Fintech and financial inclusion: if gold glitters too much, it’s not real gold
a cura di Emilio Girino

Articolo

Feb 22 2020
Fintech and financial inclusion: if gold glitters too much, it’s not real gold a cura di Emilio Girino

In the last six months I had to professionally deal with (and reject) a couple of cases. Potential customers wanted to build cryptocurrency-like systems disconnected from a least  compliance with the regulatory reality. The belief that Internet can legitimize any alternative operation is rooted in the brainiac creators. Let’s be clear: financial technology is necessary and should not be prohibited on principle, just as cryptocurrencies – most of them, as today shaped, financial products and not just payment tools –  are not the evil: traditional finance showed us worse. But do-it-yourself fintech crafts(wo)men claim to deal with finance without knowing it. Surfing Internet is enough to notice that there is a lot of platforms where you can buy credits or place securities in legal currency but outside the regulatory frameworks: a phenomenon towards which supervisors should better focus their efforts (see below). What is most upsetting is the attitude of smuggling as an inclusive instrument which, in the state of the art and of the monetary daily life, could instead entail a heavy regression of the very modest and very precarious well-being of much of the world.

A recent essay by a keen economist (M. Minenna, Il sistema finanziario del futuro: a chi servono le valute digitali di stato?, Diritto degli Affari, 3/19, 137) offers unexpected perspectives for reflection together with data from unsuspected sources (IMF, Global Findex Database). To counteract the private cryptocurrency practice and prevent its most feared degeneration (wild disintermediation, anonymity and spread of new cash), many central banks are fervent working in order to conceive legal tender state coins (Central Bank Digital Money – Cbdc), unlike the cryptocurrency which, by definition, is the opposite of a fiat currency. Everything then goes down in the mantra of cashless, of the world without cash; mantra on which the ECB itself, through its new president Christine Lagarde, invited more caution. A quick look at the aforesaid paper shows a state of affairs far removed from the utopian horizon on which fintech and its deviant inclusive ambition are running. China, India and Indonesia, i.e. 40% of the world’s population, reveal respectively 12%, 21% and 6% of unbanked people. In the Middle East and North Africa, the percentage rises to 86%. Opening a bank account requires an identity document, which about 1.5 billion Africans and Asians are missing, without taking into account digital connection problems and financial illiteracy. Meanwhile, cash continues to dominate payment systems: in India, between 2006 and 2015, banknotes increased by 14% per year, in Kenya 98% of payments are made in cash. More generally, wages and salaries are still being paid in cash in around 31% of the world. The acclaimed technological disruption that would bring to the cashless world at a glance, as today happens in Sweden, far from implementing financial inclusion, would aggravate the already heavy conditions of impoverishment and socio-economic malaise of a substantial portion of the world population.

The consequences, however, go far beyond the worrying stage highlighted in the quoted paper. A total monetary digitalization would also affect fundamental human freedoms (individuals who lawfully wanted to disappear from their usual life could no longer do so), would cause a heavy mix of payment, digital data processing and more or less (perhaps more than less) forced commercial profiling in spite of any ridiculous consensus rule, would increase the risks of theft of digital identities that could entail the instant plundering of entire financial assets. The ban of cash, seen so far as the strongest weapon in the fight against money laundering, could paradoxically weaken it. There is no absolutely inviolable or unavoidable computer system, so criminal hacking, by refining its methods of break-in and updating them to the sophistication of legal exchange schemes, would make recycling operations even more opaque and elusive.

How can we get out of it? How can we get out of it in a rational, non-regressive or repressive way, but above all not in a way jeopardizing the stability of payment systems and the trade safety?

The fledgling CBDC is not a solution, it’s simply a reaction which risks overlooking the side effects of an equal and opposite disruptive mechanism. A possible solution goes through three directions.
Firstly, it is mandatory to stem those phenomena of fintech which currently are clearly breaching the rules: we need to overcome the ideological barrier for which the network is a parallel reality where everything is allowed. In this connection, the Consob document of January 2, 2020 with which the Commission takes a position on cryptoassets, assuming a lighter discipline on hybrid cryptoassets which de facto include a financial component, deserves serious rethinking. This applies to certain cryptocurrency schemes as well as to platforms for the exchange of traditional instruments which, at present, seem completely out of control. Being too much benevolent in cases deemed as marginal for now is not a good start, on the contrary it becomes a difficult precedent to defuse.

Secondly, the world authorities should draw up an agenda for the progression of the financial-technological evolution, by measuring the economic and social impacts of sudden alternative forms of exchange and preparing instruments able to curb them, preventing the excitement of the disruption from generating overall outcomes worse than those on which traditional systems lie (in this context, it should be welcomed the recent paper of Italian Ministry of Economics and Finances aimed at collecting opinions of the relevant stakeholders about the experimental project of softly ruling certain fintech phenomena).

Thirdly, the regulatory plan and the surveillance action cannot neglect also the risk of producing, thanks to unreasonable differentiated rulings, negative effects of disparity such as to alter the competition in the market of monetary and financial brokering. Despite all its defeats, the traditional system remains an inalienable bulwark of guarantee for savers, investors and economies worldwide: ratifying a parallel system with a lower control standing would end up pushing operators towards deregulated models that would reopen the passage to bubbles, dull violations of sad and recent memory.

Financial technology must make the current mechanism more efficient, not allowing its uncontrolled libertarianism. Disruption rhymes with, but does not equate to, destruction.

Il termometro dei mercati finanziari (14 Febbraio 2020)
a cura di Emilio Barucci e Daniele Marazzina

Termometro

Feb 15 2020
Il termometro dei mercati finanziari (14 Febbraio 2020) a cura di Emilio Barucci e Daniele Marazzina


L’iniziativa di Finriskalert.it “Il termometro dei mercati finanziari” vuole presentare un indicatore settimanale sul grado di turbolenza/tensione dei mercati finanziari, con particolare attenzione all’Italia.

Significato degli indicatori

  • Rendimento borsa italiana: rendimento settimanale dell’indice della borsa italiana FTSEMIB;
  • Volatilità implicita borsa italiana: volatilità implicita calcolata considerando le opzioni at-the-money sul FTSEMIB a 3 mesi;
  • Future borsa italiana: valore del future sul FTSEMIB;
  • CDS principali banche 10Ysub: CDS medio delle obbligazioni subordinate a 10 anni delle principali banche italiane (Unicredit, Intesa San Paolo, MPS, Banco BPM);
  • Tasso di interesse ITA 2Y: tasso di interesse costruito sulla curva dei BTP con scadenza a due anni;
  • Spread ITA 10Y/2Y : differenza del tasso di interesse dei BTP a 10 anni e a 2 anni;
  • Rendimento borsa europea: rendimento settimanale dell’indice delle borse europee Eurostoxx;
  • Volatilità implicita borsa europea: volatilità implicita calcolata sulle opzioni at-the-money sull’indice Eurostoxx a scadenza 3 mesi;
  • Rendimento borsa ITA/Europa: differenza tra il rendimento settimanale della borsa italiana e quello delle borse europee, calcolato sugli indici FTSEMIB e Eurostoxx;
  • Spread ITA/GER: differenza tra i tassi di interesse italiani e tedeschi a 10 anni;
  • Spread EU/GER: differenza media tra i tassi di interesse dei principali paesi europei (Francia, Belgio, Spagna, Italia, Olanda) e quelli tedeschi a 10 anni;
  • Euro/dollaro: tasso di cambio euro/dollaro;
  • Spread US/GER 10Y: spread tra i tassi di interesse degli Stati Uniti e quelli tedeschi con scadenza 10 anni;
  • Prezzo Oro: quotazione dell’oro (in USD)
  • Spread 10Y/2Y Euro Swap Curve: differenza del tasso della curva EURO ZONE IRS 3M a 10Y e 2Y;
  • Euribor 6M: tasso euribor a 6 mesi.

I colori sono assegnati in un’ottica VaR: se il valore riportato è superiore (inferiore) al quantile al 15%, il colore utilizzato è l’arancione. Se il valore riportato è superiore (inferiore) al quantile al 5% il colore utilizzato è il rosso. La banda (verso l’alto o verso il basso) viene selezionata, a seconda dell’indicatore, nella direzione dell’instabilità del mercato. I quantili vengono ricostruiti prendendo la serie storica di un anno di osservazioni: ad esempio, un valore in una casella rossa significa che appartiene al 5% dei valori meno positivi riscontrati nell’ultimo anno. Per le prime tre voci della sezione “Politica Monetaria”, le bande per definire il colore sono simmetriche (valori in positivo e in negativo). I dati riportati provengono dal database Thomson Reuters. Infine, la tendenza mostra la dinamica in atto e viene rappresentata dalle frecce: ↑,↓, ↔  indicano rispettivamente miglioramento, peggioramento, stabilità rispetto alla rilevazione precedente.

Disclaimer: Le informazioni contenute in questa pagina sono esclusivamente a scopo informativo e per uso personale. Le informazioni possono essere modificate da finriskalert.it in qualsiasi momento e senza preavviso. Finriskalert.it non può fornire alcuna garanzia in merito all’affidabilità, completezza, esattezza ed attualità dei dati riportati e, pertanto, non assume alcuna responsabilità per qualsiasi danno legato all’uso, proprio o improprio delle informazioni contenute in questa pagina. I contenuti presenti in questa pagina non devono in alcun modo essere intesi come consigli finanziari, economici, giuridici, fiscali o di altra natura e nessuna decisione d’investimento o qualsiasi altra decisione deve essere presa unicamente sulla base di questi dati.

Political risks: the “red shift” in debt sustainability analysis
a cura di A. Consiglio e S.A. Zenios

Articolo

Feb 14 2020
Political risks: the “red shift” in debt sustainability analysis a cura di A. Consiglio e S.A. Zenios

(This is a slightly revised version of a blog posted at Bruegel on January 22, 2020, https://bruegel.org/2020/01/incorporating-political-risks-into-debt-sustainability-analysis/ )

Political stability and economic policy uncertainty can be key determinants of sovereign debt dynamics, and we show how they can be incorporated in debt sustainability analysis. We distinguish between short-term ambiguity and long-term uncertainty about political risk factors, and using a combination of narrative scenarios and calibrated probabilistic scenarios we obtain a comprehensive heatmap of high-risk debt dynamics.  We use Italy as an interesting case study and demonstrate a “red shift” in the assessment of vulnerabilities when accounting for political risks. Ignoring these risks can lead to excessive optimism and wrong decisions.

When lenders such as the International Monetary Fund or the European Stability Mechanism want to assess whether a country meets the criteria for receiving international assistance, they carry out a debt sustainability analysis (DSA). This involves debt simulations and scenarios that evaluate the likelihood of countries meeting their future obligations. The Greek debt crisis, however, exposed the drawbacks of traditional debt sustainability analysis. During crisis episodes uncertainty is high, and therefore focusing on average dynamics, or on a few scenarios, can conceal potential risks. DSA applies to crisis countries only, but an early warning system identifying vulnerabilities is relevant for all countries. A more general, less stringent, debt vulnerabilities analysis (DVA) could be used to assess a country’s debt management policies to identify vulnerabilities, without leading immediately to policy consequence.

DVA would not carry the significant connotations of DSA.  It would have less stringent criteria for raising red flags, and would not lead immediately to policy consequences. For instance, it could be used to spot when a country has debt that is non-decreasing from very high levels, even though that country might pass the DSA test. The Dutch State Treasury Agency evaluates its public debt management practices every three years, even though its debt-to-GDP ratio is only 50%. The agency carries out a comprehensive analysis prior to a political review, including an evaluation of vulnerabilities, and the implications for policy are transmitted to the Dutch parliament by the finance minister (the 2019 evaluation is available here).

Such broader analysis could, in particular, account for political risks that are currently used to guide expert judgment by the institutions, but are not part of DSA. The IMF makes references to political risks and policy uncertainty in its Article IV Consultation reports,[1] ESM uses governance and/or political risk ratings in its Sovereign Vulnerabilities Index, and ECB uses such ratings to generate a heat map, classifying RED countries in the bottom ratings tercile, GREEN in the top tercile, and YELLOW in the middle. Such broad-brush treatment of political risks is useful, but unlikely to be effective.

Political instability and economic policy uncertainty can be key determinants of sovereign debt dynamics, but are not captured adequately, with quantitative rigor, by traditional DSAs. When the IMF, the ECB or the ESM carry out DSAs, they take into account risk factors including the country’s fiscal consolidation path, GDP growth and financial assumptions relating to the sovereign bond yields. They also consider debt aging costs, macro (bank) stress tests, inflation shocks, structural shocks, contingent liabilities and privatisation receipts. We argue that political risk factors can also be quantified, and should be part of debt analysis.

Our suggestion becomes attractive because the systematic quantification of political risks has been receiving increasing attention, driven in part by the compilation of databases that facilitate cross-sectional studies. Such databases include the Ifo World Economic Survey-WES (25 years of semi-annual data for 66 countries), the World Bank (25 years of annual data for 214 countries), the ICRG index (40 years of annual data for up to 140 countries) and the Dallas Fed’s Economic Policy Uncertainty index (25 years of monthly data for 21 countries). Impetus has also been created by theoretical models and empirical evidence that the markets price political risks.

Building on these advances, political risks can be incorporated in DSA (and DVA) and can materially affect the conclusions. We first identify (see Gala et al. 2018) two key quantifiable dimensions of political risk, and second distinguish between short-term ambiguity about the political factors that cannot be measured, and long-term risks that are modelled probabilistically. Third, we use a combination of narrative scenarios about the short-term ambiguity, and calibrated probabilistic scenarios for long-term risks (and Zenios et al. 2019), to obtain a comprehensive heatmap of high-risk debt dynamics. As an example of what happens when political risks are included, we look at recent developments in Italy (see below).

Short-term political ambiguity and long-term uncertainty

To incorporate political risks in DSA, we are faced with the problem of uncertainty specification, which has been daunting economists for a very long time (see for example Knight, 1921, and Arrow, 1951). We need to account for short-term ambiguity (ie which government wins the election, what policies will they implement, will a country be able to follow an adjustment programme?) and for the long-term volatility towards a well estimated expected future state, if we think that such an equilibrium state exists. In general, it is not possible to estimate reliably an election outcome or what policies a new government will pursue.

We adopt narrative scenarios for variables with ambiguous immediate outcomes, to see what the bad outcomes might be, and calibrated probabilistic scenarios for long-run uncertainty to estimate appropriate risk metrics. We run the DSA model for a range of plausible values for the critical variables that are affected by political event, such us government surplus and country GDP growth. For the long-run risks, we calibrated scenarios of economic, fiscal and financial variables, accounting for political effects. With this approach we identify values for ambiguous variables with high probability of bad outcomes, so that they can be avoided. The result is a comprehensive heatmap of high-risk debt dynamics, with quantile optimisation for those aspects of the problem that are amenable to scenario calibration, and identification of narrative scenarios with bad outcomes that must be avoided, for the ambiguous aspects.

Italy as a case study

We applied our model to the 2019 budget agreement between the Italian government and the European Commission. We assess whether Italy can stay on a non-increasing debt path with gross financing needs below an IMF-specified threshold of 20% of GDP, and demonstrate the material effects of political risks (Note: our assessment criteria are less stringent than those of official DSAs).

We start with a scenario tree covering GDP growth, the primary balance and the risk-free rate of euro-area 5-year AAA rated sovereigns, but without political variables. The scenario tree was calibrated to Italy’s conditions and observed market data, using historical volatilities and correlations. To the scenarios of risk-free rates, the model added premia capturing the response of borrowing rates to debt levels.

A significant short term political risk was the fiscal stance of the new Italian government following the 2018 elections. We parametrically change growth and primary balance projections to cover plausible outcomes, and evaluate, using the calibrated long-term scenario trees, the likelihood of debt stocks and gross financing needs staying within the thresholds. The result is a heatmap that shows the likelihood of debt dynamics remaining within the thresholds for a wide range of the ambiguous variables. We use the model to draw the heatmap and assess Italian debt dynamics under three narrative scenarios: (i) no policy change; (ii) the new Italian government achieves its growth and surplus projections; and (iii) Italy reaches the targets in the agreement negotiated with the European Commission. For each narrative scenario we assess if its outcomes would violate the thresholds, and, therefore, must be avoided.

Figure 1 shows the heat map, with dark green denoting an extremely low probability (0.01) of unsustainable dynamics, and red denoting a very high probability (0.85). Note that for a wide range of combinations of GDP growth and primary balance, the dynamics are unsustainable with very high probability. Italy is clearly vulnerable. The map also locates our narrative scenarios: ‘IMF’ denotes projections from the IMF World Economic Outlook report for 2018. Under our model calibration, and without any change in policy, the debt dynamics are highly likely to be unsustainable. ‘Pre- agreement’ corresponds to the Italian government targets before the budget agreement with the European Commission. It improves on the previous policy but is still in the red zone. ‘Post-agreement’ presents further improvements, shifting Italy into the yellow zone, with a probability of 0.55 for sustainable dynamics. The wisdom of a policy with a 0.55 chance of achieving its objectives is questionable and additional fiscal effort would be needed to increase to 0.85 the probability of remaining within the thresholds (green). Using the model, we estimate that with a total fiscal effort of 3.5% of GDP over twelve years, capped at 0.3% per annum, Italy can reach this target. This finding is in agreement with Sapir (2018) that Italy should have been running consistently a higher primary surplus to avoid finding itself in its current predicament, although our estimates for the extra effort are lower.

[Insert Figure 1]

Source: Authors calculations using the model of Zenios et al (2019).

We then incorporated long-term political risks. We generated a new scenario tree with political stability and economic policy confidence state variables, calibrated to Italy’s volatile political variables around estimated long-term trends. To calibrate the political state variables, we assume that they converge long-term to their historical averages of 4.5 (out of 10) for stability and 15.5 (out of 100) for policy. We also estimate volatilities from the historical ratings for Italy, namely a standard deviation of 1 for stability and 11 for economic policy confidence. The political variables are correlated with growth, primary balance and interest rates, with historical correlations from -0.44 to 0.75, respectively. Regression estimates of the bond yield sensitivities to these factors are then added to the refinancing costs scenarios, adjusted according to the endogenous debt risk premium. We re-run the model including political risk premia and redraw the heatmap (Figure 2).

[Insert Figure 2]

Source: Authors calculations using the model of Zenios et al (2019).

From this, a marked increase in the area that denotes a high probability of unsustainable dynamics can be seen. With political vulnerabilities taken into account, more combinations of growth and primary surplus are highly likely to violate the thresholds. Under our model, the agreement with the European Commission, which was estimated to have a slightly better than 0.50 chance of success, would only have a 0.15 chance of success when political risks are accounted for. The additional fiscal effort that restores sustainability with probability of 0.85, is now borderline light green, with a 0.65 to 0.55 chance of success. Clearly, ignoring the political risks can lead to excessive optimism and wrong decisions.

References

Arrow, K. J. Alternative approaches to the theory of choice in risk-taking situations. Econometrica, 19:404–437, 1951.

Gala, V., G. Pagliardi, and  S.A. Zenios, International politics and policy risk factors, Working Paper, 2018. (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3242300)

IMF, Staff Guidance Note for Public Debt Sustainability Analysis in Market-Access Countries, International Monetary Fund, Washington, D.C., 2013.

Knight, F. H., Risk, Uncertainty, and Profit. Boston, MA: Hart, Schaffner & Marx; Houghton Mifflin Company, 1921.

Sapir, A. High public debt in euro-area countries: comparing Belgium and Italy. Policy Contribution No. 15, September 2018.

Zenios, S.A., A. Consiglio, M. Athanasopoulou, E. Moshammer, A. Gavilan, and A. Erce. Risk management for sovereign financing with sustainability conditions. Globalization Institute Working Paper 367, Federal Reserve Bank of Dallas, 2019. (https://www.dallasfed.org/~/media/documents/institute/wpapers/2019/0367.pdf)

[1] See, for instance, the 2018 Financial Stability Report and the 2018 Global Outlook Reports. Such references appear twenty-six times in the 2016 Article IV report for Greece, twelve times in the 2018 report, and four times in 2019.