Central banks play a pivotal role in the financial system and economies by regulating inflation and price stability. In a world where geopolitical conflicts and worldwide pandemics shape the global financial landscape, central banks are a country’s banking system’s first line of defense, ensuring an economy does not fall into a recession. Economic conditions are slowly recovering after the COVID-19 crisis, but central banking can utilize new approaches to resolve the issue as core inflation remains high.
With the evolution of technology, fintech has disrupted traditional banking systems and reshaped the financial landscape. Swissmoney, an example of the cornerstone of the fintech revolution, is one company that has shifted customer sentiment towards digital financial services.
Central banks and fintech have found common paths in many ways: incorporating technology into finances and regulation and policy issuance to fight crime in the industry. Read on to learn how central banking affects the fintech sector and vice-versa as we explore the benefits and risks of the correlation between the two financial powers.
Central banks are authorities that are responsible for analyzing and controlling the monetary system in a given country. While the first central bank dates back to the late 17th century, the concept has evolved throughout the years. Today, they are formed as public institutions; they are not competitive with commercial and investment banks and are mostly unregulated by governments (although some governments have regulatory rights).
The role of central banks varies from country to country, but in general, the primary responsibilities of these institutions are outlined in the section below:
- Regulating Monetary Policy: A framework of strategies for controlling money supply, interest rates, and open market operation to achieve economic growth
- Controlling an Economy’s Banking System: Determining the cost of borrowing and lending, shaping the reserve ratio, and lending funds when needed
- Combating Inflation: Through interest rate readjustment and balance sheet management
- Creating Physical Money: Мinting coins and printing banknotes
- Lenders of Last Resort: Lending money to commercial banks in times of crisis
Central banks’ most crucial regulatory measure is controlling the country’s monetary policy. It is a policy that utilizes strategies depending on the economic conditions to fight inflation and unemployment and promote economic growth. The most common measures central banks take are money supply management, interest rate readjustment, and engagement in open market operations. Monetary policy can have an impact on various aspects of people’s lives, such as consumer spending and borrowing, as well as on numerous industries, including the increasingly popular FinTech sector.
As the FinTech industry expands rapidly and finances merge with technology, new opportunities that were unimaginable a couple of years before emerged. However, with great power comes great responsibility, and the risks in the fintech industry, like pirate financing and data breaches, are of growing concern.
Central banks, alongside governments and regulatory bodies, step in to assess the fintech industry’s potential and risks and how it impacts business operations and humans.
Firstly, the goal is to oversee opportunities for implementing technology in financial services and monetary governance for enhanced management and productivity output. Secondly, the risks and uncertainties must be addressed appropriately to fight crime in the sector and assess the challenges of mass adoption. Finally, central banks analyze the results and develop policies and rules for FinTech service providers and technology adoption.
From one perspective, the disruptive power of FinTech optimizes financial procedures with AI and Machine Learning. It creates instruments like Central Bank Digital Currencies (CBDCs), making them a valuable tool to implement in the financial system. On the other hand, developing policies to protect personal data and prevent financial crimes is vital for the safety of economies and users.
The collaborative efforts between the FinTech industry and central banks have the prospect of transforming central banking and increasing the security and functionality of the sector.
Monetary policy, the primary policy rolled out by central banks, has direct and indirect correlations with fintech companies. By controlling inflation, cryptocurrency markets get exposed to increased volatility and price fluctuations, lending platforms need to readjust their interest rates, and payment-processing platforms’ exchange rates and transaction fees may be influenced.
Moreover, central banks work alongside other regulatory bodies to develop and enforce fintech activities regulations. One of the most prominent examples lately in the area of AI and Machine Learning is the European Union’s regulatory framework called the EU AI Act. Moreover, the US’s central banking system, the Federal Reserve, plays an important governance role in developing regulations concerning cryptocurrencies.
AI, ML, and cryptocurrencies are crucial components of fintech. Although not directly issuing regulatory rules, the supervision of central banks is critical in the decision-making process of formulating policies.
Money laundering and cybersecurity attacks are a growing concern, and security measures like 2FA, KYC, and AML policies are regularly being updated. The question of whether machines will replace human jobs and how they will impact job loss has called upon the need for stricter regulation in AI development.
Furthermore, private companies’ rising power could impair the central bank’s ability to implement monetary policies. As FinTech’s popularity increases, service providers could have the ability to influence more control over the financial systems. Therefore, central banks have the challenging duty of carefully examining the opposing threats in the industry and taking actions in risk assessment, speed of adoption, and transparency.
The relationship between central banks and fintech is increasingly crucial in a rapidly evolving financial landscape shaped by technology and global events. The collaborative steps between central banks and the fintech industry hold immense potential, offering innovative tools like CBDCs, AI, and machine learning to enhance the financial system’s efficiency. Yet, challenges such as job displacement and financial and data fraud must be dealt with through divergent policies and regulations. To what extent will central banking regulations affect fintech and how technologies will reshape the central banking system remains to be determined, but it is one revolutionary process worth observing.