Cecilia Skingsley: On central bank innovation, ask: “Why not?”

One of the mandates of the Bank for International Settlements’ Innovation Hub, which I joined in September 2021, is to “identify, in a structured and systematic way, critical trends in technology affecting central banking”.

In other words, scan the horizon and find out what is new. That brings to mind the words of my famous compatriot Dag Hammarskjöld, a Swedish economist, diplomat and second secretary-general of the UN: “Never look down to test the ground before taking your next step,” he said in Markings, his seminal lifelong journal of poems and meditations. “Only he who keeps his eye fixed on the far horizon will find the right road.” In doing that, he advised that “dizziness in the face of les espaces infinis” can only be overcome if we “accept them as the reality”.

In the financial services world, these “infinite spaces” have been very crowded with novelties claiming to be the next big thing that will change the world. Simply separating hype from real value can be dizzying indeed. More importantly, the time between a new technology arriving and its deployment is increasingly short, and success rates are erratic.

Technological prowess is not an end in itself: from the perspective of central banks, it is an enabler. For example, data analysis tools can improve monetary policy decisions and implementation and help spot financial risks earlier by combining different sources of data and information. Second, it is changing the financial landscape, and central banks are adapting to the change.

Central banks have a responsibility to ensure that innovation serves the public interest. The Innovation Hub’s broad mandate is to help central banks to make the right calls in the tech space. We do that by rolling up our sleeves and experimenting, building and testing proofs of concept and prototypes, and sharing our findings. In our first three years of existence, the hub has started 26 projects on different themes. Looking at them, three clear innovation trends emerge.

Matching problems to solutions

As we consider how the financial system of the future can operate in the best interests of the wider economy, a key priority for central banks is improving payments, so they can better support the needs of consumers, business and the financial ecosystem. The appetite for better services is strong. While they are well-developed in most advanced economies as well as in many emerging markets, there are huge gaps in many countries and for important segments of society even in very mature markets.

There is an urgent need to make cross-border payments faster, cheaper and more transparent. Lowering the cost of remittances would be enough of a goal, but it turns out that companies, and even central banks, could use some help as well. This has become one of the priorities of the G20.

There are two ways to achieve that: by improving existing payments systems; and by creating new ones. In the first case, the hub is conducting an experiment called Project Nexus, a prototype platform for interconnecting national fast payments systems like my country’s Swish and Brazil’s PIX. There are 64 of those around the world. Trying to interconnect them individually would require a maze of more than 1700 bilateral connections. With Nexus we are looking at building a pilot of a single hub for any country to plug their system into, by adopting certain technical and governance requirements, similar to how internet protocols work.

This is one path. But perhaps the right road might be one still to be constructed. Central bank digital currencies (CBDCs) are a new frontier that nine out of 10 central banks are investigating. They can, in essence, be a digital representation of each country’s coins and banknotes, thus carrying their central bank’s trust and credibility. The hub has had 11 CBDC projects testing different use cases: domestic and cross-border settlement within the ecosystem of financial institutions (Projects Helvetia and Jura, respectively); multi-CBDC platforms (Dunbar and mBridge); domestic retail (Aurum, Rosalind); cross-border retail (Icebreaker); cyber security, resilience and offline use (Tourbillon, Sela, Polaris); and application of decentralised finance protocols (Mariana).

Critics may scoff that CBDCs are a solution looking for a problem. But aren’t there are also many problems waiting for a solution? Innovation often happens in a non-linear and illogical way. In 1989, engineers at Swedish phone company Ericsson were trying to develop wireless headsets. They ended up inventing Bluetooth. I am sure nobody then could have predicted how many applications this technology has today, from wireless speakers to various wearables to Internet of Things sensors that can deliver real-time data on a wind turbine electricity output.

Of course, CBDCs are not a panacea and will not be right for every country and every circumstance. The Innovation Hub is testing these many use cases exactly to help central banks help their countries to make the right decisions. We show what can be done. Countries will decide what should be done.

New tools for different risks

A second leading innovation trend is using technology to improve monitoring of financial trends and early identification of risks. It catches less attention than CBDCs, but is equally fundamental, because it is about empowering central banks and financial supervisors to better deliver on their mandates.

Technology boosts most financial services: lending, trading, insurance and payments are all available in our mobile phones, leading to more convenience, competition and (often, but not always) lower costs. In banks, high-frequency trading is measured in nanoseconds.

Project Ellipse tries to equip supervisors with comparable resources. It aims to make supervisory work more forward-looking and data-driven by using machine learning and natural language processing to combine so-called structured data (for example, a bank’s balance sheet) with ‘unstructured’ data, like news coverage of that same bank. Ellipse delivers a dashboard able to make risk correlations and analyse sentiment, alerting supervisors in real time of potential problems. Another example of data streaming and real-time monitoring is Project Rio, which built a real-time monitoring platform able to analyse dozens of currency pairs in milliseconds.

Green tools

Project Viridis is another experiment that aims to adapt the Ellipse concept to integrate climate-related risk analysis into financial stability monitoring, a tricky task because of the absence of globally consistent and comparable climate data. Another project, Gaia, also aims to fill that void, exploring new technologies to extract climate-related data from public sources such as corporate reports. That brings me to the third leading innovation trend: green finance, the intersection of technology, sustainability and finance.

Resolving the world’s climate emergency will require innovation in all areas, finance included. The hub’s Project Genesis shows how many different technologies can come together. The vision is that a small investor could purchase a green bond aimed at financing, say, a new wind turbine farm. The first phase showed how combining tokenisation and the Internet of Things would allow this investor to be able to follow in real time both the bond’s financial performance, and how much clean energy is generated and the correspondent reduction in carbon emissions. The second phase adds so-called ‘carbon forwards’, meaning that the bond’s future repayments can be carried out using carbon credits.

Many might think that ‘central bank’ and ‘innovation’ are incompatible concepts. Equally, many might think that the hub is trying to venture into commercial products. Both beliefs are far from reality.

There is some truth in the image of central banks being necessarily conservative and cautions institutions. They can’t afford to be wrong on something as important as proposing a new form of money, because ultimately trust is their most important asset. At the same time, central banks must be at the forefront of technological developments. Here is another example of our work: the hub is developing monitoring tools for cryptos and stablecoins, along with cyber security solutions safe enough for upcoming quantum computers and their much higher processing power.

In a future in which almost everything will be digital, the public sector needs to upgrade too if it is to meet public policy objectives. That’s no longer a choice. To quote another 20th century thought leader, US senator Robert Kennedy, paraphrasing George Bernard Shaw: “Some men see things as they are and say why. I dream things that never were and say why not.”

Cecilia Skingsley is the head of the Bank for International Settlements’ Innovation Hub. Previously, she was first deputy governor of the Sveriges Riksbank and chaired the BIS’s Committee on Payments and Market Infrastructures Future of Payments Working Group.