Douglas E. Johnston, Jr., Banking and Financial Expert Witness and Economic Analyst at Five Management, LLC, shares his unique perspective regarding the emergence of negative interest rates.
Negative interest rates are a confusing topic and they may be coming to the U.S. this year. If so, they may bring with them significant changes to everyday banking for Americans. In 2014, leading European central banks initiated ‘negative interest’ terms for many new government bond issues to help stimulate the economy. Negative rates began where major buyers of low-risk government bonds agreed to accept a return less than their original investment at bond maturity. As government bond issues led the way for corporate bond activity, these once-improbable ‘negative interest’ bonds quickly captured over $2 Trillion of the European bond market, and they soon found homes within major bank bond portfolios. The Federal Reserve and U.S. banks are now looking at them.
The policy goal of negative rates is to help stimulate the economy by influencing the day-to-day operations of commercial banks as financial intermediaries. Whether it is in Europe, New York or Los Angeles, commercial banks have long performed the fundamental role of matching savers and depositors with borrowers. Negative rates are designed by policy-makers to modify this historical model, by encouraging more lending and by discouraging traditional savings.
In normal operations, commercial banks accept deposits and then re-deploy those deposits in two basic ways: 1) they lend most of their funds out to businesses and individuals, and 2) they invest the remainder in bonds – usually low-risk government bonds and large highly-rated corporate bonds. In the US, an average bank will dedicate about 75% of its surplus deposit funds toward loans and 25% toward the purchase of low-risk (and low-rate) bonds. A bank will usually earn far higher yields on its loan portfolio than from its bond portfolio, so it will therefore usually want to deploy more of its earning assets in more profitable loans.
In times of pending economic slowdown (now emerging across the globe) a bank often shifts toward investing a higher percentage of its surplus funds into ‘safer’ low-risk government and corporate bonds – rather than make higher-risk loans – as the economy weakens. But in an emerging negative-rate environment, the bank is mathematically ‘penalized’ if it remains invested in low-risk bonds – because it will realize either super-low or even negative yields on many bonds. Thus, in an emerging world of negative rates, banks will have an even more challenging task in balancing profitability and soundness/safety issues.
Since the days of Adam Smith, bank lending has been viewed as ‘the grease of the wheels of commerce’ in the economy. A borrower with new loan funds uses the money to buy equipment, and the equipment seller is thus able to hire more staff, and so on. Negative rates strike at the heart of the decision-making process for any bank, which becomes reluctant to make new loans. By ‘forcing’ banks to lend to businesses rather than invest in unprofitable bonds, negative rates are designed to produce stimulus via increased lending activity. Greater lending activity also accelerates the turnover or ‘velocity’ of the money supply, which is a parallel economic policy goal in a slowing economy.
However, negative rates clearly influence multiple sectors in unusual ways. They effectively penalize banks that do not lend enough to businesses and individuals in their markets, and they also penalize depositors and savers. At the same time that a bank sees that it must choose to make more higher-risk/higher-rate loans rather than invest in low-rate (or negative rate) bonds, its depositors also see low or negative rates on their CDs and MMAs. The average depositor is faced with the prospect of effectively paying negative interest ‘rent’ just to have an account, instead of being rewarded for savings. In this regard, negative rates encourage spending over saving, and thus they may herald the advent of a theoretical ‘cashless’ economy. Significantly, the European Central Bank and former US Treasury Secretary Lawrence Summers have recently called for the abolition of large-denomination E500 and $100 bills within the European and US economies.
Negative rates have virtually no measurable precedent in history, and so the long-term impacts of negative interest rates are not yet fully clear. Consequently, there are no current textbooks on the effects of negative rates. Even John Maynard Keynes, the legendary architect of much of the current global monetary system, did not anticipate negative rates.
The central banks of Japan and Sweden have recently announced their intentions to adopt expanded negative rate structures of their own. And on February 12, Federal Reserve Chairman Janet Yellen also acknowledged that the U.S. Fed will keep open the option of pursuing negative rates as a means of further stimulating the US economy. Should this happen, it will constitute a dramatic reversal from the Fed’s widely anticipated December 2015 initiative to begin raising rates for the first time in many years.
As noted, the linkages and consequences of negative rates in Europe are becoming better understood. The Basel-based Bank for International Settlements, also known as the ‘central bank for central banks,’ noted in 2015 that it is closely monitoring the effects of negative interest rates and expanded monetary policy options across Europe. The Fed has noted negative rates are under active consideration in the U.S., and they may soon be with us among U.S. banks as a new economic stimulus measure.
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COVID-19: Dealing with fraudulent applications for the Bounce Back Loan Scheme
By Ed Lloyd, EVP Global Head of Sales, Encompass
The COVID-19 pandemic is still having a devastating impact on businesses and the economy in the UK, and access to funds, loans and financial schemes remains a top priority for business. In many cases, this kind of support is what has helped businesses to stay afloat so far.
The Coronavirus Bounce Back Loan Scheme (BBLS) is just one example. Announced in April, it was designed to help small firms unable to access other forms of support survive the crisis by providing quicker access to funds, through a number of accredited lenders across the UK, with the government, at the time, providing guarantees around the repaying of agreed loans, provided they were evidenced to be legitimate
However, since then, the scheme has been plagued by fraudulent applications, with opportunistic criminals seizing the opportunity to strike. As a result, it has been estimated that up to 60% of the loans may never be repaid, with the National Audit Office (NAO) saying taxpayers could lose as much as £26bn, from fraud, organised crime or default.
Bounce Back Loan Scheme corrupted by fraud
Since the Chancellor extended all connected loans, with businesses now having to pay loans back in January, there have been rising concerns about the potential risks. As mentioned, the scale of fraud has been significant, with criminal gangs exploiting the situation.
And, during this time, we have seen that false applications in the UK have gone almost entirely unreported, with less than 0.5 per cent of the expected cases being flagged to the police. The latest figures from the national Action Fraud service show that only 176 reports of fraud citing a government-backed lending scheme have been received this year, which is extremely concerning. Of these, 95 were crime reports, detailing offences that had taken place, and the remaining 81 were information reports, about attempted crimes. However, the National Audit Office reported that the Bounce Back Loan Scheme alone had delivered £36.9bn to more than 1.2 million applicants.
Even the Cabinet Office has warned that fraud losses from these loans were likely to be significantly above the norm – suggesting at least £1.85bn had been claimed dishonestly
The impact this issue is having on businesses and businesspeople alike cannot be underestimated, as the government refuses to pay back any fraudulent loans, and victims are even having to fight to prove they did not make loans applications.
We are now a matter of weeks away from when businesses will have to begin to repay banks, and they are finding themselves under increasing pressure. A particular concern is that, because of the high levels of fraud in applications, some of the money used to pay back loans may be the proceeds of crime – and banks need to be able to identify this risk.
To do this properly, it is likely they would have to conduct Know Your Customer (KYC) activity on loan beneficiaries again, and to a higher standard than before, in order to ensure dirty money is not flowing into their institutions. We know current manually driven KYC processes are not time effective and they would struggle to do this correctly in the timeframe as a result.
How are criminals doing it?
Lenders have been under pressure from the government to approve these loans within 48 hours, which doesn’t give them the time they require to conduct the level of KYC checks and measures needed to identify any risks or fraudulent activity. This problem is exacerbated by the high level of demand for the scheme – and, worryingly, there is just no telling how many of these applications are indeed fraudulent.
Whilst it is true that the entire process needs a head-to-toe structural review, there is one core topic that must be highlighted here, and that is the benefits of RegTech.
RegTech, and specifically intelligent process automation, allows banks to perform comprehensive due diligence checks in order to make sure a company, or individual, is who they say they are, and this can be vital in helping businesses cope in times of unprecedented demand, when they are working to tight deadlines.
It can take the burden away from analysts within the banks by doing the heavy lifting when it comes to carrying out proper KYC due diligence, ensuring an efficient and effective process. The right software should also be able to provide corporation dates and financial audits, as well as spot and flag suspicious applications, history, or activity.
We cannot forget that COVID-19 has led to a dramatic increase in other forms of financial crime, with many criminals using its guise to trick unknowing consumers into sophisticated cyber scams, which have been designed to look like legitimate government schemes or financial aid services. What’s more, the increased pressure on banking services means the fight against fraud and money laundering in the UK has become more important but, in many ways, more challenging. Financial services institutions must ensure they invest in trustworthy and secure onboarding processes if they are to have a truly meaningful KYC programme.
It is crucial that they make use of the solutions at their disposal to ensure swift approval and compliance, and avoid falling foul of regulation. Using advanced technologies such as automation is a solution to a significant problem, and its importance is only underlined during these times of pressure and uncertainty.
Data Unions, fisherfolk and DeFi
By Ruby Short, Streamr
In the fintech world it seems every month there’s a new trend or terminology to get acquainted with. From just learning about cryptocurrency a few years ago, to the crazy boom markets of 2017-18, the market has now moved on to DeFi, or Decentralised Finance to those less in the know.
It’s a trend which is gathering momentum, too – $275m of crypto collateral was invested in the DeFi economy in early 2019, but by February of this year it hit $1 billion, and by the end of July this number had risen to $4 billion.
According to crypto exchange Binance, DeFi refers to “a movement that aims to create an open-source, permissionless and transparent financial service ecosystem that is available to everyone and operates without any central authority.” Essentially it gives full asset control to those who use it, whether this is through peer-to-peer models or DeFi applications.
These apps, known as DApps, run on a blockchain network meaning they’re not controlled by a single authority. And as they are also Open Source, they are publicly available – characteristics that make transactions quicker, more affordable and more efficient than their centralised counterparts, where data is stored on servers managed by one authority (think traditional banks).
So why is DeFi getting so much attention?
DeFi is exciting for many because it gives more people more control over their money. Where much of the financial sector is traditionally centralised it inherits bias, thus restricting many people from their funds and what they can do with it.
With this approach, anyone can make investments or get into trading much more easily, and, most importantly, keep control in the hands of the user and not large corporations.
One of the preliminary benefits of this control is the improved visibility we gain over our financial data. In fact, any data we produce in general, whether online or through smart devices is predominantly controlled by giant centralised platforms such as Google and Facebook. In many cases users are unaware of where this is being sold on, or at least have been up until now.
As with DeFi and DApps, a way to decentralise this control has been introduced – in the form of Data Unions. A relatively new concept, this is a framework that enables individuals to bundle together their real-time data with others to create valuable insights which can be sold on, offering each the chance to earn revenue. It is helping businesses and individuals realise the value of the information they produce.
How does it work?
Our data on its own holds little value, but once bundled with multiple data sets from other people and sources and combined in a Data Union, it becomes an attractive set of insights to buyers who can use it to improve their market knowledge, product or service.
Data is shared through an app on the device or object via Streamr’s Data Union framework, a toolbox, which any developer or company can integrate into their existing products. It also allows individuals to choose which particular data types they share and monetise, and which they keep private.
This information then passes, encrypted, through the Streamr Network, to the Data Union where it’s bundled with others’ data for sale on the Marketplace – a process called crowdselling, which has the potential to generate unique data sets by incentivising trade directly from data producers.
What’s more, Data Unions can be set up to capture any form of data. For instance, a music streaming company could commission their own app where users could sell their listening and genre habits paired with their demographic info.
What has this got to do with DeFi?
Data Unions can help provide a means of DeFi direct to the people that need it most.
To break this down, a Data Union is beneficial because it enables any internet user to be paid for their data, which is unlike any data tax that has been proposed by many politicians. And, the advantage of a DeFi solution is that anyone can get paid from it because the finances are no longer dependent on their jurisdiction, but on which products they are using. Putting these together can have endless benefits.
We’re already seeing this happen, with a framework being used to improve the lives of financially marginalised groups. Tracey is a blockchain enabled Data Union working in partnership with WWF.
The application incentivises Filipino fisherfolk to record their catch and trade data digitally through direct data monetisation via the Streamr Marketplace. This data makes the first mile of their seafood products through the supply chain, traceable. With regional fish stocks declining, accurate catch yield data is a desirable insight for third party members such as retailers and final buyers.
The benefits of this model are twofold. Many fisherfolk in the Philippines are unbanked, meaning they don’t have a bank account. Trading this data gives them access to finance and loans previously out of reach, changing them and their family’s livelihoods. It also enables a self-sustaining ecosystem that captures accurate traceability data and helps these areas monitor their overfishing levels for more sustainable fishing.
What does this mean for us for the future?
We’re seeing a lot of momentum building around all forms of online decentralization,and the potential is huge. Over the coming years we will see these systems become ever more integrated into the existing internet stack, which will profoundly impact our possibilities online. Soon, it will become normal to take part in the internet’s data economy.
We see internet users becoming members of several Data Unions and have a range of different options to choose from that best suits them and their data sets. Personal data monetisation will no longer be a privacy issue we’re all suffering under, but rather a question of whether we want to sell our data or not. Users will have the freedom to choose for themselves if they want to sell their data or not and ethical data sharing will become the norm.
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