FRM II - Current Issues 2020 Cheat Sheet 1- The Impact of Blockchain Technology on Finance A. Blockchain Technology Basics i. Blockchain 1. Computerised ledger; cryptographic techniques; consensus and secure. 2. The ledger is distrusting, none single point can control over it. 3. An ever-growing chain of ledger entries links the entire history. ii. A Brief History of Consensus 1. Distributed Consensus a. Agree on common data in the presence of faults b. Blockchain uses distributed consensus to agree upon transactions. iii. Bitcoin 1. Participants can agree upon a continually updated history of all transactions. 2. Users have control over their bitcoin via a digital signature. 3. Digital signatures are public, cannot be forged, and can be verified by anyone. iv. The Proof-of-Work Design 1. Competing to find a randomly chosen string of numbers and letters.
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€¦ · Web viewThe Current Landscape. Impact to Date of FinTech Firms. FinTech firms have found new niches and underserved clients. The Case of Lending Platforms. Competitive
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FRM II - Current Issues 2020
Cheat Sheet
1-The Impact of Blockchain Technology on FinanceA. Blockchain Technology Basics
i. Blockchain
1. Computerised ledger; cryptographic techniques; consensus and secure.
2. The ledger is distrusting, none single point can control over it.
3. An ever-growing chain of ledger entries links the entire history.
ii. A Brief History of Consensus
1. Distributed Consensus
a. Agree on common data in the presence of faults
b. Blockchain uses distributed consensus to agree upon transactions.
iii. Bitcoin
1. Participants can agree upon a continually updated history of all transactions.
2. Users have control over their bitcoin via a digital signature.
3. Digital signatures are public, cannot be forged, and can be verified by anyone.
iv. The Proof-of-Work Design
1. Competing to find a randomly chosen string of numbers and letters.
2. Once a miner finds, they broadcast it, along with the block and claim their reward.
v. The Adjustment on the Difficulty of the Competition
1. An algorithm automatically adjusts the difficulty of mining.
2. As more miners join the network, the difficulty rises.
3. Miners incur costs in the form of specialised computer hardware and electricity.
vi. Bitcoin Full Nodes
1. Computers only validate the Bitcoin blockchain, but do not mine new blocks.
2. To validate that the blockchain includes the transaction correctly.
vii. Blockchain Technology and Distributed Databases
1. Permissionless blockchains
2. Permissioned blockchains
3. ‘Distributed ledger technology’ (DLT)
viii. Smart Contracts
1. Enforce the transfer of digital assets.
2. Do not require a trusted third party to intermediate.
3. The blockchain network enforces the execution of the contract on its own.
ix. Tokens
1. Companies issue a new token managed by a smart contract.
2. The blockchain network’s computers validate the token’s transactions.
x. A Spectrum of Decentralisation
1. On the decentralised end: permissionless systems
2. On the other end: a traditional centralised database
3. Costs from Introducing a Blockchain
a. Decentralised security is quite costly.
b. A trusted third party to secure the ledger, operating costs are likely to be lower
c. Must weigh the ‘cost of trust’ against the high operational costs.
B. Blockchain Technology’s Opportunities and Challengesi. Impediments to Broad Adoption
1. Benefits
a. Participants don't need to trust a particular person to maintain that record.
b. Open the door to peer-to-peer transactions.
c. Reduce overall friction.
2. Challenges
a. performance and scale;
b. privacy and security;
c. Interoperability among DLTs;
d. governance, updates;
e. real world use cases;
f. collective action problems;
g. public actions, legal framework.
ii. A Framework for Understanding Transaction Costs and Trade-offs
1. The Trade-offs Worth Consideration
a. Trade-offs between centralised market structures vs distributed networks.
b. The financial sector is choosing security and scalability over decentralisation
Most financial sector applications still rely on trusted intermediaries.
2. Basic Economic Properties of Blockchains
a. More users, higher benefits of blockchain application.
b. For permissioned blockchains, reduce overall transaction costs.
c. In digital identity or medical records: centralised systems may be inferior.
C. Blockchain Technology and Financei. Where Could Blockchain Technology have an Impact?
1. Payments
a. The cross-border payments is slow and expensive.
b. Remittances and foreign currency payments were potential application
2. Digital Identity/Know Your Customer
a. Verify numerous data points about their customers.
b. Banks use DLT as the cross-institution source of proof.
3. Primary Securities Issuance
a. Blockchain-based systems can issue corporate loans.
All parties have a shared record of the transaction and any updates.
Auto distribution of cash flows.
4. Securities Clearing and Settlement
a. A shared ledger may enable real-time clearing and settlement.
5. Derivatives Clearing and Processing
a. Many clauses can be coded directly into smart contracts.
Auto execution.
6. Post-trade Reporting
a. Distributed ledgers include a full audit trail for each transaction.
Facilitate post-trade regulatory reporting.
7. Trade Finance
a. Veracity of exporter claims and make letters of credit more available.
ii. Finance Starting at the Centralised End of the Spectrum
1. Permissioned blockchains mitigate the challenges that public blockchains face.
2. Critics
a. Closed systems face a security risk because the validators can collude.
b. Members may limit the innovations challenging their business models.
iii. Crypto-finance
1. Token Sales
a. Have led to a new means of raising capital- ICO
b. Purchasers are bearing risk of the eventual success of the new network.
2. ICOs
a. VCs see ICOs as a new way to fund start-ups.
b. A high failure rate for ICOs, due to a considerable amount of fraud.
3. Cryptoexchanges
a. Enable investors in the tokens to trade.
b. Offer market-making, advisory and custodial services.
4. Regulatory Responses
a. Payment tokens- subject to anti-money laundering (AML) laws
b. Utility tokens- intended to provide digital access to an application or service
c. Asset tokens- subject to prospectus requirements and trading protections
2-FinTech and market structure in financial servicesA. Background and Definitions
i. Financial Innovation Influences Market Structure
1. The emergence of providers of bank-like services may impact markets.
2. The entry of BigTech firms into financial services increased competition.
3. The reliance on third-party service providers may increase over time.
4. A shift to open banking: greater competition.
ii. Key Elements of Market Structure
1. Concentration
2. Contestability
3. Composition
iii. Tech Innovation Affects these Elements
1. Lower barriers to entry.
2. Increase competition.
3. Incumbents: be constrained by legacy IT systems.
4. BigTech firms: possess up-to-date technology and funds, have a competitive edge.
5. Unbundle many services offered by incumbents.
B. Financial Innovation and Links to Market Structurei. Supply Factors – Technological Developments
1. Use of APIs allows different software applications to communicate with each other.
2. Mobile devices expand the availability of financial services.
3. Cloud computing offers advantages.
ii. Supply Factors – Regulation
1. Changes in licensing and prudential supervision frameworks.
2. Ensuring contestability and a level playing field is an explicit policy objective.
iii. Demand Factors – Changing Customer Expectations
1. The digitisation of commerce => more convenient experiences across the services.
2. Younger cohorts may be more likely to adopt FinTech.
3. A desire for higher returns => provide FinTech platforms with a larger investor base.
4. The convenience of investing through mobile.
C. The Current Landscapei. Impact to Date of FinTech Firms
1. FinTech firms have found new niches and underserved clients.
2. The Case of Lending Platforms
a. Competitive pressures on incumbent lenders appear limited.
3. Cooperation between Incumbents and FinTech Firms
a. Incumbents outsource to FinTech firms their business.
b. FinTech firms can access to incumbents’ client base.
ii. Impact of BigTech Firms
1. Client data allows them to carry out risk assessments.
2. Acquire market share in the high-revenue area.
3. BigTech Firms Differ from FinTech Firms
a. BigTech firms already have established networks and a large customer base.
b. Well capitalised.
c. Have ready access to the forefront technologies to process big data.
iii. Third-Party Service Providers
1. The level of reliance on cloud computing providers may be low.
iv. How Firms Utilise Cloud Computing
1. Cloud computing has the potential to improve the security and resilience.
a. Avoid vendor capture.
b. More affordable.
c. Promote greater security.
d. Enable small FIs access to sophisticated architecture.
D. Conclusions on Financial Stability and Implicationsi. Summary of Findings
1. Implications for Financial Stability
a. FinTech firms may partner, complement, or compete with existing FIs.
2. The Benefits for FinTech Firms
a. Compete more effectively in some narrow product areas.
b. Reduce the stickiness of existing customer relationships.
c. Greater decentralisation of financial services.
d. Enhancement of financial stability through wider access to financial services.
3. Macro-Financial Risks
a. The effects of competition.
b. Disruption of business models on profitability.
c. Loosening of lending standards.
4. Micro-Financial Risks
a. Cyber incidents.
b. Heightened legal risk.
ii. Implications
1. Vigilance by Supervisors
a. Monitor the impact of competition on profitability and lending standards.
b. Monitor cyber risk.
c. Understand the incentives and barriers to entry by BigTech firms.
d. Manage third-party risks.
E. China’s NPI’s online MMFsi. China’s NPI’s online MMFs market impact and risk analysis
1. Regulatory arbitrage
2. Pushed up financing costs for banks
3. Potential liquidity risks due to potential maturity mismatches
4. Assuming systemic importance in china
ii. Recent measures targeted at Chinese NPIs’ online MMFs
1. Sold by commercial banks or licensed MMF sale agents.
2. Capping instant T+0 redemption.
3. Prohibiting T+0 redemption with their own cash in advance.
4. Prohibiting NPIs from engaging in the sales of money market funds.
3-Fintech credit markets around the worldA. How does Fintech Credit Work?
i. Fintech Credit
1. Credit activity facilitated by electronic platforms -not operated by commercial banks.
2. Use digital technologies to interact with customers online.
3. Lie outside the prudential regulatory perimeter.
ii. P2P
1. The online platform provides a low-cost standardised loan application process.
2. The platform facilitates direct matching and transacting of borrowers and lenders.
3. The credit platform services the loan in return for ongoing fees.
iii. Risk Spread and Default Risk
1. Spread their investments across multiple loans.
2. Platforms maintain a contingency fund for borrower defaults.
iv. Revenue Sources
1. Retain and attract an investor base to generate fee revenue.
2. Some platforms retain loans on their balance sheet.
v. The Digitalisation of Customers and Loan Origination
1. An assessment of borrowers’ credit quality: a credit grade => set a loan interest rate.
2. Many platforms tend to assess non-traditional data.
vi. How Banks Embrace Fintech Credit?
1. Banks‘ use of new digital techniques is not yet as advanced.
2. Fintech is distinct from lower-yielding, but safer, bank deposits.
B. Fintech Credit Market Developmenti. Market Development
1. China was by far the largest market.
2. But a slowdown in many major jurisdictions.
3. Fintech credit represents a very small share of overall credit flows.
4. Measuring the size of fintech credit is challenging, in part because of its novelty,
small size and diversity
ii. The Composition of Fintech Users
1. Individuals or institutional investors.
C. What Drives Fintech Credit?i. Three major factors
1. Fintech credit volume per capita is positively associated with GDP per capita.
2. A less competitive banking sector => more fintech credit activity.
3. More stringent banking regulation deters fintech credit activity.
D. Implications for Credit Availability and Riski. Benefits