Journal 42: Industrialization and Technological Innovation in Finance

Welcome to issue 42 of the Capco Institute Journal of Financial Transformation. As anyone who has read Douglas Adams knows, 42 is the answer to the problem of life, the universe and everything. While the exact question is still being computed, we will try to live up to number 42 in the following pages as we confront head-on some of the most innovative and technology-driven aspects of modern finance.

We open this issue with the Expert Opinion section, starting from a controversial angle. In our opening article Rodrigo Zepeda introduces the industrialization blueprint. This is an extensive analysis and discussion of the industrialization process in finance, lessons that can be learned from other industries, the impact of regulation on the industrialization process, and finally on how industrialization could be framed to benefit the financial sector and the public, avoiding some of the issues that impacted other industries. This ambitious article does not spare critical opinions of the financial industry, continuing our institute engagement with the process of industrialization. We are presented with a strongly opinionated and ambitious attempt at systematizing the industrialization process in finance.

Our second opinion article deals with marketing to banking customers. Michael Schrage suggests that marketing should become more proactive when trying to change and improve customers rather than simply trying to find out their wishes.

The third opinion article presents us with an assessment of the importance of cybersecurity in today’s financial industry. Charles Mbaruguru and Maxalan Vickers propose machine learning as a key framework in addressing this risk.

The following section of the Journal presents peer reviewed research articles on a variety of themes linked with innovation. We begin with an article by Robert Sams on the potential of Bitcoin blockchain technology for distributed clearing. A number of enthusiasts are advocating a distributed approach to clearing, with Nasdaq starting to look at this as well. This would solve one of the fundamental problems associated with central clearing counterparties, namely concentration risk, and the related impact on systemic risk.

But not all that glitters is gold. Robert Sams presents us with an interesting analysis of why Bitcoin’s blockchain may not be suited for distributed clearing, highlighting the protocol governance issue and submitting that the deterrents to successful self-financing attacks would disappear if Bitcoin blockchain were turned from a little-used digital cash system to a mainstream settlement resource. These attacks could make it impossible to keep information in the blockchain aligned with legal documentation. We hope this article will prompt a discussion that may continue in subsequent issues and we encourage submissions of response articles.

To conclude the part of this issue devoted to the impact of technology on finance, we present an article by Ignacio Mas and David Porteous, on smart pathways to digital financial inclusion. The article discusses new pathways that the widespread use of smartphones will open up for extending financial services to the mass of people in developing countries, including those who are currently excluded from or skeptical about services offered by traditional financial institutions. This article also addresses a few themes introduced in our previous article, “Cyberfinance: Liberating the Financial Markets,” in issue 41.

We now move to the part of the Journal dealing with mainstream risk in finance, and present an article by Normen Rohde and Michael Mahlknecht on model validation for liquidity risk management. The authors explain how even the best models have to be complemented by a comprehensive validation framework that adapts quickly to fast-changing market circumstances. In the liquidity risk area both regulators and supervisory authorities sometimes appear to lag behind when setting clear and consistent expectations on what banks should do. This article summarizes various evolving best practices in liquidity validation and proposes new approaches, highlighting a holistic approach.

Continuing with mainstream risk management, Lois Tullo discusses the best practices for enterprise risk management (ERM) in Canadian banks, investigating how Canadian banks achieved the top ranking in Bloomberg’s strongest banks index. The article examines the development of Canadian bank ERM best practices, suggesting a number of key factors including the benefits of strong regulation and economic stability, and burning platforms of substantial loss events which encouraged the leadership teams of Canadian banks to prioritize ERM.

Journal Articles