How the big banks control the movement of money
A link to the original piece + my fine details and caveats
Instead of your usual Medium of Exchange piece, here’s one I wrote for Policy Options, published today.
There are finer details and caveats that didn’t make it into the draft I submitted to Policy Options. But I’m a sucker for fine details and caveats. So here they are anyway.
People like to talk about promoting competition in financial services, but I’m always wondering: at what margin? Financial services refers to a broad range of activities, each of which faces different regulatory frameworks and, in some cases, barriers to entry. Some business models need better access to payment systems. Some need better access to their customers’ financial data. Some need a larger and better selection of partner banks to launch fintech products (in Canada there is only a handful, whereas in the United States there are countless). Some need to become banks themselves. Some need access to bigger markets (Canada’s market is small and, in some cases, made even smaller by regulatory requirements that vary by province). These implicate several different pieces of legislation and policymakers at different levels of government. Promoting competition in financial services takes a village.
Though the history of payment systems has lessons for how to promote competition, it also has lessons for how to maintain financial stability and security. The payment systems have historically run on trust between the participants. “If you’re short today, you’ll be good for it tomorrow.” Trust is a crude way to manage financial sector risk. It puts the animals in charge of the zoo.
The history of our national payment systems is a lesson in a type of conservatism. The federal government has always had big objectives (i.e., make the national payment systems more independent of the big banks). But the federal government has always let the big banks retain a non-trivial degree of control over everything. This seems contradictory, but it’s not if you’re the sort of conservative who thinks our traditional institutions embody a practical knowledge that we’d risk erasing by changing too much and too fast. I’m not saying there’s anything wrong with that. I’m just saying that’s one way to make sense of the federal government’s approach to payments over the past forty years.
For those of you who don’t know, any amendments to the Canadian Payments Act would only let regulated fintechs access payment systems. The Retail Payment Activities Act, which will be administered by the Bank of Canada, was passed in 2021. It will regulate fintechs in payments when the Bank of Canada’s retail payments supervision capability is up and running. Under the Retail Payment Activities Act, fintechs will need to protect end-user funds and abide by operational requirements to make sure the risks of money movement are managed.
Policy change is important to making Canada more competitive, but it’s not going to solve every problem. Compared to some other jurisdictions, Canada’s markets are small and under-capitalized. We don’t have many global success stories that create the sort of virtuous-cycle ecosystems we need to produce more global success stories. Some speculate we also don’t have the right culture. In any event, policy change is part of the story. But it’s not all of it.