Archive for June 23rd, 2021

30 years of India’s reforms: A podcast with key actors

June 23, 2021

Puja Mehra, author of Lost Decade has put up an interesting podcast on India’s reforms story.

It’s been 30 years since India opened up its economy, freeing it of the licence permit raj, improving access to capital, and introducing a New Industrial Policy. But what went on behind the scenes, and how have successive governments taken these reforms forward? In a series of seven conversations with economists, policymakers, thinkers and doers, Puja Mehra unpacks the story behind India’s reforms and finds out what’s likely to happen in the near future. This is a Mint production, brought to you by HT Smartcast.

The podcast features both, earlier and current architect of India’s reforms. Should be an interesting hear.


Fiscal regimes and the exchange rate

June 23, 2021

Enrique Alberola-Ila, Carlos Cantú, Paolo Cavallino and Nikola Mirkov in this BIS paper:

In this paper, we argue that the effect of monetary and fiscal policies on the exchange rate depends on the fiscal regime. A contractionary monetary (expansionary fiscal) shock can lead to a depreciation, rather than an appreciation, of the domestic currency if debt is not backed by future fiscal surpluses.

We look at daily movements of the Brazilian real around policy announcements and find strong support for the existence of two regimes with opposite signs. The unconventional response of the exchange rate occurs when fiscal fundamentals are deteriorating and markets’ concern about debt sustainability is rising.

To rationalize these findings, we propose a model of sovereign default in which foreign investors are subject to higher haircuts and fiscal policy shifts between Ricardian and non-Ricardian regimes. In the latter, sovereign default risk drives the currency risk premium and affects how the exchange rate reacts to policy shocks.

Regulating BigTech in financial services

June 23, 2021

Nice speech by Tobias Adrian of IMF on regulating BigTech in finance.

First the business model of BigTech is different from FinTechs:

There is no doubt technology is having a profound impact on the financial services industry globally. When we think of BigTech, we think of large technology conglomerates with extensive customer networks with core businesses in social media, telecommunications, internet search and e-commerce. They are present in all continents and in most – if not all – of our member jurisdictions.

The business model of BigTechs leverages three factors: the data they already have on consumers, aiding BigTechs to understand customer needs better; the advanced analytics they use to deepen this understanding further; and the reliance on strong networks effects, from leveraging their large consumer base. Their expansion into financial services can happen very quickly, as network effects drive interaction, user activity and the generation of ever greater amounts of data.

It is interesting to see that BigTech expansion into financial services happens in a different direction than what we would normally see in fintech start-ups. The new technologies that allowed fintech start-ups to unbundle financial services, offering partial financial services or aggregation and customer interface services, are used by BigTech to “reverse” the unbundling. Based on their large global user base of non-financial products, they benefit from cross-subsidization and economies of scale and scope. That makes them well positioned to capture a significant market share of financial services once they start providing them.

There are some potential benefits in this “rebundling”. BigTechs can use their knowledge of consumer preferences obtained through their other business areas, such as consumer spending habits and credit worthiness, to offer financial services to customers who may be underserved by traditional lenders. The economic and social benefits of financial deepening can be compelling.

Why we need to regulate BigTechs?

So, why should financial regulators be concerned with BigTech?

The provision of cloud services is a good example of how BigTech non-financial services could have broader implications. The cloud is the virtual delivery of computing services that powers the operations of diverse entities across all financial services. These range from the largest bank to investment managers and smallest start-ups.

The range is wide, yet there is a strong dependency on only a few critical providers. The Bank of England, in a 2020 survey, estimated that more than 70 percent of banks and 80 percent of insurers rely on just two cloud providers for IaaS (Infrastructure as a service). [2] Globally, 52 percent of cloud services are provided by just two BigTech entities, while more than two-thirds of services are provided by four BigTechs. [3]

This concentration highlights the reliance of the financial sector on the services provided by BigTech. Ultimately, failure of even one of these firms, or failure of a service could create a significant event in financial services, with a negative impact on markets, consumers, and financial stability. The importance of these services means that in some respects, BigTechs may be already ‘too-critical-to-fail’ in some.

Fintech firms in general are not yet systemically significant, because their market share of financial services in most jurisdictions is not yet material. 

In regulation, there are two broad approaches – entity based and activity based:

The BIS and FSI [6] have recently re-ignited the discussion on activity vs entity-based regulations and their adequacy to deal with BigTechs. I would like to explore these ideas a little further.

Consider the entity-based approach — in which regulations are applied to licensed entities, or to groups that engage in regulated activities. Requirements are imposed at the entity level and may include governance, prudential and conduct requirements. The entity-based approach can be built on principle-based regulations that allow more flexibility, as it can rely on expectations of governance and risk management of the entities and groups. Most important: There is a continuous engagement between supervised firms and supervisors, allow for the monitoring of the buildup of risks and the evolution of business models. Implementation is supported by supervisory activities (such as off-site monitoring and on-site inspections). Supervisors usually have a range of early steps that can be taken to modify firms’ behavior that could lead to excessive risk-taking and instability.

By comparison, consider the activity-based approach — in which regulations are applied to any entity (or individual) that engages in certain regulated activities. Those regulations are typically used for market conduct purposes. They are generally prescriptive, and compliance is ensured by fines and other enforcement actions. Most BigTech firms are already subject to such activity-based regulations in many countries, such as AML/CFT and consumer protection rules.

In some ways, the activity-based approach may encourage competition by requiring that only relevant regulatory permissions are needed to carry out certain activities. In theory, this “levels the playing field” by applying the same rules to the same activities, whoever is doing them. However, there are some important caveats. The approach must define activities very precisely, which is likely to create regulatory arbitrage opportunities, as it may not be able to capture rapidly changing and hard to define fintech activities. There is less room for supervisors to take actions before proceeding to enforcement. Because of this heavy reliance on enforcement, the activity-based approach is generally not suitable for early supervisory action to modify risky behavior. It is also not very effective for cross-border activities, unless global regulators adopt consistent regulations and unless international agreements allow for cross-country enforcement actions.

Therefore, where firms have a potentially systemic approach and have a business model that involves various inter-related risks, a more hybrid type of regulation makes sense. Since our Global Financial Stability Report of 2014, [7] the IMF has advocated for a mixed approach to address systemic risks posed by shadow banking. There are some similarities in the regulatory challenges between those from shadow banking and BigTech. For example, both have grown outside the regulatory perimeters to have potential systemic implications. While each individual entity and service may not pose systemic issues, the combination of the entities and services, provided as bank-like financial services, also creates systemic risks. Some entities and functions of both shadow banking and the BigTech ecosystem can easily relocate their headquarters and main activities to other jurisdictions where regulations are less robust.


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