New Technologies in Canadian Financial Sector (Overview)
New technologies play a key role in the development of the modern financial system. The book is devoted to Canada’s contribution to innovation in financial services.
The first chapter provides a snapshot of the Canadian financial sector. Canada’s financial landscape is dominated by a limited number of financial institutions. Among them there are the Big Six banks (Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada), two leading life insurance companies (Manulife Financial and Sun Life Financial), cooperative Desjardins Group, financial conglomerate Power Financial (controls life insurer Great-West Lifeco and investment management powerhouse IGM Financial), and giant pension and provincial funds (the Canadian Pension Plan Investment Board, the Ontario Municipal Employees Retirement System, Caisse de dépôt et placement du Québec, etc). Foreign capital does not play a significant role in the Canadian financial services market, although its positions are quite strong in such segments as investment banking, asset management and property and casualty insurance.
Due to unique features of Canada’s federal structure and the specifics of distribution of powers between federal and provincial authorities, the Canadian financial services market regulatory system is rather complex. It includes numerous federal and provincial regulatory and supervisory bodies as well as self-regulatory organizations. Coordination of their activities is often a challenge, especially given politicization of certain issues. In general, the federal Department of Finance Canada plays the leading role in regulating the Canadian financial services sector. It determines the strategy for developing the national financial services market and is responsible for drafting relevant regulatory framework.
Canada has not yet adopted specific legislation to regulate new technologies in the financial sector. When implementing new technologies, financial institutions and fintech companies must comply with existing federal and provincial laws governing securities market, consumer rights, payment system, personal data as well as anti-fraud and tax legislation. At the same time, an active process of adapting the regulatory framework to the new realities of the financial market is going on.
Currently Canada’s largest financial institutions face a number of challenges. New technologies is one of them. On the one hand, new technologies are instrumental in improving customer service and reducing costs. On the other hand, they require significant investment. They also enable tech giants and emerging fintech companies to compete with traditional financial institutions across many market segments by offering innovative financial products and services.
Under these circumstances leading Canadian financial institutions are adjusting their strategies. They establish their own R&D centres and innovation labs both in Canada and abroad. They engage in close cooperation with Canadian universities, research organizations and innovation-focused public and public-private entities. They form alliances with foreign financial institutions. They acquire fintech start-ups and invest in fintech ventures directly or via venture funds.
One of the problems associated with the development of new technologies is digital security and cybercrime. Protection of personal data and fight against theft of funds through digital channels are high on the agenda. In addition, for financial institutions there is a number of specific operational risks, which are directly related to the fintech sector development. There are reasons to believe that measures undertaken by Canada to strengthen digital security are not sufficient. There is a shortage of cybersecurity specialists and there is a lack of understanding of issues related to cybersecurity by members of corporate boards of directors who are responsible for strategic business development. In addition, current priorities of the federal government in the field of cybersecurity have a tendency to shift from fighting cybercrime to countering digital threats emanating from other states.
The second chapter deals with artificial intelligence and big data. In these areas Canada’s positions have been traditionally particularly strong. Canadian financial institutions are already actively using platforms based on artificial intelligence and big data analysis to interact with customers. Robo-advising is another bourgeoning segment of the financial services market. Also, a few asset managers are deploying artificial intelligence and big data analysis in their decision-making processes. However, quality of service and advice provided by artificial intelligence and big data analysis platforms remain an issue. Still there is every reason to believe that the use of such systems will expand rapidly given that consumers are increasingly relying on mobile gadgets and computers to conduct financial transactions and interact with financial institutions.
One of the concerns associated with new technologies is their impact on the labour market. Naturally, а widespread adoption of artificial intelligence-based platforms brings down financial institutions’ staffing requirements. As of 2018, Canadian financial sector employed more than 750 thousand people, which is equal to 4.4% of the country’s total labour force. Thus, reduction in demand for labour in the financial sector could become a substantial factor for employment.
Another important issue regarding the use of artificial intelligence and big data platforms is related to their efficiency. At the first glance, it seems that they should be instrumental in reducing financial institutions’ costs. However, these new technologies require significant R&D budgets and capital expenditures. Therefore, it remains to be seen if any real cost savings are achieved and if any share of these cost savings is passed to consumers of financial services through lower fees.
The third chapter discusses application of distributed ledger technologies in the financial sector. In Canada, blockchain applications are presently tested in such fields as domestic interbank payments, cross-border payments and securities settlements. Participants in pilot blockchain projects include the Bank of Canada, leading Canadian banks, operator of the national payments system Payments Canada, and securities market infrastructure providers. Foreign central banks, fintech consortiums, and global consulting firms are also often participating in these ventures.
Canadian experience in deploying distributed ledger technologies as of this date enables to draw the following conclusions.
First. Blockchain-based platforms are currently losing out to traditional centralized systems for domestic interbank payments both in terms of operational risks and efficiency. However, this situation may change in the future with the improvement of existing and the development of new distributed ledger technologies. Work in this direction continues both in Canada and in other countries, including the United States.
Second. Distributed ledger technologies have a significant potential in cross-border payments. Specifically, they can be deployed to facilitate currency exchange operations between central banks using central bank digital currencies.
Third. Blockchain technologies are suitable for instant clearing and settlement of securities transactions as well as for placement of securities. However, currently there is no data that clearly confirms advantages of blockchain technologies over traditional infrastructure of the stock market. It has not yet been confirmed that the use of distributed ledger technology in the securities market infrastructure solutions could bring a significant reduction in transaction costs.
In general, experiments carried out in Canada have shown that distributed ledger technologies are viable for the financial sector, including for building critical financial market infrastructure. However, at the current stage advantages of their use in comparison to more traditional solutions do not look obvious.
It should be also noted that distributed ledger technologies pose a certain threat to financial supervisory authorities’ efforts to combat tax evasion, illegal financial transactions and money laundering. Realizing that today we live in the era of unprecedented strengthening of state and supranational control over financial transactions there is no reason to assume that state authorities will be ready to agree to any compromises in this area. At the same time, introducing legislative constraints and strict controls over blockchain-based platforms will largely nullify their attractiveness to financial institutions and consumers.
Besides, leading financial institutions, declaring enthusiasm for distributed ledger solutions in public, may at the same time actually fear that rapid implementation of blockchain technologies will cut into their profits by encouraging competition from financial market newcomers such as tech giants and fintech start-ups.
The fourth chapter is devoted to cryptocurrencies. Although digital currencies have become quite widespread in Canada, in general this segment of the financial sector remains marginal. As it was noted in one of the reports describing Canadian consumers’ attitude to bitcoin, the use of cryptocurrencies as means of payment runs into a chicken and egg situation. Much larger number of vendors is required to encourage consumers to use cryptocurrencies more widely to pay for goods and services. In turn, vendors of goods and services want to see more interest from consumers before adding cryptocurrencies to the payment options list.
Canadian financial institutions are rather cautious concerning cryptocurrencies and initial coin offerings due to weak regulatory framework and significant risks inherent to transactions with these instruments. At the same time, some smaller Canadian financial firms are trying to pioneer the digital currencies market and take advantage of relatively small competition.
Like in other countries, an active discussion is currently going on in Canada concerning specific legislation, which could address issuance and circulation of digital currencies, coins and tokens. It remains to be seen how this legislation is shaped and adopted. By now Canadian authorities have already published guidelines and regulations on taxation and anti-laundering matters in relation to digital assets.
The fifth chapter analyses implementation of the open banking concept and public debate on the matter. Canada lags behind many other nations in adoption of open banking standards as the country’s banking oligopoly seems to be rather reluctant to support fast transition. It is clear for all the stakeholders that open banking is poised to prevail in the long run. However, leading Canadian banks would like to ensure that within the open banking framework emerging financial services providers will be subject to the same strict regulations and oversight as the traditional financial institutions.
Becoming “open” may ultimately be in the interests of the largest banks if they themselves determine the extent and conditions of such openness, as well as choose partners among independent financial service providers. In addition, not keeping pace with existing and potential competitors, both domestic and foreign, in terms of open banking technology could jeopardize Canadian banks’ dominant position in the national financial services market in the long term.
Canada’s federal government seems to be enthusiastic in respect to introducing open banking to Canada. The implementation of the concept will allow Canadian public authorities to increase efficiency of their efforts to detect and prevent financial fraud. It will also provide powerful instruments to combat money laundering and tax evasion on the national level and through international cooperation involving tax authorities, financial control bodies and intelligence services. In the future, it could also provide the state with tools to restrict citizens’ rights to have access to financial services by introducing sanctions, the social credit system, etc.
The concluding part of the book provides a summary of the research findings. The author notes that although the Canadian financial system is considered one of the most sustainable in the world, the country’s financial institutions are presently facing a number of challenges. Growing competition from global tech giants and aggressive fintech start-ups is one of them.
At the same time, largest Canadian financial services companies have their own competitive advantages. They still enjoy a dominant position in the domestic market, allowing them to make monopoly profits. There operations are well- diversified geographically and product-wise, which makes them better positioned to absorb financial shocks. They can rely on a powerful lobby to ensure that their interests are taken into account and respected by the federal and provincial authorities. And, finally, they can take advantage of Canada’s well-developed innovation infrastructure to be on the forefront of the global technological race.
Canadian experience testifies that implementation of new technologies enables financial institutions to expand and customize product range as well as improve customer service. However, it also shows that digital transformation of the financial sector does not come without risks. Data ownership haziness, data breaches and cybercrime are already among fundamental factors affecting financial stability. The author emphasises that the next big challenge will be ensuring basic human rights and freedoms in the environment when governments, supranational organizations and private businesses have virtually unlimited access to personal data, information about financial transactions and people’s profiles available on the web.