Is MAS fulfilling the great innovation role of a regulator?
The Monetary Authority of Singapore (MAS) is undertaking several initiatives to drive the banking system in Singapore into the digital age.
It’s natural to think of regulators as the dead hand that denies innovation. Regulators must ensure that the system of money is stable and protected from the wear of fraud/crime, reckless conduct and inflation. The last of these relates to supply of money. On the other hand, the system needs to be liquid enough to sustain the economy (supply of money again) and modern enough to be relevant. I would argue rather, that at certain periods in history, reinventing the financial system within the framework of how people want to use money brings innovation and regulation together as partners. And MAS is rediscovering that.
The MAS is trying to:
a) lay down a common API (application programming interface) framework that allows financial applications to be created
b) foster the partnership between Banks and FinTechs
c) realign the underpinning of the financial system to that digital approach.
Let’s look at those three points in turn.
In 2016, MAS created a playbook of 411 banking APIs, which allow banks and third-party providers to create online applications for customers. Each API is outlined in the playbook and Banks may then propose an implementation. APIs may be implemented as REST/JSON or SOAP (or both) – c.f. UK where Open Banking only allows REST/JSON. Similarly, both OAuth and SAML are allowed for authentication (versus OAuth only in UK). The playbook guides the choice of authentication mechanism and other recommended security measures individually for each API. Industry data standards and a functional description is given as well. Without doubt, my favourite API is the “Reporting of Maid and Foreign Worker policy information to Govt Agency” API! If you are curious, it relates to insurance of those workers and the obligation of the insurer to report personal details. But it shows how the regulator is looking at binding all operations associated with a transaction into a real-time application.
In fact, the playbook is a description of proposed APIs, not just for Banks, but for Insurers, Asset Management Companies, Government agencies and the Regulator as well. So, it supports the idea of an ecosystem at the outset.
By the end of 2017, Banks had implemented APIs from the playbook to the following degree.
Through the API framework, MAS are encouraging the Banks to act as digital platforms. While they can create applications themselves, there is also an expectation for Banks to work with Third Party Providers and FinTech firms in particular.
The firms must be registered in Singapore (similarly to the way firms in UK are registered at Company’s House) so that they are under the legal and court regime of the country. However, the guidance in the playbook is that it is for each Bank to practise diligence when partnering, and to follow outsourcing regulation from MAS. That is to say, risk is with the Bank and it should have controls, including contractual terms, to assure data security and financial conduct. So far about 450 FinTech firms have registered in Singapore.
As well as the enabling approach through the API system, there are financial incentives in terms of awards and grants to “(a) promote the undertaking of more experimentation within the financial services sector, and (b) accelerate the development and dissemination of nascent innovative technologies in the financial services.” This is the Financial Sector Technology and Innovation (FSTI) - Proof of Concept scheme run by MAS.
The efforts above are to foster innovation from a consumer perspective by integrating finance into the applications that customers want to use. It reaches through to the products in the financial system, their servicing and required reporting. Underpinning the financial system, in common with most countries, is the central banking role and the reserves system of the MAS.
In Singapore, the currency is the Singapore Dollar (SGD). MAS has sponsored a program to develop SGD-on-ledger as a cryptocurrency on a distributed ledger. The participating banks in that program were Bank of America Merrill Lynch, Credit Suisse, DBS Bank, The Hongkong And Shanghai Banking Corporation Limited, J.P. Morgan, Mitsubishi UFJ Financial Group, OCBC Bank and UOB Bank alongside the Singapore Exchange. (Note the participation of J.P. Morgan whatever the reported comments of Jamie Dimon.) SGD-on-ledger can be exchanged for SGD on deposit at MAS by the Banks and hence used for Interbank Payments. As a result, the MAS retains control over the currency, consistently with its role managing the stability of the Banks through their reserves.
In 2017, the technology was used to trial Interbank Payments and test benefits of liquidity savings and operational efficiencies through a real-time system. Citi and Standard Chartered joined at this point. The experiment will extend and complete in 2018 with the Singapore Exchange leading an exercise to understand how this digital approach can be used to satisfy payment on or before settlement of a security (known as DvP). The Banks will look at extending into Interbank FX transactions and guarantee of payment on or before payment in exchange (known as PvP).
Thus the MAS is taking a lead to establish a digital banking platform integrated into the regulation system.
The System of Reserves
The reserves system, that Singapore is digitising, originated back in the 19th Century. The Bank of England drove change then as Great Britain was the powerhouse of the Industrial Revolution. Innovation was needed to move the financial system from a coinage and precious metals system into a paper system. As economic expansion needed greater quantities of money, banks released notes in place of coins. Alarmed at the potential loss of control over the money supply, legal change was made in 1833. Bank of England notes were made legal tender and notes from other banks deprecated. This placed the Bank of England over the note system in the way the Royal Mint had been for coins. Meanwhile, innovation was taking place with the clerks from the various banks meeting in the Five Bells tavern in central London to swap bills of exchange written against bank accounts. The cheque clearing house system had been invented. This was predicated on the understanding that banks held reserves that allowed paper obligations to be met and deposits could be withdrawn on demand. Indeed the Bank of England Act required the Bank to limit notes to its bullion holdings. But that requirement was regularly suspended and eventually repealed. The need for the paper system to match economic prosperity was too great. All this built a weakness in the system that caused panics and runs on banks.
Henry Thornton (economic scientist) and Walter Bagehot (journalist) are credited with developing the classical theory of lender of last resort. This theory required the protection of the banking system by the central bank acting to maintain liquidity in the system by acting as lender of last resort to prevent a collapse. The Bank of England finally adopted this role in 1866. It regulated who could set up a bank, required their reserves to be deposited with the Bank of England and provided funds in extremis. Thus the paper system was established as a secure financial system by a combination of innovation and regulation.
Before paper, there were coins!
Back in the 17th century in England, about 20% of coinage was counterfeit, until Isaac Newton – arguably one of the greatest scientists in history - took over as Warden of the Royal Mint. He innovated the design and manufacture of coins with elaborate designs and protective edges. But this was backed by the King’s instruction for recoinage and new law where “to make or possess equipment useful for counterfeiting coins” was high treason under the Coin Act. In other words, innovation and regulation went hand in hand to establish a credible coinage system of money - the threat of being hanged, drawn and quartered for high treason being quite a strong reinforcement measure! Newton’s appointment, the recoinage and the Coin Act all occurred in 1696.
Digital moves in UK and USA
Based on these precedents on coinage and paper systems, what are regulators doing in UK?
There is an Open Banking company set up in 2017 by the UK Competition and Markets Authority (CMA). It is a relatively narrow focus at present based on CMA’s concern about low rates of change of current accounts. There is a group of six APIs covering reference data (e.g. branch addresses and opening hours). There is an Account and Transaction API specification and a Payment Initiation API specification. These offer read and write functions. The latter addresses the Second Payment Systems Directive (PSD2) from the EU.
The UK approach does enforce these APIs across all the major Banking groups operating. Previous examples suggest that this is very positive. But at the moment, the function is low.
In USA, there is no significant regulator activity to promote Open Banking and APIs. There are industry initiatives such as BIAN defining APIs. It’s goals are similar but depends on a benign attitude by the regulators rather than active promotion and enforcement.
So why aren’t the UK and USA regulators being as encompassing as Singapore? Perhaps, it’s a reaction to light regulation and the resulting financial crash. Mohamed A El-Erian wrote in “The Only Game in Town”, after the crash, the central banks were charged with restoring global financial stability. And it’s been a difficult game between quantitative easing to recover growth and managing interest rates to avoid inflation. The old rules and practices of central banking have been needed more than ever. Perhaps, the old rules were right all along?
But El-Erian argues, this is not going to be enough. Stability is beyond finance at this point, in the heat of business change and social cohesion.
Charles Montagu, First Earl of Halifax, founder of the Bank of England and patron to Isaac Newton at the Royal Mint, said, “Content is to the mind like moss to a tree; it bindeth it up so as to stop its growth.” MAS is certainly not content! Will a Computer Scientist be behind a new system of money? And will it be enough as the business world struggles for growth, inequality is more conspicuous, and social tensions and pessimism for our future abounds?
My thoughts are that while the economic challenges are greater, the MAS is certainly addressing the issue of money as a digital currency in a dramatic and ambitious way. If you are interested in the history of the link between innovation and regulation - or in what the MAS are doing - then please feel free to get in touch with me.