Transcript of Speech and Q&A Session Role of the Financial Sector in Sustaining the Recovery

Philip Lowe

Thank you very much Luigi and good morning, everybody. I'd like to thank Bank Indonesia and particularly my good friend, Governor Perry, for the opportunity to participate. I'm really sorry, I can't be in the room with you, rather I'm still here in Sydney and I hope to be in Indonesia later in the year for the next G20 meeting.

As others have already said, this symposium addresses a really important issue. How do we recover together? And then how do we make sure that the momentum that we currently see in the global economy is maintained once we're through the pandemic? But both Mattias and Perry have spoken very well about the role of productivity reforms. I'd like to mainly talk about the role that the financial sector has to play in this important mission of recovering together and sustaining the recovery and I'll touch on some financial stability issues, as I do that.

I want to focus my remarks on four ways that the financial sector can support the recovery. The first, is to be an absorber of economic shocks, not an amplifier of shocks. The second is to be a source of finance for new productive investment, including the transition to a green economy. And the third is the role productivity improvements within the financial sector itself can play in promoting growth, including through the development of new forms of money and new forms of payment. And the final thing that I want to talk about is the role that finance can play in improving inclusion and reducing inequality in our societies. So I plan to say a few words about each of those four issues.

First, if we are to recover together, then we need the global financial sector to be an absorber of shocks. Here, I think it's useful to compare the 2008 global financial crisis with the pandemic. In the financial crisis, the global financial sector amplified the shocks and it made things worse, and the result was severe economic pain in most of our countries. In the pandemic, the reverse has been the case. The financial sector has acted as a shock absorber. Banks gave repayment holidays to borrowers, which helped. They extended repayment terms and they made credit available at low interest rates to borrowers who needed it. As a result, the banks lessened the shock, they helped limit damage to our economies, and it's one of the reasons that many of our economies have been quite resilient.

Banks were able to play this role because of the reforms to capital and liquidity over the previous decade. The G20, the FSB and the standard-setting bodies all played important roles in the development of these reforms. It is a really good example of what can be achieved when we work together. In this case, by working together, we developed a safer global financial system.

Looking forward, we can't be sure where the next shock's going to come from. I think we can be sure, there will be another shock. We've already talked this morning about the prospect of rising interest rates around the world. This increase in interest rates is occurring in an environment where debt levels are much higher than they were before, particularly in the advanced economies. And it's also occurring after a very big run-up in asset prices, including the cost of housing in many countries. So rising interest rates on high debt with high asset prices – you can see the fault lines here.

I think it's also relevant that the increase in interest rates is not likely to be synchronised across countries, given there are very different inflation dynamics in our countries, and Perry talked about this earlier. The US and many European countries have quite high inflation at the moment, but here in Asia, inflation is not particularly high. In Australia, our core measure of inflation has only reached the midpoint of our target range for the first time in seven years. And in much of Asia, inflation is not particularly high. I think we know from previous experience that when countries are on different paths, in terms of interest rates, stresses do emerge in the global financial system. So I think it's quite possible, in fact, probable, that there'll be stress points over the next couple of years. In this environment, we need to make sure that the post-crisis financial reforms are maintained and where they still haven't been fully implemented, that they are implemented. Building this resilience is going to be really important over the next few years.

The second issue I wanted to talk about was the role of the financial sector in providing finance for productive investment, including for the transition to the green economy. If we are to have a durable recovery from the pandemic, we need businesses and governments to invest. If they don't invest, the recovery is only going to be lacklustre, once the snapback from the pandemic is over. If they don't invest, real interest rates will stay low, savers are going to get low returns, real incomes will not grow very much and we will all pay the price for that. So the expansion of our productive capital stock is crucial to our collective prosperity. Some of this expansion can be financed from firms' internal resources, but much of it needs to come from external resources, including from banks and from the bond and the equity markets. One area that we'll need major investment is the restructuring of our energy systems, including the way we produce and use energy, the way we store energy and the way our energy distribution networks are configured. The financial sector is key to this investment.

I think we all know, people in this area need to make decisions under considerable uncertainty. It's really hard to know exactly how our climate's going to evolve. It's hard to know what new technologies will emerge, and it's probably hard to know what the future policy environment will be as well. Given this uncertainty, participants in financial markets need the information now to be able to assess and price climate risks and opportunities so that they can fund the investments that are needed for the transition to a lower emissions' economy. The FSB and the standard-sitting bodies are rightly setting supervisory expectations for the measurement and management of financial risk and climate change. Regulators, including here in Australia, are conducting climate stress tests to help measure the exposures in the financial system. And there are many international efforts underway to improve the quality, consistency and breadth of climate risk disclosures.

Some countries are also developing green finance taxonomies to define what is sustainable and to direct investment towards these activities. It's important that these taxonomies don't just focus on activities that have an immediate benefit, but also include activities that are necessary to ensure the transition to net zero over time. So Australia very much supports Indonesia, in placing the financing of this transition to a green economy on the GT20 agenda. If we don't get this right, it'll be a source of future instability in our financial systems and our economies.

The third issue I wanted to talk about is the role of finance as a source of innovation itself, and that innovation can help improve our collective living standards, because we all know finance is in many ways at the forefront of many of the new technologies that have been developed over the past decade. Think artificial intelligence, big data analytics, and distributed ledger technologies. These changes in technology are also reshaping how we think about money. If you look back through the broad sweep of history it's pretty clear that what societies uses money is shaped by technology.

Sometime back in history, people used silver and gold coins for money. Then they use paper instruments, then they used paper banknotes. In Australia, we use pieces of plastic polymer banknotes with the sophisticated holograms on them. And in many countries, the main form of money now is electronic bank deposits that can be moved over the internet almost instantaneously. So as technology changes, so does what we use as money change. We can't be sure what the next innovation in money will be, but I think there's a fair chance that it will be a form of digital token that sits in a digital wallet or a digital device. If that's what happens, it offers the potential for lower costs and for more flexible payments for people, and I think it'll be more inclusive. It's hard to know where this is going to end, but I think there are significant opportunities here.

If money does evolve along these lines, it needs to be supported by a really strong regulatory regime. One option that's on the table is for these digital tokens to be backed by central banks, just as central banks today, back the banknotes. So you could think of this as a form of central bank, digital currency that's available for retail use. Another possible option, is the tokens are not backed by central banks, but are backed by private entities. This would be some form of stable coin against our national currencies. If this is what happens, then I think we really need to give close attention to the design and the collateral banking of this privately issued money.

I say this because history is littered with examples where private money worked really well for a time, but then something happened, confidence is damaged and it all ends in disaster and financial crisis that hurts people. And that's the reason I think why our currencies today are backed by the state and that we have state-sponsored deposit insurance. So, the collateral underpinning of this and the regulatory regime is really important. Things that seem like they're working well for a while, if they're not backed adequately can turn out to be very bad for the society if there's damage to the confidence. So the challenge here for us all is to develop a regulatory regime that promotes innovation, but that can also deal with the stability issues that can arise with new forms of money, particularly stable coins. The central banks, the FSB and the G20 are all working on this and it's a really important part of our agenda for the future.

Beyond the notion of money, there are many other opportunities for innovation and productivity improvements in the financial sector to lower costs and to develop new products that help people. One of the reasons that financial intermediation can be expensive now, and it can often be limited to borrowers who already have well-established connections, is that there are often acute information asymmetries, which the lenders can't easily overcome. This is particularly an issue for the micro and small businesses that are an important source of dynamism in our economies.

Some of the new technologies can lessen these information asymmetries by increasing the available sources of data and making it easier to process that data, easier to collect the data and to monitor the loans. As a result, in many countries now we're seeing new lenders emerging who are using this new information technology. These new lenders are lowering costs and making finance easier to get for micro and small businesses. In some cases, it's the market-based financing that Luigi talked about. So I think this is an exciting area too. We need to make sure that the regulatory arrangements are supporting stability in this area, but that they also continue to encourage the innovation that's possible by this new financial technology.

The last thing that I wanted to talk about was the role of finance, in promoting inclusion and reducing inequality. And this is one area I think we all have a lot to learn from Indonesia on, particularly – its financial inclusion agenda. There's a lot of innovation occurring here, including development of fast payment systems, the increasing use of open APIs and the adoption of QR codes, which lower payments costs for micro businesses. I think more broadly, the hope is that improvements in information technology and data processing will help small businesses that haven't been well served by the financial institutions. It will help overcome these information asymmetries, and given those asymmetries are most acute for micro and small businesses, they're the ones who could potentially benefit most.

One other area, where there is considerable scope for improvement that would enhance inclusion is cross border payments. We spoke about that in the first session. For many people, cross border payments are still too costly, they're too slow and they're too inconvenient. And in Australia we see firsthand how this disadvantages people who are less well off. It's a really major issue in the South Pacific, where the cost of remittances is very high. Poorer people pay these costs to their disadvantage and to the disadvantage of their communities. It's a really important issue that we address.

The Reserve Bank of Australia and the Reserve Bank of New Zealand are working with the South Pacific central banks to try and address this, but it's proving hard to make progress. This means that it's really important to keep the focus on the G20's roadmap on cross border payments. This is a project with a lot of layers and it's going to take time to pay off. And we really welcome the Indonesian Presidency support for this work. It's particularly important for people who are less well off. It's certainly possible that a central bank digital currency will help here. So too, might the various initiatives that are underway to improve payments infrastructure, including ideas to link up fast payment systems, especially in this part of the world. This is an area that's important that the central bank community and the private sector keep working on.

So in conclusion, I want to thank again the Indonesian Presidency for putting this item on the agenda. It's important that we recover together. And once we are past the economic snapback from COVID, that the economic recovery can be sustained. The financial sector can help us do this. It can do this by maintaining buffers against future problems. It can do it by financing business investment, including the transition to a green economy. And it can do that by being innovative and by being supported by a regulatory regime that promotes this innovation, but also protects people and it can address the financial stability issues that can come with new forms of money. And finally, the financial sector can help by bringing more people into the system in a way that they can afford, and that suits them and helps improve their own situation. So thank you, and I look forward to our subsequent discussion.

Question & Answer Session


Thank you very much, Governor Lowe, for your various, very insightful comments

Now, we are supposed to have a question and answer session. We've actually theoretically reached the end of our allotted time. But since we started with some delay, I think that we can allow, I would say, not more than a couple of questions from the audience, if there are any, and then I will give the floor to the speakers for answering those questions or commenting on each other's speeches, if they want to. Are there any questions from the floor? Please, the lady in the second row.


Thank you. Thank you for all the very good presentations. I have very short questions. Thank you, I already heard how Financial Stability Board is doing to try to figure out that digital transformation will benefit the society at large. My question is, aside from what you've mentioned about our live learning process, you've mentioned about all the financial inclusion and so forth, there are novel risks of security issues, new and advanced faster accelerated technology issues and so forth. Is there any study that the Financial Stability Board have already done? I just want to know about that because I always follow all the issues. And secondly, how about you Dietrich, maybe I can ask you a question because as we all know that the acceleration of the digitalisation, especially CBDC, central banks have been one of the leading sectors to adopt this new technology. Do you think there are any other very short answers for future actions needed, future strategy, so the CBDC that are going to be issued or going to be introduced by some countries will benefit others rather than upsetting others who are not yet ready to issue CBDC. Thank you.


Thank you very much. Maybe one other question, if there is one. I don't see any hands raised. So in that case, I would like to give the floor first to Dietrich. I think that he was the one, there was a question that was addressed to, you Dietrich, and then the others will have a chance to make a few final comments. So Dietrich and answer the question.

Dietrich Domanski, Secretary General, Financial Stability Board

Thanks, Frederico, and thanks for this question. Well, the FSB has through a dedicated group followed rapid advances in financial technology over the past couple of years, and on a number of occasions, published reports that provide an overview of trends or look into specific areas. Our current focus, as I mentioned, is on the crypto asset ecosystem in its various forms and guises, and we just published our risk assessment on financial stability risks from crypto assets. Now I think looking ahead what seems to be the case is that decentralised finance brings together many of new technological applications – smart contracts, AI applications and decentralised ledger technology. So we'll be working in terms of analysis with a focus on that in the coming months and share any insights that we gain from that with our members at G20 and, of course, also with the wider public. Thank you.


Thank you. Juda, do you want to intervene now?

Juda Agung, Deputy Governor, Bank Indonesia

Yeah. I think everybody is now preparing for the CBDC. It's kind of something that we cannot avoid in the future because digitalisation in the economy and financial sector has been growing very fast. That is why the central bank needs to facilitate the transaction in the future. That's why CBDC is something that we have to prepare. And if we look at the BIS paper survey on the countries that 80 per cent of central banks have been conducting research, preparing for the CBDC. In terms of technology, I think there are many options and also whether wholesale versus retail CBDC is still under discussion, the pros and cons, of course, and benefit of that.

And we are, in Bank Indonesia, also already started this study on the CBDC as well as the implications for the monetary policy, implication on the financial stability and so on. So because the design of CBDC will determine how we conduct monetary policy. For example, whether CBDC is a kind of interest-bearing asset, or zero interest. This, of course, will affect the way we conduct the monetary policy and the implication on the financial stability of assets. If the interest is positive, then, you know, there is a risk of this intermediation from commercial to the central bank. So this discussion still going on in Bank Indonesia and of course, we need to share the experience from countries that already have kind of pilot projects on this, like China and the Swedish central bank and other central banks, like Bahamas, Eastern Caribbean and so on, would be my answer.


Okay. Thank you. And as I said, I very much agree with you that we need a further reflection on that to be not just the first round, but the second round, the third round implications of this with this kind of operation. Philip, I don't know whether you want to add some final remarks?

Philip Lowe

I can thank you. I want to also thank you for recognising the Aboriginal art behind me because I think the First Nations People of Australia have a huge amount to teach us about sustainability. I hope you also noticed the Memorial Pole between the Australian flag and the Aboriginal flag. That comes from East Arnhem Land, which is up in the northern part of Australia and in fact, it's closer to where you are in Jakarta, than where I am in Sydney. I think it's a symbol of the connection between our countries.

In terms of the substance of the issues we've been talking about, I just want to follow up a couple of points. The first of those is on climate change and financing climate change, Dietrich talked about this. The financial sector has a huge role to play here, but we know that the financial sector can only play that role if it's got the information. We've got many years of experience where financial institutions can't play their role properly if they don't have the information and when they don't have it, they restrict credit or they price it inappropriately and there's a real risk that that can happen in this space as well. So the collective effort we're all pursuing at the moment to improve information in this space is really important. That involves the work that central banks are doing on stress tests, the disclosure by private companies about how they're managing climate risks and the taxonomies. So I think as a group, we need to keep a focus on those things, otherwise the financial sector will not be able to play the role that it can play in financing the transition to the green economy.

The last point I wanted to make was on central bank digital currencies. The Reserve Bank of Australia, like many other central banks, is undertaking a lot of experiments. I think we're a long way from the point of issuing a central bank digital currency for retail purposes. There are still technology issues to work out, but as Luigi's been saying there are significant public policy issues to work through as well. I think the most likely cases for central bank digital currencies are going to be in the wholesale space. In a way central banks already issue a digital currency, that's electronic settlement balances. So it's not too far a stretch to issue other forms of settlement balances that can be used in closed systems, either with smart contracts or some other set of arrangements. So we're currently exploring how that would work for wholesale purposes and the exploration we are doing suggests there are some business cases that might be worth developing there. But on the retail level, I think it's still some way away. Thank you very much.


Thank you. And I would like to thank the participants in this panel discussion. Philip Lowe, Dietrich Domanski and Juda Agung. I think, well, first of all, as moderator for the very good self-discipline in sticking to the allotted time. So even if we started with some delay, we have not added to the delay during our discussion, but above all for the various interesting and thought-provoking remarks that they made, which I think leave every one of us a bit wiser than before. So if you want to show your appreciation for the panellists, please do so now, and let me add that I wish to thank very much the Indonesian Presidency for convening this. First of all, for the organisation of this G20 meeting, but also for convening this event of ours, which I think we profited from, every one of us. Thank you very much and have a good day.