Financial technology (fintech) has long been on the minds of central bankers, as mobile payments and other digital methods of exchange have come to the fore during the past decade. The latest innovation – blockchain and distributed ledger technology (DLT) – has proven of great interest, with many financial firms coming together to make proof-of-concept (PoC) models.
But as the global financial system undergoes such a digital transformation, central banks face the challenge of finding a balance between the continued fostering of competition and the protection of consumers. While a number of central banks launched ‘regulatory sandboxes’ – environments in which fintech firms can test their products in a more relaxed regulatory environment – one central bank sought a different approach.
“The latest wave of innovation in fintech has shaken up traditional thinking about how to deliver financial services, defining the pace and shape of innovation in what has sometimes been quite a slow-moving industry, technologically speaking,” says Andrew Hauser, executive director of markets and banking at the Bank of England.
In June 2016, the BoE launched its ‘FinTech Accelerator’, a programme that would allow the central bank to improve its familiarity with fintech products, as well as give fintech firms some insight into the emerging questions and needs central banks might have as policymakers, regulators and operators.
“The FinTech Accelerator was launched with the particular aim of partnering with firms working on new and emerging technology to harness fintech innovations for central banking,” says Sharmista Appaya, acting head of the FinTech Accelerator. “The accelerator has not only allowed us to interact with an industry sector that we previously had little to no interaction with, but has also enabled us to collaborate, teach and learn with them.”
From June 2016 to June 2017, the BoE completed 10 PoCs in the areas of DLT, cyber security, machine learning and data analysis, which prompted the central bank to ask further questions about whether these technologies have a place within the central banking world. “True understanding also requires central banks to roll up their sleeves and get their hands dirty with the technology itself,” says Appaya.
The FinTech Accelerator works on a cyclical basis, taking in a certain number of firms during each round of testing.
I am very impressed by what the BoE are doing. They are taking a systematic look at these emerging technologies, and asking the question of how they can appropriately be industrialised
Richard Heckinger, former vice-president, Federal Reserve Bank of Chicago
“I am very impressed by what the BoE are doing. They are taking a systematic look at these emerging technologies, and asking the question of how they can appropriately be industrialised,” says Richard Heckinger, former vice-president at the Federal Reserve Bank of Chicago. “I have not seen a central bank that has done it so systematically”.
While 10 PoCs were carried out in the first round in October 2017, 16 firms were accepted into the FinTech Accelerator programme. “Firms are chosen through an open, competitive selection process on the basis of a well-defined central banking use case,” says Hauser.
Shoring up defences
One of the FinTech Accelerator’s success stories is its work with Anomali, a cyber-security company that was accepted in the BoE’s first round of testing.
With an increasing number of cyber threats to identify and respond to, the UK central bank decided it needed to explore different solutions to keep ahead of possible threats. The BoE realised intelligence teams needed the ability to perform link analysis to identify relevant patterns and provide context to threat information – a process its existing threat detection models had struggled to fulfil.
Anomali appeared to provide the perfect solution with its ThreatStream product, which works to works to “collect, integrate, hunt and investigate” cyber-security intelligence data. The firm was asked to demonstrate its PoC during a period of two months, which involved showing ThreatStream’s capability to automatically seek links and patterns while corroborating and analysing data with context.
“All PoCs are time-bound, and will in most cases be ring-fenced from the bank’s daily operations for the course of the PoC. For this, we often use a cloud instance to test the technology,” says Appaya.
Anomali’s collaboration was deemed a success by the BoE, which went on to form a permanent partnership with the company in February 2017. “The bank found that the platform was intuitive. It integrated well with existing sources of information, and allowed highly efficient, automated ingestion and sharing of data,” said the BoE.
Legally, the BoE has to advertise tenders publicly. When issuing its cyber-security tender, the FinTech Accelerator gave Anomali a “level playing field”, says Appaya.
Boarding the blockchain
DLT has also piqued the interest of central banks around the world. While some are exploring whether it is viable to launch central bank digital currencies using a ledger network, others are examining whether the technology could revolutionise payments.
“The BoE is asking the questions interested counterparties want them to ask,” says Heckinger. “DLT, cryptocurrencies, cyber security – they are all major trends at the moment.”
One of the FinTech Accelerator’s first PoCs was with Chain which examined the maturity of DLT, with a particular focus on resilience, in relation to building the BoE’s new real-time gross settlement (RTGS) system, which currently processes around £500 billion of payments ($673.4 billion) – about one-quarter of the UK’s GDP – among banks every day.
“Our project with Chain raised questions about the confidentiality that could be maintained in a DLT system and the potential trade-off between privacy, performance and resilience in the system,” said the BoE.
Prior to its work with Chain, in March 2017, the BoE decided to partner with Ripple to create a PoC that focused on high-value cross-border payments in which transactions in two different currencies were executed simultaneously in two different RTGS systems based on the interledger protocol. Ripple Connect acted as the interface that allowed the BoE’s internal systems to integrate with the blockchain.
One issue that emerged was the wholesale market producing different challenges in comparison to retail corporate transactions – specifically, the availability of liquidity. Nevertheless, the BoE has plans to make its new RTGS system interoperable just in case.
“We want to ensure that the next generation of RTGS is able to support private-sector DLT-based systems in the future,” says Appaya.
Fostering a community
While the FinTech Accelerator has helped the BoE better its understanding of the fintech landscape, the initiative has also created a fundamental shift in the way the central bank interacts with the rest of the banking community, and the way it thinks about emerging technologies.
“Engagements with fintech firms have exposed central bankers to some very different ways of working and thinking: more agile, more willing to experiment, less bound by convention,” says Hauser.
Engagements with fintech firms have exposed central bankers to some very different ways of working and thinking: more agile, more willing to experiment, less bound by convention
Andrew Hauser, Bank of England
“Our broader interactions with those firms – even those not successful in their application – have been of great value, allowing us to reach a much wider external audience keen to learn with us.”
Such an approach, says Heckinger, should be adopted by all central banks: “A casual approach does not work.”
Under the umbrella of the FinTech Accelerator, the BoE has created a successful community of firms that raise and share ideas under Chatham House rules.
As Appaya says: “Our fintech work has allowed us to have an open and honest exchange of ideas with a range of technology firms, and has provided us with insight into emerging questions we might have as policymakers.”
The community meets on a regular basis through round tables and events run via the central bank.
The Central Banking Awards were written by Christopher Jeffery, Daniel Hinge, Dan Hardie, Rachael King, Victor Mendez-Barreira, Iris Yeung, Joel Clark and Tristan Carlyle