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2021 | Buch | 1. Auflage

Financial Services in the Twenty-First Century

The Present System and Future Developments in Fintech and Financial Innovation

verfasst von: John J A Burke

Verlag: Springer International Publishing

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This textbook covers financial systems and services, particularly focusing on present systems and future developments. Broken into three parts, Part One establishes the public institutional framework in which financial services are conducted, defines financial service systems, critically examines the link between finance, wealth and income inequality, and economic growth, challenges conventional paradigms about the raison d’être of financial institutions and markets, and considers the loss of US financial hegemony to emerging regional entities [BRICS]. Part Two focuses on financial innovation by explaining the impact of the following technologies: cryptography, FinTech, distributed ledger technology, and artificial intelligence. Part Three assesses to what extent financial innovation has disrupted legacy banking and the delivery of financial services, identifies the main obstacles to reconstructing the whole financial system based upon “first principles thinking”:
Nation State regulation and incumbent interests of multi-national companies, and provides a cursory description of how the pandemic of COVID-19 may establish a “new normal” for the financial services industry. Combining rigorous detail alongside exercises and PowerPoint slides for each chapter, this textbook helps finance students understand the wide breadth of financial systems and speculates the forthcoming developments in the industry.

Inhaltsverzeichnis

Frontmatter

Financial Services: Public Framework and Relationship to Capital and Income

Frontmatter
1. Introduction
Abstract
Imagine a world in which payments, domestic or international, were executed instantaneously by smart devices or some method not yet in existence. Imagine payments made directly between debtor and creditor, without any “third party” intermediary, bottlenecking the process and charging pre-set tolls to access cables, routers, and software programs. Imagine a world in which banking was bytes and bits: no physical building, no physical location, and no “in presence” requirement. Imagine a world where money is an electronic record held in virtually immutable electronic blocks traceable to factual origin, and where movement of that money leaves an audit trail to verify its legitimacy. Imagine a world where, regardless of geographic location, all financial accounts, current, savings, and investment, were seamlessly linked together forming an electronic real-time matrix managed from a single instrumentality. Imagine a world where you see “all information” effecting economies, companies, and financial instruments, unfiltered by third parties, imposing fees and using outdated infrastructure to implement decisions about your money, your borrowing, your investment. Imagine no government-imposed roadblock upon how you conduct your economic life. Wonder is the start of knowing.
John J A Burke
2. Essential History and Fundamental Purposes
Abstract
Financial systems do not exist in a vacuum. Rather, financial institutions and transactions take place within a global public space. The primary constituents of this public institutional framework are Nation States, derived from the 1648 Treaty of Westphalia, the United Nations established in 1945, and the institutions that emerged from the 1944 Bretton Woods agreement: pre-eminently the International Monetary Fund and the International Bank for Reconstruction and Development (the World Bank Group). In 1948, the General Agreement on Tariffs and Trade (GATT) officially entered into existence, and in 1995, the World Trade Organization was established incorporating the 1948 GATT. The Bretton Woods agreement also established a new international monetary order appointing the US dollar as the sole international reserve currency, with the dollar pegged to the price of gold, and all currencies pegged to the US dollar. Although the Bretton Woods international monetary system terminated in 1971 when then President Richard M. Nixon announced that the United States would no longer exchange gold for currency, the legacy of the public institutional structure, in which financial systems operate, survived the demise of the gold peg, and continues to exert extraordinary influence on the behaviour of finance. A review of this public space therefore is prerequisite to understanding financial systems and evaluating the term “global finance”.
John J A Burke
3. The Financial System
Abstract
The title of this textbook makes it necessary to define the term “financial services” for purposes of exposition and subsequent analysis. It is virtually impossible to describe the extant financial services system as it exists in every distinct region of the globe. The infrastructure holding together the individual pieces that allow cross-border delivery of services was developed by historical accident without a pre-conceived master plan. To resolve these impediments to providing a meaningful narrative of financial services, this chapter focuses upon the UK financial system. It is large in relation to the economy, is an important financial centre for global transactions in financial assets, and has already been mapped by the Bank of England. The UK financial system is a microcosm through which financial services generally may be defined and analysed. Brexit, and the purported loss of London as a global financial centre, are irrelevant for purposes of illustration, since the UK is rich in financial institutions. This chapter is descriptive leaving for later critical analysis of underlying and misleading assumptions.
John J A Burke
4. Capital in the Twenty-First Century
Abstract
It appears unorthodox to analyse “Financial Systems” by reference to Thomas Piketty’s Capital in the Twenty-First Century. However, it is the exact place to start, as Piketty speaks to global economics and the phenomenon of unequal distribution of assets and income. The financial system does not exist in a vacuum and lacks plausible deniability to eschew its role in the distribution of income and capital to individuals, whether legal or natural persons. While financial systems may be agnostic as to asset distribution, financial systems are the instrument through which capital is created, income distributed, and interest rates set. Implicit in this chapter is the question whether financial systems are a causative factor in economic growth, and if yes, in what way and in what manner of allocation of resources. Therefore, a précis of Piketty’s work is essential to understanding and evaluating financial services, institutions, and markets. This approach does not diminish the importance of traditional extant textbooks, but questions why they tend to assume that financial systems unequivocally promote economic growth and turn a blind eye to its effect upon the plight of human beings. The consequences establish a fertile context in which to rethink the purpose and structure of global finance.
John J A Burke

The Conventional Paradigm: Questioned

Frontmatter
5. The Conventional Narrative: Deconstructed
Abstract
“One of the principal conclusions of modern economics is that finance is good for growth. The idea that the economy needs intermediation to match borrowers and lenders, channelling resources to their most efficient uses, is fundamental to our thinking” (Cecchetti and Kharroubi 2012; Arcand, Berkes and Panizza 2012). Some researchers purportedly “have established a convincing causal link running from finance to growth” (Goldsmith 1969). However, the “iron link” between real economic growth and financial intermediation is overstated as recent empirical work has shown. Increased financialisation is adverse to aggregate real growth, draws resources away from their most productive use, and exacerbates financial crises. In addition, the premise, unless substantially qualified, that financial services are responsible for economic growth is misleading and ignores compelling non-financial factors that drive economic expansion. It also fails to recognise the political use of the financial industry to gain advantages in international trade and to impose suffering upon populations to push regime change. As already stated, financial services do not exist in a vacuum and are instruments of multiple purposes. This chapter demonstrates the fallacy of the “principal conclusion” in its strong form, illustrates legitimate use of finance driving economic expansion, identifies factors unrelated to finance that increase GDP, and lastly shows how countries misuse the financial sector for political policy.
John J A Burke
6. Commercial Banks Create Money Out of Nothing
Abstract
There are three main competing theories of banking: (McLeay et al., Money Creation in the Modern Economy, Bank of England Quarterly Bulletin 2014 Q1, 27 Mar. 2014 at https://​papers.​ssrn.​com/​sol3/​papers.​cfm?​abstract_​id=​2416234, 2014) financial intermediation, (New Economics Foundation at https://​neweconomics.​org/​, n.d.) fractional reserve, and (Tobin, Commercial Banks as Creators of ‘Money’ (Cowles Foundation Yale University, 1963)) credit creation. The vast literature on this subject asserts the validity of the financial intermediation theory. This chapter sets forth each model and then demonstrates that, drawing upon empirical evidence, the only model to survive empirical scrutiny is the “credit creation” model: commercial banks create money by reclassifying entries in its balance sheet, unavailable to non-financial corporation and to non-bank financial institutions. Clarifying the “defining characteristics of commercial banks” has far reaching consequences. First, commercial bank credit creation accounts for 97% of the money supply. Second, banks, when making loans, do not draw down their “reserves” held at the Central Bank; “reserves” are used to settle interbank payments through the Central Bank. Third, if as asserted the Basel Accords are based upon the financial intermediation assumption, the Basel Accords are impotent to stabilise the global banking system. The “credit creation” model also calls into question a second unverified claim found throughout the literature: credit creation leads to economic growth as measured by gross domestic product.
John J A Burke
7. Money
Abstract
Chapter 6 has proved that commercial banks create money and use seigniorage profits to enrich themselves to the detriment of the real economy. Our inquiry into money does not stop there. The “philosophical” or “technological” nature of money remains open. The rise of cryptocurrencies enhances the importance of this question. The history of money is fascinating and a pre-requisite to understand contemporary financial systems and institutions. This chapter does not have any ambition to cover the compelling story of financial history, as Niall Ferguson has brilliantly done. Rather this chapter reviews the evolution of money from physical assets to mathematical functions and makes an inquiry into what constitutes money in the sense of currency. “Money” should be easy to define due to its common use to make purchases of goods and services, open bank accounts, and invest in financial instruments like stocks and bonds. However, money is a multi-faceted concept, elusive to define precisely, as “its nature has varied substantially over time” (McLeay, Money in the modern economy: an introduction, Central Bank of England, Quarterly Bulletin, 2014) (Michael McLeay, Amar Radia, and Ryland Thomas, Bank of England Monetary Analysis Directorate, Money in the modern economy: an introduction, Quarterly Bulletin 2014 Q1, found at https://​www.​bankofengland.​co.​uk/​quarterly-bulletin/​2014/​q1/​money-in-the-modern-economy-an-introduction, last visited 9 April 2018). Heilbroner and Galbraith state, “money is surely one of the most perplexing inventions of human society” (Heilbroner and Galbraith, The Economic Problem, Prentice Hall, 1990) (Robert L. Heilbroner and James K. Galbraith, The Economic Problem 328 [Prentice Hall 9th ed. 1990]. Heilbroner died in 2005 and the Ninth edition has never been updated. However, this text is a masterpiece among texts of its type and is required reading for anyone interested in financial services). This chapter describes the evolution of money from metal to electronic data within the framework of the economist definition. The learning objectives are: (1) knowledge of the functions of money, (2) the primary embodiments money has taken over centuries within Europe and North America, (3) money as “trust” without reliance on anything of value, and (4) the future money is likely to take in a digital ecosystem. The learning outcome is the ability to think critically about the institution of money.
John J A Burke

Technologies Influencing Financial Services

Frontmatter
8. The Genesis Files
Abstract
The “Genesis Files” comprise a series of articles written by Aaron van Wirdum for Bitcoin Magazine in 2018. They provide a significant historical background on Bitcoin, the first widely successful cryptocurrency, and its progeny. The composite articles demonstrate that the founder’s original intent was to augment online privacy and to produce an untraceable payment system. The overarching concern was ownership, control, storage and access of private individual data gleaned from Internet transactions. The problem: who or what was going to manage information in the next century—government, organisations (commercial and otherwise) or individuals. In retrospect, the encroachment of large organisations using permissioned networks and government imposition of regulation does not render the efforts of Chaum and the cypherpunks in vain, though their romantic vision of a benign anarchy is defeated. The cypherpunks’ strategies and creations designed to return to the individual the control of communication and information, including financial transactions, are noble, and perhaps the extant situation of “corporate/government” control is reversible. This chapter follows the historical sequence followed by van Wirdum in his serial articles: Timothy May, David Chaum, Adam Back, Wei Dai, and Nick Szabo. Many other computer scientists and cypherpunks contributed to the movement’s efforts to anonymise identity and transactions. They are mentioned when possible.
John J A Burke
9. Cryptography
Abstract
Cryptocurrencies and distributed ledger technology use principles taken from the science of cryptography to design their architecture and enable their functions. Understanding cryptographic concepts therefore is a prerequisite to understanding cryptocurrencies and distributed ledger technology. The challenge of writing about cryptography derives from its lengthy history, complexity, and, in modern cryptography, reliance upon mathematics, especially prime numbers and modular arithmetic—matters that are explained based upon the exceptionally lucid and accessible writing of Simon Singh. This chapter provides a brief overview of cryptography, ciphers, symmetric cryptography, asymmetric cryptography, digital signatures, hashes, and mobile communications. Two outstanding achievements deserve mention at the outset: (1) the Diffie-Hellman-Merkle key exchange, and (2) the RSA public key cryptography, without which cryptocurrencies and DLT would not exist. The next chapter then places these topics within the context of the “genesis files” that laid the foundation for the first successful electronic cash payment system: Bitcoin. The Internet and YouTube are full of useful and colourful explanations of modern cryptography. However, The Code Book by Simon Singh is the masterpiece that makes the complex and arcane story of cryptography accessible to non-specialists (Simon Singh, The Code Book: The Science of Secrecy from Ancient Egypt to Quantum Cryptography Anchor Books, 1999).
John J A Burke
10. FinTech
Abstract
Financial innovation arguably started in Mesopotamia where the first books of account were inscribed in clay tablets. The bond market derives from war. Ferguson (2008) states, “The ability to finance war through a market for government debt was … an invention of the Italian Renaissance (Niall Ferguson, The Ascent of Money: A Financial History of the World 70 [Penguin Books 2008]). The joint stock company of the seventeenth century produced the first initial public offering, and established the first stock market, where shares of the United Dutch Chartered East India Company traded in a secondary market. The House of Rothschilds constructed an international finance system in the nineteenth century and used what now is called “big data” to enhance their fortune. Derivatives and securitised financial instruments, which developed in the twentieth century, magnificently illustrate financial innovation. Lewis Ranieri’s mortgage-backed securities (MBSs) left a notable impression in the twenty-first century. However, the term “FinTech” refers to disruptions to the financial services industry following the 2008 financial crisis, and the use of mobile technology. FinTech covers many innovative institutions and markets, for example, neo-banks, use of cryptocurrencies, improved payment systems, and crowdfunding/crowdlending peer-to-peer platforms. Although financial innovation started centuries ago, FinTech is the “next episode” of financial innovation.
John J A Burke
11. Distributed Ledger Technology
Abstract
The term “distributed ledger technology” (DLT) is notoriously difficult to define and often is used by institutions, ranging from private to public organisations, in inconsistent and contradictory ways. For example, the World Bank, the European Central Bank, and the Bank of England each propose different definitions of the term. The lack of consensus on a coherent definition “has resulted in misconceptions and the widespread formation of unrealistic expectations as to what this technology can achieve” (Rauchs … Zhang, Distributed Ledger Technology Systems: A Conceptual Framework, University of Cambridge, 2018). Lack of consensus also has resulted in making discourse about “distributed ledger technology” virtually impossible given the myriad and diverse conceptions held by institutions and individuals. However, in 2018, the University of Cambridge published a seminal paper (Cambridge Report) establishing a conceptual framework to deconstruct and to define a DLT (Michel Rauchs et al., Distributed Ledger Technology Systems: A Conceptual Framework, University of Cambridge August 2018). The Cambridge Report, and its proposed definition of distributed ledger technology, provides an unparalleled and logically compelling framework to classify a distributed system as “distributed ledger technology”. In essence, “A DLT system is a ‘consensus machine’: a multi-party system in which participants reach agreement over a set of shared data and its validity, in the absence of a central coordinator” and in an adversarial environment (Rauchs). This chapter restates the conceptual framework of DLTs as defined by the Cambridge Report. Subsequent to explaining the architecture of a DLT, the chapter then uses the Bitcoin Network as a case study to demonstrate an application of the Cambridge DLT framework to an existing system. Following the Bitcoin case study, the chapter explains the mechanics of Bitcoin, and then discusses cursorily Ethereum and “Hyperledger”, as they present important and complex variations on Bitcoin. The aim is to provide readers with foundational concepts of DLT especially as used in the context of financial services.
John J A Burke
12. Artificial Intelligence
Abstract
Artificial intelligence (AI) is the most important technological development as opposed to FinTech and distributed ledger technology, to impact the future of financial services and diverse other business processes. AI has the capacity to change the world as we know it, and fundamentally transform not only the financial services industry but also the myriad businesses funded by the financial services industry. Although AI is the oldest of the three technologies, it is developing at an unprecedented pace, and is approaching the goal of “cognitive reasoning”. The financial services industry already deploys AI in many business applications; examples include credit decisions, risk management, fraud prevention, algorithmic trading, chatbots, and automation of repetitive tasks (Arthur Bachinskiy, “The Growing Impact of AI in Financial Services: Six Examples, 21 February 2019, found at https://​towardsdatascien​ce.​com/​the-growing-impact-of-ai-in-financial-services-six-examples-da386c0301b2. Each application requires qualification as to level of functionality. For example, “smart chatbots” often are not smart at all.). AI will impact the future of financial services in ways difficult to predict because of the advent of “big data” and the searing pace of development in the field. The latter quickly renders obsolete existing statements and explanations of the field. Constant vigilance is required to make certain that textual information is accurate.
John J A Burke

The Future of Financial Services

Frontmatter
13. BRICS
Abstract
In 2001, Jim O’Neill of Goldman Sachs authored a paper entitled “Building Better Global Economic BRICs” thereby coining a new acronym as an investment term. At the time of publication, BRICs comprised four countries: Brazil, Russia, India, and China. O’Neill posited that the combined GDP of the four large emerging economies would exceed that of the G7. O’Neill also posited that, over the next decade, the annual rate of growth in the BRICs economies would surpass that of the G7 thereby raising the policy question of BRICs representation at global economic policy meetings. In 2003, Goldman Sachs published a paper entitled “Dreaming with BRICs: The Path to 2050” in which the investment firm projected, ceteris paribus regarding its assumptions, that the combined economies of the BRICs would be greater in dollar terms that the G6. On 20 September 2006, on the proposal of Vladimir Putin, the Federative Republic of Brazil, the Russian Federation, the Republic of India, and the People’s Republic of China held the first BRIC ministerial meeting in New York. The respective foreign ministers expressed their “interest in expanding multilateral cooperation” thereby transforming BRICs from an investment term to a political and economic reality of Nation States. In 2010, the Republic of South Africa joined the BRICS expanding the group’s geographical composition. Since 2009, the BRICS have held annual summit meetings. Although Goldman Sachs closed its BRICS investment fund in 2015 due to its poor performance, the BRICS countries continue to strengthen their international relations and pursue common goals. This chapter reviews the history of the BRICS, traces their development from 2001, and analyses the potential of establishing a multi-polar world.
John J A Burke
14. Modern Monetary Policy
Abstract
Monetary policy is a tool used by central banks to manage a country’s economy. Central banks generally have two mandates: (1) maintain inflation targets of approximately 2%, and (2) maintain employment at a maximum percentage of the labour force not exceeding “the natural rate of unemployment”. Central banks conventionally achieve these goals by adjusting the short-term bank rate, the interest rate at which central bank member banks may borrow from the central bank. Lower rates are designed to ease credit conditions and stimulate economic activity. By contrast, higher rates are designed to tighten credit conditions and slow down economic activity. The bank rate is expected to cascade through the economic environment to effect other market interest rates. In addition, central banks manipulate the money supply by means of open market operations, either purchasing government debt to increase the money supply or selling government debt to decrease the money supply. When these conventional tools do not work, as they have not worked since the 2008 financial crisis, central banks have turned to quantitative easing or QE. The programme of QE takes place when the government creates money from nothing, and the central bank uses these funds, often approaching a trillion dollars per year, to make large asset purchases, ranging from zero-risk government debt to higher-risk private debt. The object is to stimulate growth by easing credit conditions with greater volumes of currency than that available by conventional means. Modern Monetary Theory (MMT) explodes the central assumptions of conventional monetary policy. This chapter restates MMT as enunciated by Stephanie Kelton in her book The Deficit Myth (Stephanie Kelton, The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy, (John Murray Press 2020). This chapter restates MMT as articulated by the author in her book).
John J A Burke
15. Impact of FinTech: A Prediction
Abstract
This textbook began with a dream of a global seamless financial services rail to serve payments, investments, and lending without intermediation by trusted third parties, where information is free and instantaneously available to everyone, geographic location is meaningless, and all financial transactions are transparent, though pseudonymous. Government is not needed and the stature of Nation States is reduced to benefit the stature of individual human beings. This was the dream of the cypherpunks, and original thinkers like Satoshi and Buterin. The dream cannot be realised, it is already partially dead, and the romance of revolutionary possibility is gone. The textbook also covered technologies and developments, such as FinTech, distributed ledger technology, and artificial intelligence, that have already impacted the financial services industry and will continue to impact the sector, though not as originally conceived. FinTech firms may compete with traditional banks, but not the largest banks or financial institutions in the world. Successful firms also run the risk of purchase and take-over by incumbent entities in the industry. The question whether the hegemony of the United States over the global financial system may be displaced depends primarily upon China’s ability to create a world reserve and trade currency based on the yuan (China manages the value of the renminbi. Tom Mitchell and Xinning Liu, Why Beijing’s ‘managed float’ of renminbi has drawn US ire, August 6, 2019, The Financial Times. Markets are unlikely to accept a managed currency as a world reserve currency as markets will not know its true value, if measured by supply/demand forces). The Internet of Things depends upon building a matrix of smart connections to synchronise information and devices, and the matrix may be built in the cloud. The most successful introduction of FinTech financial services took place in parts of the world with a large number of underbanked or unbanked customers, specifically China and Africa. A major advantage was the lack of legacy banking infrastructure and the widespread use of mobile telephones. In advanced countries, FinTech companies primarily have piggy-backed on top of legacy infrastructure. Cryptocurrency has evolved from Bitcoin to more than 5000 altcoins. Concomitant with this growth was the development of markets where coins are traded and converted into currency. The ultimate outcome of digital money remains to be seen, turning particularly on domestic and international financial institutions. Blockchain’s promise to provide multiple benefits to diverse industries appears to have been co-opted by large organisations like IBM, but time will tell. Existing implementations of artificial intelligence to financial services will evolve beyond existing chatbots and algorithmic trading, as this domain is quickly innovating.
John J A Burke
16. Conclusion
Abstract
Financial services in the twenty-first century differs from the pre-2008-era banking and financial services industry, especially in the domain of payments, probably the weakest function of legacy banking. One observer states, “Today’s financial services enterprise is a markedly different organisation from its predecessors at the beginning of the 21st century – and those that survived the credit crunch of 2008” (Anders, Bank to the Future, Banking Circle, 2020). The key differences rest on greater digital capability, “data driven business models”, and focus upon customer experience. The global pandemic of 2020 also accelerated the transition to digital as all businesses, including those in the financial sector, were forced to rethink ways of conducting business and making transactions with customers. According to la Cour, “The financial enterprise of tomorrow has already arrived”. This author is less sanguine. Chapter 14 established the limited menu of financial services FinTechs offer customers and stressed the obstacles of creating a bank or financial services firm that is wholly distinct from legal institutions and that is novel, in the purest sense of the term. Deploying a combination of new technologies has the capacity to continue the digitalization of financial services expanding the menu of financial services offered to the public, the method of delivery, and their costs. However, there is a disjunct between claims that “the past is dead” and the practical experience of customer interaction with financial services entities, such as over-reliance upon physical residency. If banking moves to the “cloud”, why should a customer be nailed to the physical territory? A revolution in financial services requires building the model around a global customer. A second question is: has anything changed in the role of the financial services industry and the growing inequality of income and wealth in which it is used as an instrumentality? The answer bluntly is nothing has changed. The financial services sector serves most effectively the population constituting the 1% decile of the world.
John J A Burke
Backmatter
Metadaten
Titel
Financial Services in the Twenty-First Century
verfasst von
John J A Burke
Copyright-Jahr
2021
Verlag
Springer International Publishing
Electronic ISBN
978-3-030-63967-9
Print ISBN
978-3-030-63966-2
DOI
https://doi.org/10.1007/978-3-030-63967-9

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