At the BaFinTech industry meeting, which the Federal Financial Supervisory Authority (BaFin) organised this year in collaboration with the Bundesbank for the first time, Bundesbank Executive Board members Joachim Wuermeling and Burkhard Balz spoke about the opportunities and risks of the digitalisation of banking business and central bank digital currency. The format was aimed at representatives of supervised and non-supervised enterprises in the financial industry – in particular fintech firms, credit institutions and insurers. The conference focused on current issues relating to the digitalisation of the financial industry and fintech innovations, with contributions by experts from BaFin and the Bundesbank as well as others.

Wuermeling: As supervisors, we want to enable digitalisation

Joachim Wuermeling took the perspective of banking supervisors, who inspect the models in which artificial intelligence (AI) and machine learning (ML) are used. Artificial intelligence and machine learning could make large amounts of data manageable, Mr Wuermeling said. “And in the financial sector, banking supervisors – BaFin and the Bundesbank – have a vested interest in this.” This way, digital technologies could make individual banks more stable through better analyses and data management or the use of advanced analytics in risk management, thereby creating added stability for the financial system as a whole. Supervisors are therefore seeking to act as enablers of digital transformation, he continued.

Mr Wuermeling went on to say that supervisors view ML, first and foremost, pragmatically, noting that supervisory practices were focused on which ML characteristics, if any, were present in a particular methodology and how pronounced they were. He explained that this approach would help to identify ML innovations and the risks they pose, to address them appropriately, and to avoid lumping all new applications at banks together – the underlying principle of risk-oriented supervision. The more complex an ML model’s design, the more difficult it was to describe the relationship between input and output verbally or using mathematical formulae, Mr Wuermeling said, adding that it was then often difficult for modellers, users, validators and also supervisors to verify the results in detail. According to Mr Wuermeling, checking that a model’s behaviour overall is explainable and plausible was therefore more important than for every detail to be verifiable. Understanding these decision-making processes would be all the more significant if decisions made by ML systems were to have far-reaching effects on individuals or on a bank’s risk situation, he added. “Consider, for example, AI-based assessments of creditworthiness. We want to understand decisions, we want to shed light into the dark,” Mr Wuermeling continued.

Quality of the data is crucial

Mr Wuermeling also stressed the importance of data quality. “If you feed a machine learning engine with data that are not varied enough, or are insufficient or fake, you are going to get incorrect results – and then run the risk of making the wrong business decisions,” Mr Wuermeling warned.

The Bundesbank Executive Board member was critical of the idea of special approval requirements, as proposed by the European Commission for credit assessments. “Where there is double regulation and there are dual supervisory processes, there is a risk of innovation being smothered and of supervisors losing the sense of what can and should be done that they draw from their daily work.”

Balz: Digital euro might make sense

At the same event, Burkhard Balz gave a number of reasons why a digital euro might make sense. The first reason was strategic sovereignty in European payments. Mr Balz explained that there was still no simple, universal, pan-European payment solution from European providers. “Instead, as soon as we cross an internal European border (if not before), we rely on international card systems and internet payment procedures provided by bigtech firms in both bricks-and-mortar retail and online trading,” said Mr Balz. However, he added, these bigtech firms have set their own rules and standards and thus restricted the use and access rights of third parties, meaning competition and market neutrality were at risk in the world of payments, too. “If we do not want to leave the huge potential that can lie in the use of crypto-tokens and stablecoins in the hands of the few, we must therefore act swiftly,” Mr Balz explained, adding that developments by other countries also needed to be monitored. He gave the example of the Chinese e-yuan, which was already being comprehensively tested in practice. If, like Alipay, it is accepted as a means of payment at popular destinations for Chinese tourists abroad, he said, it could also become more important in international trade and payments and strengthen China’s currency against the dollar or the euro. Mr Balz also cited the declining use of cash as a reason.

“More than 340 million people would be able to use central bank digital currency to pay”

Mr Balz also discussed what a digital euro could deliver. The digital euro could offer all groups in society quick and convenient access to a digital means of payment, even for the less “digitally native”. The issuance of a digital euro would not be driven by business interests. It would not only strengthen European sovereignty but also play a part in the development of pan-European digital ecosystems. “More than 340 million people would be able to use central bank digital currency to pay anywhere in the euro area, across borders and independently of international providers,” Mr Balz added. The Bundesbank Executive Board member also stressed, however, that central banks and supervisors would need to analyse potential risks to the real economy, financial stability and monetary policy, while nevertheless avoiding large outflows of deposits from the banking sector and sudden shifts to central bank money. One potential option, according to Mr Balz, would be setting limits on digital euro holdings or setting tiered interest rates. He also made it clear that the Eurosystem would continue to offer cash in the future, saying “The digital euro will complement cash, not replace it”.