Death throes of physical notes? Bank tech ineptitude is paving the way for cashless currency market

Cashless society may be looming, not because of advancement but because of so many IT failures. What effect would this have on currency trading? We take a detailed look at how the end of notes and coins was predicted almost three decades ago and how Tier 1 banks are now victims of their own legacy systems. FX brokers – you are in a position of power!

Ever since George Orwell wrote his incredibly insightful dystopian look at the year 1984, which at the time of putting pen to paper was an unthinkable dot in the distant future, there have been mixed views on the potential of a cashless society.

Those who advocate the use of modern technology and are globalists in terms of political persuasion tend to advocate the obsolescence of centrally minted paper and metal currency in its physical form in favor of electronic payments systems and methods which allow the distribution of fiat currency via cash free transfer solutions, whereas nationalists and luddites tend to favor the restriction of digital payment methods in order to control their local market.

In many first tier countries in the Western hemisphere, a paperless, cashless environment is already available to many members of the public, with Apple Pay in widespread use, connecting a cellphone application to a retail bank account and scanning point of sale terminals instead of handing over the physical cash.

In highly advanced and environmentally conscious Sweden, parking payments are cashless and paperless, and in London, bus travel and London Underground travel has been charged by tapping a contactless credit card onto a transponder for many years.

Whilst all of this appears to be very avantgarde and makes the world a more practical place by centralizing all payments into applications and removing the need to exchange cash when traveling, or handle coins when on the move and need to pay quickly, the reason for its popularity is perhaps not such a forward looking one.

Today, British consumer affairs entity Which? has found that Britain’s major high street banks, which are at the very top tier in terms of institutional FX dealing, are suffering IT failures at the rate of one a day, threatening access to cash and blocking essential purchases for groceries and transport.

Customers were prevented from making payments on 302 occasions in the last nine months of last year, consumer experts Which? said.

Which?’s report added that efforts by banks and retailers to make customers switch from real money to plastic cards and electronic payments must be resisted, as the data shows how the technology used in the UK’s finance system can be fragile.

Since last year, the Financial Conduct Authority has required banks to inform it of operational or security incidents which prevent customers from using payment services.

Which? found the average number of significant breaches across each of the 30 banks and building societies it listed was one a month. It said Barclays reported the most with 41, followed by Lloyds Bank with 37, Halifax/Bank of Scotland had 31, Natwest suffered 26, RBS with 21 and Ulster Bank at 18.

TSB, whose botched introduction of a new IT system last year caused customers to lose access to online banking services, reported 16 incidents.

The legacy nature of bank infrastructure should ring alarm bells for liquidity takers in the FX industry, largely because that is a core business activity for Tier  1 banks and is a far higher profit generator than retail banking however if they are unable to modernize and continue to experience outages and system failures despite the vast in-house teams, then there is cause for concern when it comes to single dealer platforms.

technical failures often go far beyond minor glitches with people unable to access their money, monitor online accounts or make payments for everyday essentials, such as groceries or bus rides.

Which? said the figures ‘reveal that serious banking crashes are even more common than previously thought’.

It is calling on the Government to give a single regulator the statutory duty to protect access to cash and build a ‘sustainable cash infrastructure’. This would respond to concerns among millions of customers and small firms that banks are trying to phase out real paper money and coins by stealth.

Recent research found that ‘hole in the wall’ cash machines are closing at a rate of almost 500 a month while the nation’s banks are racing to axe branches in order to cut costs – with more than 3,300 closing since 2015.

Only in nations in the Middle East, some parts of Asia, South America and North Africa where government controls on population are rife is the traditional banking method favored, as it makes it easy to place capital controls and movement restrictions, as well as control the market via non-transparent cartels (as is the case in Israel which heralds itself as a fintech center, when in actual fact, the structure of the country’s mafia-esque business and government environment hampers any form of progress.)

It may well be a series of technological faux-pas that is ironically creating the development of a cashless environment, fueled by new investment entities in London that rival the banks and often offer better services, such as Revolut, the One Account, Travelex, and Transferwise, all of which are cashless payment and investment management platforms, the effect on the electronic trading market should be a good one if the brokerage sector gets it right.

FX trading, after all, is an absolute pioneer of cashless financial independence, and some firms in the industry such as Saxo Bank and Swissquote offer their own banking services for private and corporate clients, all of which are cashless and linked to their trading accounts via highly advanced proprietary systems.

Indeed, it was Saxo Bank’s Jennifer Hansen who told FinanceFeeds over two years ago that “We should be emulating Alibaba, Amazon, Netflix and Uber.” She is right.

When looking at this situation from the perspective of academics, a less biased rationale is noticeable and should be heeded.

City of London University’s Christopher Houghton Budd, of the academic institution’s Cass Business School Department of Banking and Finance conducted extensive research back in 2004 when the current method of exchanging money was absolutely non existent.

Visionary: George Orwell

In his research, Professor Houghton Budd reviewed the development of e-money in terms of both electronic payment methods and electronic issue, with special attention paid to the latter. The discussion included both mainstream developments, such as Mondex, and ‘alternative’ schemes such as LETS.

He looked at synergy between electronic issue of money and free banking precepts, to a consideration of some implications for the future of central banking generally, deducing that it offers an ‘contestable’ model of central banking, which endeavored to show the effects that e-money may be expected to have (and, indeed, may already be having) as regards monetary policy, financial supervision and seigniorage. It concludes that even in its current stage of development, the emergence of e-money not only reflects and supports key free banking concepts, but may be nudging modern central banking towards free banking practice.

Professor Houghton Budd alluded to an assertion by an economist in 1990 that it is the free competitive issue of money that guarantees a stable and efficient monetary system.

The consideration at the time was that money is accepted as a public good and because money acts as a basic convention in society, like language and standards of physical measure. The research pointed to the network externalities involved in the use of money in transactions and criticizes Turkish economist of the time Hayek’s assumption that complete, symmetric and free information would obtain in a monetary system based on competitive currency.

He also questioned the transition period and argues that the change to competitive issue would be inflationary itself and generate uncertainty for future prices.

Yes, indeed it would, as one of the measures of how finite a particular currency is comes from the issuance numbers generated by central banks that issue coins and notes, which is in turn used by issuing banks to determine benchmarks against other currencies, hence creating a currency market.

A totally cashless society, therefore, would potentially be more volatile and place the market control in the hands of the traders, and not so much total control in the hands of Tier 1 market makers whose IT issues are slowly cementing the demise of their own control as new technology led rivals offer better solutions to retail customers.

One generation of people being used to app-based financial services should be enough to totally familiarize the world with non-paper currency and digital payments, let alone hold the upper hand on circulation over the issuing banks.

When paper shows the Queen’s head or George Washington’s visage, and has a printed serial number on it, it is very much the property of a central bank. When it is hosted on servers and e-commerce systems such as Amazon and Google, who has control?

This is the way to what economist Hayek described as the necessity for an “outside agency to control the banking system in the otherwise free working of a free market.”

There is no government role in regard to the quantity of money produced inside or outside the banking industry, and outside money free of central bank control is desirable.

The academics at Cass stated that money issue is not seen as a device of governments to achieve their goals, but operates as the means for individuals to pursue their own purposes. That said, certain academics and economists not reject the idea of a clearing house at the center of the financial system when without a central bank.

That is the interesting point. The Cass study in 2004 stated that there is a school of thought that this should be a market mechanism designed to eliminate imperfections within the financial system, which is exactly what is coming to fruition now as the legacy systems cannot cope with modern financial requirements.

As envisaged by author Kevin Dowd in his works “Laissez-faire banking” and others, free banking is regarded as the multiple issue of currencies by competing banks, whose notes, however, are interchangeable and redeemable against a “community-recognized commodity”, while option clauses protect against “sudden excessive demands for liquidity”. This last is an arrangement that obviates the need for a lender of last resort, since free banking is a system in which monetary and financial stability are guaranteed by market determination of the preferred currencies and interest rates.

Dowd (1996) has underlined the basic requirements for successful free banking based on private money. One of them was the emergence of a clearing system. Another was the use of option-clauses – auto-control mechanisms used in cases of ‘fire-sales’ to defend against bank-runs.

Imagine a world in which sovereign currency is very much the default measure of everything, but is not subject to government corruption or ineptitude by banks. Banks would have to share their systems with internet providers as consumers would hold funds on Google, Amazon, Baidu and more, and firms would have to offer storage facilities for cash instead of using direct debits from bank accounts.

An important consideration would be necessary within the financial sector to help individual institutions that were solvent but facing a liquidity crisis. Some 26 years ago, Dowd defined the distinctive features of a free banking system as:

1. Multiple note issuers who would guarantee to redeem their notes in a commodity recognised as valuable.

2. A regular note exchange between note issuers, and

3. The insertion of option clauses into the convertibility contracts to protect the note issuers against sudden excessive demands for liquidity (Dowd, 1993).

An important contribution to the literature came from Hayek (1990). While not restricting free banking to a commodity standard only, when arguing for the denationalisation of money, Hayek said that “the past instability of the market is the consequence of the exclusion of the most important regulator of the market
mechanism, money, from itself being regulated by the market process.”

He thereby invoked the idea of the invisible hand as the basic requirement for a successful monetary policy regime. The invisible hand is thus seen to lead to the most reliable money, while competition is deemed to play its part in the issue of money also.

Hayek also argued that central banks should be abolished, since the free issue of competitive currencies would solve the lender of last resort and elasticity of circulation problems in a financial system. He argued that the demand for a lender of last resort arises from liquidity crises created by nationalised currencies, whereas
under competitive issue there is no risk of excess liquidity as the competing currencies are fully backed by purchasing power. It is in this sense that central banking can be seen to be not the only choice for a monetary policy framework, especially if it is not able to guarantee the integrity of money as a reliable medium
of exchange and store of value.

Thus, the thought leadership is not new, but the catalyst – ironically the crumbling IT architecture within major banks – may well be.

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