DIGITALIZATION AND FINANCE

Digitalization is revolutionising finance. The Task Force distilled the fundamental features of digital financing and explored how it is changing possibilities for citizens using the financial system, whether as buyers or sellers, savers, borrowers, investors or taxpayers.
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Era of Digitalization

The long wave of digitalization is changing the fundamentals of how we live. Today, over half the world’s population is online, a one hundred-fold increase since 1990. It is said that 90 percent of the world’s data is created every two years, implying a 10-fold increase in data every two years. Identities are formed, relationships maintained, and goods and services transacted online. Tens of millions of businesses depend on digital markets, with an estimated 1.9 billion people purchasing goods online in 2019.

 

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“In 2018, there were more “things” (8.6 billion) connected to the Internet than people (5.7 billion mobile broadband subscriptions), and the number of IoT connections are forecast to exceed 22 billion by 2024” UNCTAD

 

In this era of digitalization data is the lifeblood of automated decision-making and innovation. Massive amounts of data can increasingly be stored, shared and analysed cheaply, making it accessible, intelligible and valuable.

Artificial intelligence enables more sophisticated targeting, design, and customization of all kinds of products and services. Application Programming Interfaces (APIs) allow different companies’ software to interact automatically.  Digitalization enables innovative solutions in education, energy, agriculture and land use, transportation and other sectors.

 

Digital identity systems are particularly important for people to be able to operate in this world. Like passports, they authenticate and validate a person’s unique identity. Almost half of the world’s population, about 3.2 billion people already have some form of ID able to be used online.  This is expected to rise to 5 billion by 2024. Whilst many digital IDs are issued by national or local governments, such as India’s Aadhaar and Estonia’s e-ID, many others are issued by commercial or non-profit organizations, from the two plus billions of Facebook-registered users through to Sweden’s BankID, Belgian itsme, or MOSIP. Financial institutions have said that by relying on the Aadhaar tech stack, account opening costs have decreased by over 40% and opening an account has become instant instead of taking three days to approve.

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By 2025, 463 exabytes of data will be created each day globally – that’s the equivalent of 200 million individual DVDs per day.”
World Economic Forum

Digitalization reshapes the transition to sustainable development. Most obviously, it opens the possibility of accelerating the ‘dematerialisation’ of the economy, with associated environmental benefits, increased access and reduced costs. Digitalization could help reduce global carbon emission by 15 percent through innovative solutions in energy, agriculture and land use and transportation The Carbon Trust in collaboration with the mobile operators’ association GSMA estimates that mobile technologies may enable emission reductions in other sectors that are ten times greater than the direct emissions related to the technology itself. Nevertheless, there is still a challenge to control energy use and impacts.

Digitalization allows many economic activities to go online, services to substitute for physical goods, small and medium-sized enterprises to access world markets, and materials to be more effectively tracked in order to be reused and recycled. Health and education services can be digitalized, with reduced costs and with distance from major urban centres becoming less of a barrier to access. Infrastructure becomes smarter, from buildings that can use less energy and clean and recycle water, to transport systems that are more flexible and less polluting. Digitalization enables physical assets to be shared and more intensively used, such as cars, roads and homes but also clothes, equipment and even food.

 

 

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Fundamentals of Digital Financing

Digital financing is broadly defined as financial services delivered through digital processes and infrastructure. There are three core features of digital financing:

  1. Availability of more, cheaper, readily accessible and more trustworthy data. When data is shared, linked and combined across boundaries, and analysed using machine learning and artificial intelligence it enables targeted pricing and risk analysis, which unlocks new insights and possibilities. More and better data enables product-personalization and service innovation.
  2. Radical reduction in the cost of financial intermediation. Digitalization, driven by market innovators, sets up a chain reaction of disruption, powered by ever-cheaper and faster computing. Digitalization allows financial value chains to be unbundled into separate components, enabling low-cost, automated customization of everything from payment processors to point of sale machines to billing and invoice management, cashflow and liquidity management, bookkeeping and payroll management, lending, equity, invoice financing and insurance.
  3. Innovation in financial products, enterprises and markets. Digitalization enables new business models, such as cryptocurrencies and crypto-assets, peer-to-peer lending, crowdfunding platforms, online marketplaces and aggregators, smart-devices linked or index-based insurance. These are not just cheaper ways of doing existing things but offer new ways of bringing together hitherto fractionalized interests in financing decisions – such as by local communities, young people, parents and other interest-based groups.

 

These core features are driving the practice of digital financing, and its potential to make a difference.

The transformational opportunity from digitalization is to enable evolution from financial inclusion to citizen-centric finance. Citizens care about far more than financial returns, with those wider concerns collectively expressed in the SDGs. Digitalization can help citizens in directing the use of their money more effectively to realize their financial and non-financial goals, by delivering the right information, improved access, greater accountability and smarter financial services.

Greater citizen engagement in financial decision-making can be as individuals, for example consumers, savers and investors, and as pension and insurance policy holders. However, this does not mean that digital finance’s impact is solely driven by the atomized decisions of 7.5 billion people acting as consumers and individual savers and investors. Rather it concerns all of the myriad of ways that people organize collectively, at family, community and city level, through trade unions, religious groups, community and identity groups, and through political processes and oversight. Citizen-centric finance concerns the effective aggregation of influence through these many channels and the way that they can shape and channel financial flows through different intermediaries.

Citizens and Digital Financing of the SDGs

 

 

 

Key definitions

  • Digital financing is broadly defined as financial services delivered through digital processes and infrastructure.
  • Digitalization is the integration of digital technologies into everyday life, changing the way that we interact and live.
  • Digitalization of finance comprises the systemic changes to the financial system, aided by technology including changes in business models, products and services.
  • Digitization is the shift from paper to digital format and the shift from manual to automated processes.
  • Financing includes processes of buying and selling, taxation, procurement, contracting, saving, credit, investment, and insurance, through both public institutions and private intermediaries.

 

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Digital Financing Today

Digital infrastructure and digitalization impact every aspect of finance, starting with access, availability and affordability. Mobile payment platforms have turned mobile phones into interfaces with the financial system and are now used by over 1 billion people. In 2017, 69 percent of adults had an account with a financial institution, up by seven percentage points since 2014. In many countries in Sub-Saharan Africa, over 60 percent of the adult population have a mobile money account. Digital payments systems in developing countries have often involved new distribution models (through networks of agents, and stable connectivity and power supply for them) and improved interoperability so that users of different platforms and systems can make seamless transfers that are as good as cash. For example, MTN and Orange, with the support of GSMA have developed Mowali, a system to enable interoperable transfers across Africa.

 

Digitalization has catalysed changes in existing banking systems. Digital identity and online account opening reduces bank account opening costs dramatically. Mobile payment systems have required changes in interbank clearing systems. A growing number of countries in Asia, Latin America, Europe and the US have implemented fast payment systems that make funds available instantly. Fourteen banks, including UBS, Barclays, Banco Santander, Credit Suisse, HSBC, Deutsche Bank, have invested over US$63 million in the most ambitious blockchain-based utility settlement coin ‘Fnality’ to make clearing and settlement more efficient. Central banks including Canada, China, Sweden, and Uruguay are seriously considering offering central bank digital currencies, and several have moved on from research to piloting. Banks are also using AI and advanced analytics to assess credit risk more effectively and extend credit to more borrowers.

Digitalization has the potential to enable every nut and bolt of financial processes to be unbundled and commoditized, including budgeting and financial planning, payment processing, point of sale machines, billing and invoice management, cashflow and liquidity management, invoicing, bookkeeping and payroll management. Digitalization has allowed processes and products to be redesigned for cross-border remittances, banking, foreign exchange services, retirement management tools, investment advice and management, stock broking, spread-betting, borrowing and lending. Digital innovations enable new business models such as financing models, cryptocurrencies, peer-to-peer lending, crowdfunding platforms, online marketplaces and aggregators, smart-devices linked and index-based insurance.

Noisy stock exchange floors are being replaced by algorithmic traders. One estimate suggests that 90 percent of equity-futures trades and 80 percent of cash-equity trades in the US are executed without any human input. Over a third (35 percent) of US public equities is run by computer-managed funds, with funds with human managers now accounting for only 24 percent. The conversion of financial assets into digital tokens could further transform the clearing and settlement of securities trades.

The coronavirus has triggered an unprecedented twin global health and economic crisis. With millions confined in their homes, the importance of the digital world has grown. Digital financing solutions have been used to provide social safety nets, maintain liquidity and ease financial pressure on businesses.

Digitalization is changing the financial sector and bringing in new players. Many existing financial institutions have digitalized their services through acquisition, in-house development, outsourcing and partnerships. Banks have invested over US$1 trillion in developing, integrating and acquiring emerging technologies. Mainstream financial institutions are developing digital first services, including for underserved clients and new markets. There is an increasing trend towards open source initiatives in the financial industry. Open source projects and shared standards allow interoperability and open innovation rather than tying companies into proprietary technology and locking data into incompatible formats.

Mobile operators and new innovators have become key players. In 2018, ‘fintech’ investment hit record high US$120 billion, representing about a third of global venture capital funding. Meanwhile, fintech and telecom companies are also acquiring banks, such as Lending Club’s recent purchase of Radius Bank and Telenor’s acquisition of Tameer.

To date, the relationship between incumbent financial institutions and innovative start-up firms appears to be largely complementary. Partnering allows fintech firms to viably operate while still being relatively small and benefitting from access to incumbents’ client base. Incumbents benefit from access to innovative technologies. For example, BBVA Bancomer in Mexico has run pilots with fintech startups through their open sandbox project to test new types of data for alternative credit scoring and to drive customer engagement through automated SMS messaging.

Digital retailers and social media platforms are moving into financial services. They are able to amass large volumes of data, which allows them to offer highly relevant, personalized financial services directly or in partnership with traditional financial companies. Ant Group, a related company of the Alibaba Group has launched services including mobile wallets, savings accounts, personal investing, lending, and credit scoring serving 900 million people in China, by partnering with financial institutions. Its Yu’e Bao cash management platform uses liquidity prediction and management technology to help fund managers plan and execute investment strategies.

Other established tech giants are also increasingly venturing into financial services. Apple has moved from ‘Apple Pay’ mobile payment services to providing credit through ‘Apple card’, online retailers undertake small business lending. Facebook is consolidating its payment products under a new brand Facebook Pay in addition to developing a global cryptocurrency Libra which will use Facebook’s digital identification infrastructure. Google is reportedly planning to expand into banking. Ride hailing platforms such as Grab and Uber are moving into financial services, including offering credit lines and insurance products to drivers.

In public finance governments are making investments to digitalize their financial systems. This goes beyond government IT systems to developing interoperability between public and private sector information systems, mandating digital identification, and undertaking digital (financial) literacy education. The Government of Benin, for example, is working with Estonia’s IT solutions provider to roll out a secure, interoperable data exchange platform to facilitate digital service delivery. Digitalization has boosted efficiency and transparency of budgets, payments and procurement enabling cost savings, efficiency gains, and improvements in accountability. According to a CGAP estimate, switching from cash to electronic delivery of government benefits generates roughly 40 percent in savings per transaction.

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Digital Financing Trends and Insights

As part of the Task Force’s work it under took an analysis how will digitalization is reshaping financial markets and monetary systems in order to consider how it is affecting how the SDGs are financed and what the  biggest opportunities, barriers and risks are.

Key trends and insights from this initial research undertaken with knowledge partner Accenture, are summarised below:

Trends Insights
Core infrastructure is undergoing substantive changes as legacy institutions invest in the overhaul of core systems and keep up with new market entrants that exploit niches with newer technology. Retail innovations are leading the pack, as tech-based models proliferate across finance and the real economy, primarily as a force for greater inclusion and choice.
Front-office innovations are being implemented to engage customers and collect data, both helping to decrease costs and provide the data needed for better product design, services and choices. Public finance lags behind, as governments are slow to adapt and unlock the potential that digitalization provides in the mobilization and utilization of finance and the possible innovations for financing public infrastructure and goods.
There is a proliferation of digital business models, both within finance and in the real economy, built on digital finance (e.g., ecommerce and pay-as-you-go models). Technology solutions are still developing and finding valuable uses, with artificial intelligence making great leaps in recent years and blockchains and the Internet of Things still in search of the best applications to finance.
Global monetary systems face new questions and challenges, as new models mature, and blockchain-powered cryptocurrencies emerge and seem poised to go mainstream. There will be a period of competition of ideas and business models and a race for data, but companies with existing or possible future datasets, which fuel the growing digital economy, that can absorb the best ideas will have the advantage.