The Era of Digital Financial Innovation: Lessons from Economic History on Regulation

March 12, 2020

Economic history gives us many examples of instances when financial innovations, rapid growth in credit supply and increased reliance on short-term financing have led to financial instability and crises. Therefore, at a time of rapid changes in the financial sector, it is important that regulators pay close attention to what is happening and take appropriate action.

In this report, David Longworth, former Deputy Governor of the Bank of Canada, focuses on the major macro-level risks arising from current and future digital financial innovation and what the implications are for Canadian regulators.

Regulators should enact a number of policies, including requiring the use of Explainable AI (XAI) in lending decisions, taking care not to rush into open banking regulations, extending the coverage of stress tests to include stresses relating to borrowing from non-bank financial intermediaries, and increasing the amount of data on lending and short-term financing from lenders, whether regulated or not.