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Get ready for self-driving banks

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The writer is the US acting comptroller of the currency

In 1961, Popular Science magazine envisioned self-driving cars. The reality arrived sooner than anyone anticipated, and before safety regulators could adapt. Most automotive laws — on speed limits, giving signals, drink-driving — had been designed to protect against dangerous drivers, not dangerous cars. Autonomous vehicles brought new risks that legacy rules never considered. As one headline on the Wired website put it: “Who’s Regulating Self-Driving Cars? Often, No One”.

Banking is headed down the same road. And it’s being driven by the technology behind decentralised finance, or DeFi. But just as the original rules of the road protected us from other drivers, so our current bank regulations exist mainly to prevent human failings.

At the US Office of the Comptroller of the Currency, we require every bank to have officers responsible for its safety — such as a chief risk officer and a chief audit executive. We limit how much banks can lend to their directors. We even make some bank employees take a certain amount of vacation so others can sit at their desks and identify potential fraud. We call it bank regulation, but we’re really regulating bankers.

DeFi turns all this on its head. It leverages blockchain technology to deliver services with no human intermediation. One example is creating money markets with algorithmically derived interest rates based on supply and demand — rates that traditional banks set by committee. Other DeFi projects include decentralised exchanges that allow users to trade without brokers, and protocols for lending that do not involve loan officers or credit committees. Although these “self-driving banks” are new, they are not small. They are likely to be mainstream before self-driving cars start to fly.

However, self-driving banks present the same challenges and opportunities as autonomous vehicles. On the opportunity side, they can allow savers to stop shopping around for the best interest rates by having algorithms do this for them. They can also end discrimination against certain borrowers by having software make credit decisions. They could even eliminate the risk of fraud or corruption by no longer being run by humans at all.

Self-driving banks also present new risks, though. If technology accelerates withdrawal of depositors’ funds, just as high-frequency trading can accelerate equity sell-offs, that could increase liquidity risk compared with traditional banks. Asset volatility could be a concern for similar reasons. And the management of loan collateral could be more difficult if humans are not involved in valuations.

There is also a risk that, in the absence of federal regulatory clarity, US states rush to fill the void and create a patchwork of inconsistent rules that impede the orderly development of a national market. This is exactly what happened with self-driving cars.

Federal regulators must therefore determine what a regulatory scheme for self-driving banks should look like. Could they ensure fair treatment of customers by such a bank? Sure. Most bias and compliance issues are failures of software. Not the software you code, but the kind hard-wired into human brains. Bias can creep also into the rules of algorithms, but it is easier to root out.

Could regulators properly examine a bank that exists only as software? Yes, we can. It may be easier than supervising banks today. Our examiners could be retrained to read the algorithms that make deposit pricing or credit decisions and work out whether they comply with legal requirements.

Could regulators ensure self-driving banks properly serve their communities? Absolutely. Their greater efficiency would free significant amounts of capital that is lost to operating costs today or slowed by decisions dependent on human grey matter. Of course, algorithmic banks would change the nature of employment in the financial sector — with far fewer bank tellers and more coders. But creating better compensated and value-added jobs may prove a societal benefit in the long run.

Could the OCC even grant a national bank charter to open-source software that manages deposit-taking, lending, or payments, if it doesn’t have officers or directors? Not yet. Under current law, drawn up on the assumptions of the early 20th century, charters can only be issued to human beings. But those antiquated rules should be revisited, just as regulations that still mandate the use of fax machines should be.

Could we usher in a future where we eliminate error, stop discrimination, and achieve universal access for all? Optimists like me think so. How different would banking in the US be today if regulators, bankers, and policymakers were as bold as carmakers 10 years ago?



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A blueprint for central bank digital currencies

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Britain’s choice of world war two codebreaker Alan Turing to feature on its new plastic £50 note is ironically apt, and for several reasons. His work on cryptography speaks to the new front in monetary debates — how best to protect personal data in an age of digital payments. At the same time, the discrimination the war hero faced for his sexuality shows why privacy is important, including from the government.

In an interview with the Financial Times this week, European Central Bank executive Fabio Panetta said that a digital euro would protect consumer privacy — the public’s greatest concern over a central bank digital currency, according to a consultation by the ECB. Referring to Facebook’s attempt to launch the Libra stablecoin, Panetta warned that if central banks did not provide an alternative they would cede the ground to Big Tech. Companies could then use their dominant market position to set privacy standards.

Central bank digital currencies, however, raise questions about how to protect data from the state. If CBDCs became the dominant money then central banks could have vast data repositories of nearly every transaction in an economy. The need to clamp down on illegal money laundering would mean central banks, just like commercial banks today, would not allow individuals to hold their money anonymously — linking these transactions, however compromising, to individuals.

That might be acceptable in authoritarian regimes like China, where a digital currency project is moving ahead at pace. In democracies it is not. For this reason the Bank for International Settlements is right to call for the preservation of a two-tier financial system in its annual economic report. The so-called central bankers’ central bank advocates an account-based design with regulated private banks dealing with the public and the central bank maintaining digital currencies to make the payment system more efficient. It calls for digital identities tied to these accounts — fighting identity fraud as well as money laundering.

This arms-length structure would preserve privacy — since the state could access records only once a criminal investigation begins — and allow the private and public sector to do what they do best. The BIS argues the central bank coins could work as the plumbing of the system while banks and others could innovate and have responsibility for keeping data secure. Alternative token-based designs for a digital currency could preserve anonymity but facilitate crime.

One such token in the private sector, bitcoin, is the favoured means of payment for hackers’ ransom demands, as well as for some of those avoiding tax; this week the South Korean government seized millions of dollars’ worth of cryptocurrency from 12,000 people accused of tax evasion. Monero, a cryptocurrency that promises even more privacy than the pseudonymous bitcoin, has started to become the choice of many criminals. Cash has the same problem: at one point investigators concluded 90 per cent of £50 notes were in the hands of organised crime.

A two-tier financial system means banks could, as they do at present, have responsibility for checking identities and keeping up with “know your client” rules. While state-run identity schemes such as India’s Aadhar can be used to make sure digital currencies are going to the right place, there are valid ideological questions about government-run ID schemes. The BIS blueprint is a good start for central banks considering digital currencies, but more radical steps such as handing more personal data to the central banks need more widespread consultation and support.



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Pakistan’s Gwadar loses lustre as Saudis shift $10bn deal to Karachi

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Saudi Arabia has decided to shift a proposed $10bn oil refinery to Karachi from Gwadar, the centre stage of the Belt and Road Initiative in Pakistan, further supporting the impression that the port city is losing its importance as a mega-investment hub.

On June 2, Tabish Gauhar, the special assistant to Pakistan’s prime minister on power and petroleum, said that Saudi Arabia would not build the refinery at Gwadar but would construct it along with a petrochemical complex somewhere near Karachi. He added that in the next five years another refinery with a capacity of more than 200,000 barrels a day could be built in Pakistan.

Saudi Arabia signed a memorandum of understanding to invest $10bn in an oil refinery and petrochemical complex at Gwadar in February 2019, during a visit by Crown Prince Mohammad Bin Salman to Pakistan. At the time, Islamabad was struggling with declining foreign exchange reserves.

The decision to shift the project to Karachi highlights the infrastructural deficiencies in Gwadar.

A Pakistani official in the petroleum sector told Nikkei Asia on condition of anonymity that a mega oil refinery in Gwadar was never feasible. “Gwadar can only be a feasible location of an oil refinery if a 600km oil pipeline is built connecting it with Karachi, the centre of oil supply of the country,” the official said. There is currently an oil pipeline from Karachi to the north of Pakistan, but not to the east.

This article is from Nikkei Asia, a global publication with a uniquely Asian perspective on politics, the economy, business and international affairs. Our own correspondents and outside commentators from around the world share their views on Asia, while our Asia300 section provides in-depth coverage of 300 of the biggest and fastest-growing listed companies from 11 economies outside Japan.

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“Without a pipeline, the transport of refined oil from Gwadar [via road in oil tankers] to consumption centres in the country will be very expensive,” the official said. He added that at the current pace of development he did not see Gwadar’s infrastructure issues being resolved in the next 15 years.

The official also hinted that Pakistan’s negotiations with Russia for investment in the energy sector might have been a factor in the Saudi decision. In February 2019, a Russian delegation, headed by Gazprom deputy chair Vitaly A Markelov, agreed to invest $14bn in different energy projects including pipelines. So far these pledges have not materialised, but Moscow’s undertaking provided Pakistan with an alternative to the Saudis, which probably irritated Riyadh.

Arif Rafiq, president of Vizier Consulting, a New York-based political risk firm, told Nikkei that a Saudi-commissioned feasibility study on a refinery and petrochemicals complex in Gwadar advised against it. “Saudi interest has shifted closer to Karachi, which makes sense, given its proximity to areas of high demand and existing logistics networks,” he added.

Rafiq, who is also a non-resident scholar at the Middle East Institute in Washington, considers this decision by the Saudis as a setback for Gwadar, the crown jewel of the China-Pakistan Economic Corridor, the $50bn Pakistan component of the Belt and Road.

The Saudi decision “is a setback for Pakistan’s plans for Gwadar to emerge as an energy and industrial hub. Pakistan has struggled to find a viable economic growth strategy for Gwadar,” he said. Any progress in Gwadar in the coming decade or two will be slow and incremental, he added.

Local politicians consider the shifting of the oil refinery a huge loss for economic development in Gwadar. Aslam Bhootani, the National Assembly of Pakistan member representing Gwadar, said the move is a loss not only for Gwadar but for all of the southwestern province of Balochistan. He said he would urge the Petroleum Ministry of Pakistan to ask the Saudis to reconsider their decision.

The decision has shattered the image of Gwadar as an up-and-coming major commercial hub. In February 2020, the Gwadar Smart Port City Masterplan was unveiled, forecasting that the city’s economy would surpass $30bn by 2050 and add 1.2m jobs. Local officials started calling Gwadar the future “Singapore of Pakistan”.

Rafiq said such dreams are unrealistic. “A more prudent strategy [for Pakistan] would be to use the city as a vehicle for sustained, equitable economic growth for Balochistan, especially its Makran coastal region,” he said.

Relocating the refinery from Gwadar to already developed Karachi also implies that CPEC, or BRI, has failed to promote Gwadar as a mega-investment hub. “Foreign direct investment in Gwadar will be limited and will remain exclusively Chinese,” an Islamabad-based development analyst said, “limiting the city’s scope for development”.

The refinery decision has once again exposed the infrastructural shortcomings of Gwadar, which Pakistan and China have failed to address in the past six years. Without highways and railways connecting it with northern Pakistan, the city will never develop as its proponents hope.

A version of this article was first published by Nikkei Asia on June 13, 2021. ©2021 Nikkei Inc. All rights reserved.

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Oil hits highest price since April 2019 before moderating

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The price of crude oil briefly hit its highest level for more than two years on Monday, lifting shares in energy companies, as traders banked on strong demand from the rebounding manufacturing and travel industries.

Brent crude crossed $75 a barrel for the first time since April 2019 before falling back slightly, while energy shares were the top performers on an otherwise lacklustre Stoxx Europe 600 index, gaining 0.7 per cent.

The international oil benchmark has risen around 50 per cent this year, underscoring strong demand ahead of next week’s meeting of the Opec+ group of oil-producing nations.

US manufacturing activity expanded at a record rate in May, according to a purchasing managers’ index produced by IHS Markit. Air travel in the EU has reached almost 50 per cent of pre-pandemic levels, ahead of the July 1 introduction of passes that will allow vaccinated or Covid-negative people to move freely.

“This is a higher consuming part of the year,” said Pictet multi-asset investment manager Shaniel Ramjee, referring to the summer travel season. “And the oil market is pricing in strong near-term demand that is better than previous expectations.”

In stock markets, the Stoxx Europe 600 dipped 0.3 per cent while futures markets signalled Wall Street’s S&P 500 share index would add 0.1 per cent at the New York opening bell.

The yield on the 10-year US Treasury was steady at 1.494 per cent. Germany’s equivalent Bund yield gained 0.02 percentage points to minus 0.154 per cent.

Equity and bond markets have consolidated after an erratic few sessions since US central bank officials last week put out forecasts indicating the first post-pandemic interest rate rise might come in 2023, a year earlier than previously thought.

US shares tumbled last week, while government bonds rallied, on fears of tighter monetary policy derailing the global economic recovery.

Wall Street equities then bounced back on Monday, with a follow-on rally in some Asian markets on Tuesday, as sentiment got a boost from more dovish commentary from Fed officials.

Fed chair Jay Powell, in prepared remarks ahead of congressional testimony later on Tuesday said the central bank “will do everything we can to support the economy for as long as it takes to complete the recovery”.

John Williams, president of the Federal Reserve Bank of New York, also said that the US economy was not ready yet for the central bank to start pulling back its hefty monetary support.

Jean Boivin, head of the BlackRock Investment Institute, said that “the Fed’s new outlook will not translate into significantly higher policy rates any time soon”.

“We may see bouts of market volatility . . . but we advocate staying invested and looking through any turbulence,” Boivin added.

The dollar index, which measures the greenback against trading partners’ currencies and has been boosted by expectations of US interest rates moving higher before other major central banks take action, was steady at around a two-month high.

The euro dipped 0.1 per cent against the dollar to purchase $1.1901, around its lowest level since early April. Sterling also lost 0.1 per cent to $1.3909.



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