investors and financiers. Some $3.5 trillion is needed annually for investments in sustainable infrastructure and to fund the innovation and re-engineering of business in every sector of the economy, according to research for COP26.

Finance should be full throttle building data and risk management tools, mainstream standard disclosures and mobilizing capital to support the transition to a lower-carbon economy. It should also lend support to Mark Carney's United Nations private finance agenda into this year’s COP26. The transition will be faster if policy makers develop market based incentives to support this transition – as well as taxonomies which reflect shades of green and constant innovation.

2) Accelerate a digital-led recovery for small businesses

Digital transformation is particularly urgent for small businesses, which are the engine of most economies. They provide over half of all private sector jobs in the US and Europe. They are job creators, community builders, innovators and enablers of opportunity.

And yet guaranteed lending programmes around the world highlighted the growing gap between large and small firms access to finance. Finance has a critical role to play in helping small businesses recover from the profound impact of the pandemic.

Some financial institutions have already begun to pivot their small business lending strategies to foster a much broader sense of digital enablement. Integrating inventory management with working capital, minimising fraud, or helping connect businesses to digital marketplaces are just as important as payments. This is an urgent priority for finance.

Governments have an important role to play by providing an enabling policy environment. These include everything from democratizing access to data to tax credits for investments in digitizing their businesses to removing barriers to sell and finance across borders. Particular attention is needed to rethink where multiple barriers limit the ability of international suppliers of digital financial services and e-commerce solutions on a cross-border basis.

3) Encourage central banks and financial regulators to embrace resilient innovation

The pandemic has accelerated clients’ digital expectations and the need for technology investment by at least 3-5 years according to Mohit Joshi, President Infosys. This requires urgent and far greater investment by financial firms, technology providers and regulators. We also suspect we’re on the verge of a seismic shift in the way banks and insurers manage software – to buy not build – as firms now understand they need best of breed. What's more, many more non-traditional players are playing larger and larger roles in financial infrastructure. Regulators will need to play catch up with these profound changes and update regulation for the digital age.

Regulators and the private sector will have to collaborate in new ways as technology breaks down barriers. For instance, moving to digital payments without leaving anyone behind will require significant upgrades to broadband and mobile telephony networks. Meanwhile, open finance will require competition authorities, data regulators, financial regulators and lawmakers to think about problems holistically, as opening up data may create unintended risks. Innovations and regulatory change can solve problems, but also bring new risks — or old risks in new forms. The unlevel playing field between technology companies and regulated institutions requires urgent attention, argues Santander Chair, Ana Botin.

Another enabler of resilient innovation is public cloud infrastructure, which has matured to the point they can meet the high expectations of regulators and financial services. Firms should be able to benefit from the agility, cyber-security and platform for innovation that this technology offers. Regulators need to trade off the additional resilience this can bring - as the pandemic has shown – against other risks.

The unbundling of the banking system could raise some fundamental challenges to traditional models of regulation, modelling the economy and how central banks operate. Enhancing the payments system for the digital age will also require new playbooks to implement stablecoins, central bank digital currencies and other payment innovations.

Simply put, central banks and policy makers should ensure regulation and infrastructure keep pace with innovative business models.

These priorities dovetail with broader ambitions. Promoting financial literacy, better digital ID, shaping inclusive payment systems, catalysing other digital government initiatives and strengthening cyber security will also be key.

We’re under no illusions about how complex the agenda is. There will be many who call to go slow to protect their vested interests, such as protecting and subsidising weaker regional banks. But this could slow down investment in the new financial infrastructure, so we will need resolve and ingenuity.

The crisis underscores the urgency to enable innovation, build infrastructure and prompt resilience for the recovery. We need to seize it for the benefit of all.

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