Hello, and welcome to another episode of the Odd Thoughts podcast. My co host Joe Wisenval is away this week. I've actually noticed a pattern to Joe's absences, which is that he suspiciously goes missing whenever we're scheduled to talk about
negative rates on the show. In any case, we recently had the annual gathering of monetary policymakers in Jackson Hole, Wyoming, and as you can imagine, negative interest rates were a big feature of that meeting, and in fact, the title for this year's symposium was Challenges for Monetary Policy, which kind of gives you an idea of the headspace that a lot of central bankers are operating in at the moment.
But one of the most interesting things to come out of Jackson Hole this year, certainly a thing that got a lot of attention, was a speech by Bank of England Governor Mark Karney, where he talked about the idea of getting rid of the dollar as a reserve currency and basically replacing it with a virtual currency that would look a lot like Facebook's Libra in the sense that it could be a sort of consortium of digital currencies
maintained by central banks, a multipolar virtual currency. He actually called it a synthetic hegemonic currency, or s h C for short. Now, Carney's idea did raise a lot of eyebrows, not least because central banks have been critics of cryptocurrencies
in general and of libra in particular. So I thought to myself, who better to help us gain more insight into Carney's thinking and to also talk to us about negative rates and the future of payments and the future of all of finance in fact, than Hugh van Stine's. Hugh charired a review of the future of finance for Mark Carney and was his senior advisor at the BOE. He'll also be shortly joining UBS as an advisor to their CEO, and he's taking a break from his gardening
leave to come on odd lots Hugh. It's so good to have you, Tracy, Thanks very much for having me. So I guess we need to start with Carney's Jackson Hole speech. But we do know that Carney is due to leave the BOE in a few months, So I guess my question is, since you are someone who worked quite closely with him, how seriously should we take his proposal for this sort of multipolar virtual currency. Well, look, I mean I'm going to speak myself here rather than
for for the mark. I mean, I thought it's a really great speech because it put its finger on a number of the dilemmas that policymakers are wrestling with. I mean, first, let's let's be clear. Technology is transforming the basis advantage and financial services, and big texts are entering, fin texts are playing scale is far more important, and the regulations to catch up. So I think first and foremost, it's
about the way technology is transforming the system. I think second is that payments is the battleground between big tech payments firms and banks, and it's kind of existential. And as you've pointed out regularly, Tracy, the combination of negative rates and a disruptive environment is one which is an existential threat for for banks. And I think the challenge for firms entering payments liber Facebook is just the first
of which most recent of which is pretty challenging. And I think that one pushback that some had is that, you know, this was a little bit right out there in terms of forward thinking. But one question I often got challenged is what can we learn from the Chinese financial system is it just the gallapagus of the financial world. And I think it's not science fiction. I mean, there you've got and Financial and we chat pay controlling of online payments, and Financial now has got the most customers
of any financial services firm in the world. If you can combine what they've gone in China and India, it's over a billion five time city group. So I think that the payments, both in terms of currency and in terms of new entrants, being the battleground. I think he's put his finger on something really important right in China has actually announced that it is close to releasing its
own cryptocurrency. Whether or not that's going to be an actual cryptocurrency or something that's more akin to digital cash, we don't know just yet, but but definitely there seems to be some interest from some central banks, at least in virtual currencies. So, just on the notion of payments, you know you've said before and you just said it then that payments are now the battleground. Can you expand
on that a little bit? Why is there so much pressure around this particular space in financial services, particularly low rates. They're not that many areas which have got strong growth and payments clearly is one where people are moving offline to online. I mean, one thing that we on earthed in our port was that, let's take a sweet, we've had an eight reduction in cash transactions the last decade.
The UK is probably four or five years behind that, the US is probably another four or five years behind that. There is a very long tailwind of shifting commerce online and everyone wants to be the gateway into the online commercial world. So I think that's one key aspect around payments. I think second is these are person to person apps, whether it's you know, Ali in Pay in China, whether it's Swish and Sweden, whether it's Ideal in Holland. These
are sort of category killers. You know, they really munch through cash and are provide convenience and flexibility for customers, which you know customers are quite frankly lapping up. So
I think there's that transformation. But I think the big thing for financial regulator and a particular central bank where you know money is what it's all about, is the role of big text either becoming a toll road that they just want to be the toll which people get into the commercial world, but potentially be coming much bigger and financial services, and that with their advantages of scale with other related businesses quite frankly a way of thinking
which is very different from financial services. So if you take the Libra white paper plus all the other papers they put out on that day, you know, there's over eighty pages on the tech and there's just under a dozen pages on the way the syndicate work. There's not a single page on regulation. And I think that's really atypical, and I think that's something which that means it's really difficult for a traditional policymaker regulator to get their heads
around because there's just nothing there. Well, I was going to ask you the fact that a lot of these tech companies have made such massive inroads into payments so quickly, is that actually down to the tech or is it down to regulatory arbitrage in the sense that they are not hindered in the same way that banks are. I think there's an element of an un leveled playing field where they are coming in on a different basis. But it doesn't have to be that the big text win.
I mean, just go back to Sweden. Swishes a bank consortium app which allows anyone to pay one at anyone, So you need to get over the hurdle of antitrust about how banks collaborate with each other. But there's a country where actually it wasn't the big text who drove the innovation. So I think this is much more about do the banks have the budget, do they have the
ability to respond? And of course, going back to one of your favorite topics, in a world of negative rates, bank profitability is pinched and as a result of that, they just don't have the tech budgets that some of these other firms have. And I think the other bit is that you know, I mean I met with over entrepreneurs and fintech companies for the review I did for the governor. They have a very different profit motivation. They
can withstand losses for three five more years. There's not a single bank which can really do that art for for a five year basis, so they just start with a very different basis of competition. I do want to ask you about regulating payments come panies, but before I do, you've mentioned China several times as being very ahead in the payment space. Um, we have things like Ali pay, and we chat over here. How did they get to
that place? Because a lot of people would call them a sort of special case in the wider evolution of technology and financial technology in particular. I think it's a really important exam question to think about what we can understand and what may be borrowed from other markets, and what's what's different. So first is the payment firms are really pump primed by a big tech firm. So whether it's Ali with U and Financial or we Chat with we Chat pay, they use their existing cleon tell and
network effects to the hugely sair advantage. I think second is that they really did offer phenomenal promotions to get acceptances. So in one case they offer taxi drivers in ebaging a premium if clients paid with Ali pay, and also gave the clients a discount if they're paid, So they were really smart about discounting and generating client interest. And then and the third of course is maybe what is
different is they've got a whole financial supermarket. Now in most Western regulatory structures, different regulators have have have purchased on different parts of the financial system, and you've got one financial supermarket which is a bit different. The other
error which is is different to China is identification. There is an element that everyone is identified, and one of the big issues that everyone's wrestling with in the West is how you can make how you reduce fraud, and how you make sure you know who your client is. And actually some of the emerging markets probably have leapfrogged the West on on this and maybe and obviously quite frankly, have a different sense of um, you know, libertarian values
about what the States should or shouldn't know about you. Right, So, how much of the China example would be replicable in for instance, at the UK or the US. Well, I think so, First, you've already got some pretty strong capacitors. And I love Alex ram pull at A sixteen Z has got a great line that the quintessential debate between an incumbent and a new entrant is does the new
entrant get distribution before the incumbent gets innovation? And I think that battle is really about you know, what China shows us is that the new entrant got distribution incredibly quickly.
And I think as you look into the States, you've got some pretty serious payment firms Visa, MasterCard, MX, PayPal, as well as some of the key banks, JP, organ and so forth, which have got really big positions in payments already, I think two very few big texts want to have the hassle of bank and payments regulation and all the capital that goes with that. So most of the firms so far I've tried to be a wallet or or or a toll road on the back of
the existing banking system. But you know, what I think we could see is that over a period of time these firms could grow broader and deeper. And many of the financial FinTechs that I met have ambitions for, you know,
quite frankly, world domination. And I think therefore it's about making sure that the banks and the payment firms respond, you know, and really understand that existential challenges pretty real, right, So as these tech firms potentially grow bigger and encroach ever more on the financial space, and to your earlier point, what are the challenges posed by that for central bankers? How are they exactly supposed to respond to this new
group of financial intermediaries. So there's a couple of things, and it does vary country by countries. So first is around innovation. Most geographies want to encourage innovation of new firms, but in many jurisdictions you've got a concept of a startup or you've got a systemic financial payments firm, and
very little in between. And so I was struck that the Singaporeans in the last year injected a new third category saying, actually, if you've got half a million and billion customers, we need to deal with you in a different way. And so payment regulation has to probably be updated to reflect that these are now very large firms which may not yet be systemic, but whose failure would be pretty brutal for the system. I think second is
around what it means for the banking system. I use skimming off the cream of profits for banks and leaving them just simply as dumb pipes, in the words of one of my colleagues who who looks at this space, or maybe even maybe not done pipes. That's undfair, high
cost due diligence machines, but nonetheless not very profitable. I think that's worth well, yeah, I think that is, and I think that but that that it is interesting that quite a few of the payments firms are trying to rely on the know your customer checks that the banks do, and then they don't get rewarded for it, and so there is to be honest, a slight unleveled playing field between payment firms and banks in most but to be honest, not all jurisdictions. But the third thing tracy there is
coming back to actually who's being left behind? And I know that that I was struck by a huge interest in what does the decline of cash mean for those who potentially may be getting left behind, whether it be elderly, disadvantaged or potentially disabled. And if you look at Sweden, where cash has fallen by eight percent of the last decade, they start to hit some crunch points. And one thing that I spent some time looking at in the review is how close are we to those crunch points in
the UK or other markets? And what would you do to make sure that there is a minimum or even a viable infrastructure to at least maintain that cash system. And so you end up with some quite out there discussions of should in the long term it be the responsibility of the state or the central bank to keep
the cash economy viable. But I think you know, for many listeners in the States that sounds like a bit of site sci fi, but it's something which in Norway and Sweden, where less than ten per cent of transactions are now done with cash, is something which is pretty important. So why exactly do we need cash? So there's a big debate as always about what is the right mandate for the central bank. At the moment, it's society's decision
how we pay, not the central banks. And so I think that the Bank having like other central banks, takes it as a political decision what the future of cash should be. And if you look at the sort of a debate in history, I mean in the nineteenth century there were some pretty big debates about who had the responsibility to print money, should you have private sector money or not. Today we're gonna be debating who how much
should there still be cash in the system. I think over the next ten years what we're talking about is not cash less, but just increasingly cash light as a year by year more payments are done online. But I think it's really a political discussion, and if you look in Sweden, it's getting more intense about you know, where the politics lie. And I think at the moment, the assumption is there should be some cash to allow people
to transact. But you know, you and I can debate, you know, twenty years out what that should be just when it comes to the sort of value of cash in a society. If we go back to the negative rates idea, I mean, negative rates basically make cash uncompetitive, whether it's physical and you're stuffing it under your mattress, or whether you know you're putting it in a bank and it's a sort of digital number. What does that mean for central bankers who whose purview is you know,
of course monetary policy. It's all about the money and cash is uncompetitive. So look on this I should really say this is my personal view than the banks view. But obviously we don't have negative rates in the UK. When I was Morgan Stanley, I argued vociferously that negative rates were a high risk experiment, and in particular that you know, most of modern macroeconomics takes the financial system and then assumes it away just basically ignores banks and
intermediaries and their own actions. And I think ignoring that friction comes at a cost. And you can see that the way that negative rates are played out, As you know you were discussing a few weeks ago, Japanese bank regional banks are the least profitable in the world and actually have really been sort of supported by clipping coupons
as government bonds get get revalued. I think that the corrosive impact of negative rates on bank profitability is very strong, and I think there's been two great new papers, one by Professor Charles Goodheart or the lsc in another and norgious nor justis Bank Working paper, both of which you challenge the orthodoxy and say, actually, if you ignore banks and insurers, you do it at your peril because as you get towards low rates and move into the les
in Wonderland rule world of negative rates, the credit transmission simply becomes much less effective. And I think that's really something which policymakers need to weigh up as we think about confronting the global slowdown. I certainly, for my vote would be hardly against any further moves more negative. And I think also what really struck me doing the review is, you know, tech is really important, but also cyber defense.
European banks, particularly Urozone banks, are spending almost half the proportion of their tech budgets on digital transmation then their US colleagues. Now some of that is being subscale, and ye know, we can debate whether there should be more M and A in Europe. But some of it is just the lack of profitability, and of which negative rates is a key component. So I think it's a it's a tough experiment, and that's before we go onto you know,
people storing cash in deposits and and being disincentivized. So I think it's a remains a high risk experiment here three or four years on. But just on this point, this is one thing that I don't understand, because central banks must know that banks are important transmitters of monetary policy. So if banks are structurally unprofitable, doesn't that worry the
central bank? I think it does. But I think that what you've put your finger on is a as a key difference between probably the Anglo Saxon world and else and some of the other systems, where I think the Anglo Saxon world firmly believes in a positive interest rate, even if it may be low. I think a second is, you know, because macroeconomics have just assumed this way, there is very very little in the literature that central bankers
are relying on to understand how this works. And I think it's fair to say negative rates work in in quote a myriad of ways you know, they obviously impact net interest income margin further banks like the top line, but in some cases as your markets get revalued up commission income, the sale of asset amount of wealth mantial products can increase low rates. Clearly a suppressed bad debts, and that's been a key defense of you know, ECB
and and and others in support of the policy. But when you really dig deep, it's probably more QUEI than negative rates who have done that, because there's more about tackling the bad debt problems in Spain, Portugal, Greece. Itally and arguably QUI would have been more effective than negative rates and suppressing it. But you know, as you and I and your listener though, that's already priced in. So at this point, you know, lower lower bad debts is
priced in. It's much more about what the next step is from here, and a very unprofitable system is one which is more brittle, and so I think that's a that's definitely concern one. You know, Larry, someone's recently came up with the great um analogy about black hole economics. The one that I've debated more with a bunch of academics I've been working with is it's more like steroids.
Storids and short blasts can be very effective in repair, but long term dependency on steroids starts to dissolve your bones and makes the pay more brittle. And maybe negative rates are more like steroids than other analogies. So just to continue that analogy, if you have banks that are sort of reliant on the steroids of easy monetary policy, and we're reaching the limits of that potential monetary policy.
And at the same time, payments is a space where you can still make money as a financial intermediary, but you're getting a lot of tech firms encroaching on it, and in the meantime, lending out money doesn't actually earn you any interest. What does that mean for the banking business model? Is there a future for banks in their current form? I think that no. I I firmly think there is, And I think we go back to this that it's first technology at one level allows many new entrants,
but also provides real scale economies. And in a world where let's say large corporates are obsessed, rightly obsessed about their security and money, the firms who've got the single best cybersecurity should win out. So number one there's a I think tech is becoming an arms race for the winning financials and back sorry, winning banks. So I think that's one aspect which is really important. I think to
what flows from that is scale is more important. And so it may well be that actually the combination of low rates and tech actually accelerates more M and A, which is you know, let's be not let's be honest, has been somewhat on hold in recent times, and you can see that with a couple of recent US transactions which have really been around payments and the tech space. And I think third is it really will be about
becoming a low cost manufacturer. And so I think there is going to be relentless hard work for bankers and making sure they've got a lean and a very effective platform. Because you know, throughout my professional care career, let's take sort of um, when I used to sit on and exutary trading for many many years ago before we got moved into the research box. The you know, commissions have gone down through thick and thin, double digit year by year. And I think that banks have been able to confront
that through becoming more efficient and more scaled. So I think there's a lot of industrial logic which needs to flow from this, but they'll probably need a bit of luck as well. Is there space for regulation to play a role in this? Could payments companies big tech companies entering the payment space? Could they be regulated like banks?
And one of the reasons I asked this is because one of the outcomes of your review was the BOE starting a consultation on opening access to its balance sheet to payment providers, which you know it's kind of uh controversial in many ways. Yeah, I mean so, I think the way that the President I see this through is
having a level playing field. It is not the job of the bank to pick winners or losers, but provider the the infrastructure and set of rules and standards to ensure that there is just a great suite of financial services which are safe and secure for society. So I view this much more about the level of the playing fields.
On one hand, if there are some really high quality payment firms who pass some pretty high hurdles of security, cybersecurity and resilience, then why shouldn't they potentially have access to part money at the Central Bank overnight and help a foster competition. But the other aspect of a level playing field is the payment firms or the Big Text have to be held to the same standards as banks, So whether that be with knowing your customer and antimony
laundering controls, whether be cybersecurity, whether it be resilience. And that's why the other part of my report was to argue for updating payments regulation. Now within the UK, that's obviously a role for the government and they're kind of busy at the moment with other things and I can't imagine what, but the former Chancellor, you know, did commit the Treasury to looking at a updated payments regulation. As I said, I think what the singer Porens of Dana.
Introducing a third category or you know, large important payment firms which are held high standards is at least an intriguing idea which you know, many jurisdictions I'm sure must be looking at. And the other bit about reciprocity of data. So one of the big challenges is if the banks are asked to share their data with Big Text, what do they get in return, or at least how do they get compensated for that? And so a level playing fielding information is probably just as important as having really
high standards. So I'm going to ask you a very broad question now for which I ask your forgiveness in advance. But when you look a decade into the future, what exactly does the financial system look like to you? Who is dominating and how are central bankers responding? Well, look, I have the humility to know that I thought about to try and think about scenarios because none of us are clever enough to to be able to forecast the future.
But so let me let me turn it around saying that the scenarios that I think policymakers really must think through. So one would be that if we have a two by two of the rate environment and have the degree of disruption, the one where we have negative or low rates and high disruption is very challenging for the banking system. So thinking through what does that mean then for scale
their budgets to respond. What can they be allowed to do in response to these competitive challenges potentially changing you know, what market shares they can have to try and have more scale. That's something I think is really important to weigh up. A second is if big tech, in the scenario where big texts become really important, or at least even fin techs are a much broader range of players
are skimming the cream. What standards do we hold them to, particularly knowing that the network effects are so powerful that when a firm is large, like let's say the Chinese payment firms, it's very difficult to row them back. And so you know, one reason why I think the bank talked about you're making sure they want to get ahead of Libra of than just respond when it's out, is to try and think through firms which could become systemic
and get further ahead. I think the other aspect of tracy, which is slightly more you know, basic, but I think it's really important, which is the central bank needs to have the capabilities and the kind of know how of
the tech world. You know, most central banks around the world are dominated by outstanding public servants who have got PhDs in economics, and I think that's an important skill set, but we need to make sure that they also have much richer understanding of cyber of technology and you know, the tools and so you know, one scenarios that the regulator of the future is more like on the Star Trek enterprise, you know, with the data coming in automatically
to you know, screens and understanding so they can get their finger on the pulse much more quickly. And what is quite frankly a complex and challenging world, right, So was the technology aspect of your research? Was that difficult when you were at the b o E. Did you, you know, for instance, have to I guess, tap specific expertise or ask specific people to help you on technological issues. Yes, I mean I was blessed that everyone was very happy to help out, and so I met with over three
hundred entrepreneurs, techy CEOs, cyber experts. Many other policy makers around the world lent they had too, so I was able to dig deep. I mean, obviously I have the humility that even in a year, I can only scratch the surface of some of these important questions. I think that you know, one thing that I put my finger on is that it's still quite a paper based world. And so if you're sitting there as a regulator, I calculated that the average bank regulator is receiving the complete
works of Shakespeare twice a week in terms of data. Now, you simply can't comprehend that without modern technology. And if you know, going back to my life as a research anaist, you needed to automate feeds, you need to create alert screens, you need to complete you rethink the way you you run with hypotheses and make sure you get the appropriate data.
And the other thing is regulation is blooming complex. So the UK rule book is longer than the complete works of the Old Testament and unfortunately gets updated regularly, and so you know this is no one individual can keep on top of that data. So it's not just the regulator, it's the people at the banks themselves who are trying to keep on top of a god gangin amount of data.
So without embracing technology and quite frankly embracing cloud technology, so banks and regulators communicate their data more cheaply, more effectively. I think it's going to be part of the secret source of of an effective central banker in the future. What was the most interesting part of working at the BOE on this project? Did you Did you go searching
for the BOES gold reserves for instance? Well, I think I mentioned that, you know, Bill Winters, who had previously done a review, so that I should get access to the gold vaults on my security pass. But I realized that was a joke and I when I tried to get in there were people with guns, so I'm afraid I never found out how much of the gold Gordon Brown sold off, But no, I think it's um. It
was two things. One was we hosted a large and round tables and to try and keep them you know, bouncy a bit, you know, we we had typically you know, four or five people from the incumbents. Four or five attack has done a few clients to ground the conversation, so it just didn't become sort of finance babble. And it became really crystal clear to me that some of the fin techs not only are challenging the status quo, they don't even know where some of the rules are.
And I think that's a very odd environment for regulators to comprehend. And therefore, you know the natural Pavlovian reaction that is to sort of close up. And yet you know the world is developing and is moving at a pace, and so you do need to keep very open, alert
and engaged. And I think that was one aspect. I think second was this sort of international comparisons um and understanding what we can learn, whether it's from China, from Sweden, from other other industries about how to respond and certainly was I thought about what the bank regulator of the future should look like. I was probably spending more time to thinking about data analytics, digitization of data, taxonomy is quite frankly data science than I was thinking about, you know,
PhD s and economics. All Right, Hugh, I think we'll have to leave it there, but thank you so much for coming on Odd Thoughts. As you know, I've been following your work for so very long, including when you were a star analyst really over at Morgan Stanley, and it's been great to chat with you again. Thanks so much. Well, this has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway, and you can follow Joe Wisenthal on Twitter
at The Stalwart. You can also follow our producer Laura Carlson at Laura M. Carlson and finally, make sure you're following Bloomberg Podcasts on Twitter at Podcasts. Thanks for listening, Ye