The State of Fintech in Japan

Welcome to Pacific Exchanges, a new podcast from the Federal Reserve Bank of San Francisco. I’m Nick Borst.

And I’m Sean Creehan. We’re analysts in the Country Analysis Unit here at the San Francisco Fed. Our job is to monitor financial sector developments in Asia, and as part of the Fed’s public mission, share information and analysis with listeners like you. We inaugurate the podcast with a series of episodes that look at the state of innovative financial technology commonly known as fintech in Asia.

Fintech is a buzzword that gets thrown around a lot, but what exactly is it? One simple definition would be the use of software to provide financial services online or through mobile phones. This can involve banks but just as often involves startups. Fintech firms operate in a number of sectors ranging from lending to personal finance, digital and mobile payments and virtual currencies.

We’re excited for you to join us in the episodes to come as we explore how fintech is impacting people’s lives in Asia. We sat down with Shuhei Aoki, executive strategist at Hitachi. Before joining Hitachi, Shuhei served as a director of general payment and settlement systems at the Bank of Japan. We invited Shuhei to speak with us about the reason non-financial companies are getting involved in fintech and what impact it’s likely to have on the Japanese financial system.

Welcome to the San Francisco Fed, Shuhei. Thanks for joining us. Could you tell us a bit about your work at Hitachi? Why does a company like Hitachi care about fintech?

Hitachi does many different things and of course people know Hitachi as the manufacturer of air conditioners, or cleaners, or home appliances, but in fact that home appliances business is only 6% of Hitachi sales. Hitachi’s largest business is information and communication technology and the most important customer group is the banking group.

Actually, Hitachi is very much related to financial businesses and therefore naturally, we need to be prepared to supply technology/fintech to those financial institutions as they demand those new technologies. Also in terms of the blockchain and of course you may say that a blockchain is closely related to fintech, but actually blockchain is not the kind of technology used specifically to banking businesses.

In Japan, many business people outside the banking community ask Hitachi to provide blockchain technology and some products and so on. For Hitachi, banking business is of course the most important customer base. Also for non-banks, the business group is also interested in blockchain. For those reasons, Hitachi is very much interested in fintech.

In addition to blockchain, what are the other major developments in fintech that you see and how might this cycle of innovation differ from previous cycles that we’ve seen in the past were new technologies have impacted the financial system?

In the past, especially in the banking community, technologies were used by banks— traditional banks—to enhance their business, enhance their operations in terms of safety and efficiency. For instance in the ‘70s and ‘80s, the new technology was used by banks to process huge amount of increase, amount of the payment and others items.

In the ‘90s and the 2000s, the banks utilized the new technology to implement safety measures like delivery versus payment (DVP), real time gross settlement (RTGS) and all those new safety measures for payment services. This time around, the new technology is not used by banks primarily. The new technology is used by non-banks to get into banking services. The current fintech is a little different from the past fintech.

What would be a couple of examples of some of these non-banks that listeners might be familiar with that are now in the fintech space?

Unlike in the US, for instance Square and other similar services are not very much expanding in the Japanese market. Non-banks are getting into the banking business especially in the customer interface area, for instance some of the startups are providing accounting services for individuals. Some of them are providing account aggregation services. Those are the kind of peripheral services that are provided by the fintech companies in Japan. It’s very different from the US market, I think.

You talked about previous eras of fintech and one of the interesting things I think in Japan is for a long time you’ve been able to make payments using a mobile phone, but cash is still a large part of people’s daily transaction in Japan. It’s heavily used maybe more so than you would expect. Is cash still important in an age of fintech?

Cash is still very much used. After the interest rate being driven to zero or negative, the cost of holding bank notes is coming down much further, so the people have banknotes that are a lot more than before. Anyway, the bank notes are still an important means of payment in Japan. It looks a little strange that in Japan you have a different payment instrument like credit card, debit card and all the other traditional services.

Of course, I say bank notes are still used, but the use of bank notes as a payment method and payment instrument is declining slowly. People are shifting from bank notes to credit cards and other things. Probably when the Japanese banks implement faster payment services, 24/7, two years from now, the people may use fast transfer across bank accounts in place of a bank notes usage.

Maybe the use of bank notes will be declining further from here. Still the bank note is a very important payment instrument and especially when the new payment devices are being introduced, the role of the bank note is very, very important. That’s my view because if I’m going to use a new payments device – is this payment instrument safe? Probably I’m not sure, but I can be bold or I can take a little risk of using that methodology because if something bad happens, I can go back to the bank note as well.

Cash is a still backstop. Even for the fintech world, cash is still important.

Right. In terms of the fintech development, the bank notes are even more important than before. It’s a little strange to say that that bank notes are very important in the era of fintech new technologies.

I was wondering if you could talk a little bit about how Japanese banks are reacting to the entry of these new non-bank players into a space previously that they’ve dominated? Do Japanese banks see potential for cooperation, competition or is it a mix of both?

It depends on the size of the banks. The largest banks, they are actually very positive about collaborating with the fintech companies or to use fintech for their own businesses. This is because the target of the new businesses, new fintech businesses, one, is the masses and the other is the medium and small firms and companies.

These targets are different from the targets of the large banks. They are primarily looking at rich individuals and large firms. For large banks, the fintech companies are not really rivals. Even if you collaborate with fintech, you have nothing to lose. They are very much positive about getting closer to fintech things.

On the other hand, for smaller banks their customer base is non-rich people and medium small-sized firms which are very much similar to the fintech businesses. In fact, fintech is a threat from the eyes of smaller banks, but at the moment, smaller banks are not really reacting very much. They are taking the wait-and-see approach at the moment because they do not have many resources to study and apply these new things. I think fintech is very much positive for large banks and potentially negative for smaller banks, but smaller banks are not reacting very much.

What do you think are some of the best practices for regulators fostering positive developments with regard to fintech?

I think there are two things. One is maximum encouragement of bank efforts to enhance efficiency of their services no matter if fintech is involved or not. The second thing is the minimum regulation on fintech firms in order to keep innovation going. I think those two things are critically important.

Do you see example of where regulators have done a good job of calibrating differences and regulations for banks versus non-banks making sure that non-banks can grow but not at the expense of regulatory arbitrage?

Actually the non-banks are not so much regulated in Japan. I think at the moment, the level playing field problem is not actually there, I think because non-banks so far do not complain that they are being regulated so much and so on.

What about from the reverse perspective though, banks feeling that maybe some of the nonbanks should be regulated differently. Is that something you hear?

At the moment, large banks do not react like that because for large banks, the fintech companies are friends with those whom they should collaborate. For the smaller banks, I think there are reasons for them to cry and shout, but at the moment, they are still very much silent.

There’s not a critical mass of banks complaining to really compel action by the regulators?

Yeah, and also the smaller banks in many cases are located in the smaller towns and the smaller cities. Japan is an aging society and in those places, there are not so many young people who are very much interested in the new services of fintech and so I think that’s one of the reasons why smaller banks are not actually feeling that fintech is a nuisance for them.

Before joining Hitachi you were the director general for payments and settlement systems at the Bank of Japan. I’m wondering now that you’re in the private sector, do you see any role for virtual national currencies around the world. You hear a lot about blockchain, decentralized currencies without really a central bank, but what about the idea of entity like the Bank of Japan issuing a virtual national currency?

The BOJ developed a virtual currency in a laboratory. That was about probably 20 years ago with one of those technology companies. BOJ didn’t actually try to really implement or really use this technology and the reason would be that central bank issuing virtual currency itself will be very bad for the private businesses and private banking services because virtual currency issued by the central bank can of course replace bank notes.

It’s virtual but it’s issued by the central bank and it’s not different in that sense from the bank notes, so that’s one thing. At the same time, it’s kind of like flying bank notes. You can use the virtual currencies issued by the central bank not just to pay face-to-face but you can use that central bank money for the payments to remote places.

This remote payment using the central bank money is actually a threat for the funds transfer services provided by the private sector. The thinking was that the central bank virtual currency looks like a good idea, but in reality it will be a huge problem for private sector. In order to avoid any undue pressure on private banking services, we stopped the proceeding with this virtual currency, central bank virtual currency idea.

People might move forward and cut the banks out of that intermediation loop?

Yeah.

That’s was a concern?

Right.

Looking at all the developments we’ve seen recently with blockchain and it seems like every couple weeks there’s a new initiative consortium of banks working on some blockchain related product, can you give us a sense of how important you think blockchain is going to be anywhere from sort of a passing fad to this is going to completely revolutionize banking? How important do you see these blockchain developments?

The blockchain development will be very, very important. Of course blockchain is used by virtual currency things like bitcoin and the other coins. That’s one thing. Some of the private banks like the largest bank in Japan, they are now introducing a blockchain technology for their payment services and it’s not a new currency, the service of course handles Japanese yen. The bank is implementing this blockchain for their funds transfer services between their branches.

For example, if I’m a customer of Bank A and you are the customer of Bank A, and if I pay my money to you within the bank, they are trying to use blockchain technology for this as a trial. What they are thinking ultimately is that this blockchain fund transfer service can be used between different banks and also the cross-border payments.

At the moment, domestic fund transfer is very costly because they have to use the domestic fund transfer system. It’s similar to ACH. When it comes to the cross-border fund transfer service, then you have to use the SWIFT or the other things and also the foreign exchange is involved. If you are going to use the blockchain technology, then you don’t have to use the SWIFT and the other corresponding banking services.

They can bypass a lot of these legacy systems?

You just use the internet.

In addition to the impact of blockchain on the financial system, what other applications do you see for blockchain going forward?

Blockchain will be used not just by banks but I think that blockchain will be very useful for non-bank business transactions including automobile sales, used car sales inclusive, housing, and expensive things like diamonds and the other jewelry. I think when those things are traded, I think the blockchain technology will be very useful. I think in the coming years, that the blockchain technology will be used perhaps more in the business field rather than the banking field. It will be not proper to call blockchain as just fintech.

Its uses are much broader potentially?

Yes.

Any risks that you see particularly in that development with blockchain?

It depends on the design of the risk management accompanying the new services. You need to design so that these efficient systems are also very safe. We may have to think about the best practice of things and so on when those technologies are actually implemented in new services.

Thank you so much, Shuhei. This has been fascinating conversation. We really look forward to seeing how this all develops.

Okay. Thank you very much for inviting me.

We hope you enjoyed today’s conversation with Aoki-san. For more episodes like this, you can find us on iTunes and Google Play at Stitcher. For even more content, look up our Pacific Exchange blog available at frbsf.org. Thanks for joining us.