The true potential of digitalization in all spheres of the economy and society is probably yet to be discovered. It will be a dynamic process that will take time – and indeed will evolve over the years – although there will be moments of strong acceleration and vertigo, as could be the current one with the emergence of the new artificial intelligence, the generative one, in which the pioneer in the public eye has been ChatGPT, but others are following, such as Bard (Google) or AutoGPT. In any case, the implications of intense digitalization for the financial services industry have already been abundant, but there are still countless more to come, as this is one of the activities where information plays a central role. This affects people, businesses and governments and is a major geopolitical issue.
Digital also has significant risks, which, if inadequately monitored, could generate considerable damage of all kinds and truncate a process -which seems unstoppable- that could bring great benefits in terms of productivity and well-being. Supervision of these risks is critical, particularly in the financial sector, where a large part of society’s savings are deposited and where their stability is decisive for the proper functioning of the credit market. We all recognize that the primary objective of financial stability is to avoid banking crises. However, it has other purposes, which are also transcendental for the proper functioning of economic activity, such as offering sufficient and solvent credit. And, in this sense, digitalization should make this process more efficient while at the same time not increasing financial stability risks.
The crisis that has shaken a certain group of medium-sized U.S. banks, such as Silicon Valley Bank and First Republic Bank, among others, is not unrelated to the risks of digitization, when certain mistakes are made in the internal management or external supervision of the institutions. First of all, these banks have been exposed to a business segment that suffered from overvaluation and the correction has caught them without other sectors to rely on. However, just as importantly, if not more importantly, the business model and the liquidity and asset risk management of these banks left much to be desired. The impact of the existence of abundant digital deposits – with great ease of mobility – and rumors (not always substantiated) from social networks played a significant role in the problems that ensued. Nor did the initial reaction of the supervisor, the Federal Reserve, certainly help. However, in the digital environment, the demands for good management, good governance and external communication and sufficient solvency become even greater, because of the ease that potentially exists in many jurisdictions of such rapid transfers of deposits from one bank to another. This does not mean that what happened in the United States will necessarily happen in all countries, which is unlikely at this stage. However, it would be wrong to consider that this is a problem exclusively for that country and not to take the appropriate measures, on the one hand in the management of institutions and, on the other, in their supervision, to avoid situations of instability in the future, as digitalization progresses and makes the financial process more efficient and faster, but also challenged by new risks. A recent paper by economists Naz Koont, Tano Santos and Luigi Zingales entitled “Destabilizing Digital ‘Bank Walks'” shows with data from the second quarter of 2022 that deposit withdrawals were significantly higher in digital banks than in traditional banks in the United States. They also highlight that deposit withdrawals were more voluminous in territories where internet (and digital) usage is higher. This leads us to reflect on the value of tangibility for the customer and what level of trust is placed in a purely virtual bank versus one with online services but face-to-face relationships.
It is in this context that the digital future requires new models of liquidity and risk management and new perspectives on supervision. This is an important debate for the coming years, where digitalization will progress, but will need to produce financial security and stability. In this context, it seems timely to suggest that any major initiative such as central bank digital currencies should consider these financial stability risks, not only to avoid problems in individual institutions but also to ensure that the credit market functions properly. A context in which the digital currency (be it the euro or the dollar or any other) allows private deposit capabilities at the central bank is an environment that can generate serious dysfunctions in the traditional banking sector if it does not guarantee the proper functioning of the credit market, where, today and in the foreseeable future, banks will continue to play a central role. And they need a solid base of adequately remunerated deposits to finance the necessary credit.
The existence of a “risk-free” account that would allow significant deposits at the central bank, an idea that was once hypothesized, could generate significant dysfunctions in the functioning of the credit market and financial stability. Cash still has a role and having a diversity of payment options is important, useful and safer. Digital currencies are a breakthrough, no doubt, but one must consider the implications in a broad sense for financial markets and the economy, in the fine – and not so fine – print of these projects.