BOJ Governor Ueda: The future of payments and the role of central banks

Bank of Japan Governor Ueda spoke at the 40th anniversary of the Center for Financial Industry Information Systems (FISC), exploring the…

BOJ Governor Ueda: The future of payments and the role of central banks

Bank of Japan Governor Ueda spoke at the 40th anniversary of the Center for Financial Industry Information Systems (FISC), exploring the evolving landscape of payment systems and the central bank’s role in shaping its future. His speech delves into the history of currency and payment systems, highlighting the interplay of security, efficiency, and convenience. Ueda then examines the influence of technological advancements, digitalization, and globalization on the future of payments, emphasizing the challenges and opportunities they present. Finally, he outlines the Bank of Japan’s initiatives in navigating this evolving landscape.

1. Introduction and Appreciation of FISC’s Contributions

Governor Ueda begins by acknowledging the significant contribution of FISC to enhancing the safety and efficiency of financial information systems in Japan over the past 40 years. He emphasizes the importance of FISC’s work in driving the modernization and security of the financial services industry.

2. Evolution of Payment Systems and Digital Technology

2.1. The Essence of Money — Maintaining User Trust

The core of this part of the speech revolves around the fundamental role of money and the critical importance of trust. Ueda illustrates the inefficiencies of barter systems, where a “double coincidence of wants” is required for successful transactions. Money, as a universally accepted medium of exchange, eliminates this constraint. He emphasizes the importance of Delivery versus Payment (DVP), ensuring simultaneous exchange of goods/services and payment to mitigate counterparty risk.

Maintaining trust in money requires robust anti-counterfeiting measures. Ueda uses the example of Edo-era Japan, where various techniques were employed to deter counterfeiting, and draws parallels to modern central bank practices, including advanced security features and periodic currency redesigns.

Crucially, maintaining trust hinges on preserving the value of money. Ueda references Hayek’s “Denationalisation of Money,” which argues that free competition among currency issuers would lead to the survival of the most stable and reliable currencies. This historical perspective sets the stage for discussing the impact of technology on competition in the currency and payment space.

2.2. Development of Digital Technology and Improvement of Payment Systems

Ueda traces the impact of digital technology on payment systems, illustrating how advancements in messaging and bookkeeping have revolutionized fund settlements for businesses, individuals, and financial institutions. He highlights key milestones:

  • 1973: Launch of the Zengin System, enabling nationwide interbank data communication.
  • 1988: Introduction of the Bank of Japan’s Financial Network System (BOJ-NET).
  • 1994: Implementation of DVP settlement in BOJ-NET, eliminating settlement risk for Japanese government bonds (JGBs) and Bank of Japan current account balances.
  • 2001: Transition to Real-Time Gross Settlement (RTGS) for JGBs and BOJ current account balances, reducing systemic risk.
  • 2002 — present: Progressive dematerialization of various financial instruments, including JGBs, commercial paper, corporate bonds, investment trusts, and listed stocks.

These developments highlight the increasing efficiency and reduced risk in payment systems driven by digitalization. Ueda acknowledges the trade-offs between security and efficiency, citing the increased liquidity demands under RTGS and the BOJ’s response through intraday overdrafts.

3. Progress of Digitalization

3.1. Digital Economy

Ueda explores the rise of digital platforms, exemplified by GAFA (Google, Amazon, Facebook, Apple) in the US and Alibaba and WeChat in China. These platforms have become expansive ecosystems facilitating various economic activities, from e-commerce to financial services, often utilizing their own digital payment instruments. He notes the network effects and economies of scale that drive the growth of these platforms, but also cautions against the potential for monopolies and oligopolies.

3.2. Ensuring Interoperability

The proliferation of diverse cashless payment methods creates fragmentation, potentially hindering convenience for merchants and consumers. Ueda stresses the importance of interoperability among payment systems to avoid these issues, emphasizing the need for efficient mechanisms to ensure seamless transactions across different payment instruments.

3.3. Emergence of DLT

Ueda discusses the emergence of Distributed Ledger Technology (DLT), blockchain, and smart contracts, and their potential to reshape the financial landscape, particularly in the realm of digital assets. Decentralized Finance (DeFi) platforms, built on public blockchains, offer various financial services with potentially lower costs and greater accessibility. However, he notes concerns regarding price volatility of cryptocurrencies, investor protection, and the potential for systemic risk amplification.

While acknowledging the potential of DLT, Ueda highlights several challenges:

  • Scalability and transaction throughput.
  • Finality of payments.
  • Legal and operational risks of smart contracts.
  • Governance in decentralized systems.

He emphasizes that the notion of smart contracts as a “magic wand” is misleading, particularly for complex transactions where unforeseen contingencies cannot be pre-defined contractually. DLT might find suitable applications in areas like large-value cross-border payments, where centralization is difficult and transaction volume is lower.

3.4. Importance of Service Resilience

Digitalization offers increased access to goods and services, but it also introduces new vulnerabilities, particularly to cyberattacks and natural disasters. Ueda points to international discussions highlighting the need for robust cybersecurity measures for Financial Market Infrastructures (FMIs). He stresses that as digital ecosystems become more integrated into daily life and financial markets, the importance of resilience and risk mitigation will only grow.

3.5. Importance of International Standardization

International standards play a crucial role in ensuring interoperability and security in cross-border payments. Ueda highlights the work of the International Organization for Standardization (ISO) and its financial services technical committee (ISO/TC68) in developing international standards for information exchange and security measures. The Bank of Japan’s involvement in ISO/TC68 underscores its commitment to promoting global standards and facilitating interoperability.

4. Perspectives on the Future of Payment Systems

4.1. Advantages and Disadvantages of Traditional Payment Systems

Ueda analyzes the strengths and weaknesses of traditional payment systems, focusing on the role of bank deposits. The credit creation function of banks allows for flexible management of liquidity demands, particularly for large-value transactions. However, traditional systems can be costly and slow for cross-border payments.

4.2. Structure of Currency and Payment Systems and Their Required Properties

Ueda emphasizes the enduring importance of trust and general acceptance in money and payment systems. While bank deposits and e-money benefit from deposit insurance and regulatory oversight, they ultimately rely on the existence of central bank money (cash and central bank reserves). He argues for a balanced coexistence of private and central bank money, each playing its respective role in the payment system. Central bank money underpins trust and stability, while private money fosters innovation and caters to user needs. The key challenge lies in defining the appropriate balance and division of labor between central bank and private sector initiatives.

5. Initiatives of the Bank of Japan

5.1. Project Stella

The Bank of Japan actively participates in Project Stella, a collaborative research project with the European Central Bank exploring the potential of DLT for financial market infrastructures. This project involves two phases:

  • Stella 1: Investigated the application of DLT to securities settlement.
  • Stella 2: Examined the potential of DLT for cross-border payments.

5.2. Project Agora

The Bank of Japan is involved in Project Agora, a BIS-led experiment exploring the application of new technologies, including DLT and smart contracts, to improve cross-border payments. The project involves seven central banks and private financial institutions, focusing on the concept of a “Unified Ledger” that integrates central bank and commercial bank money while preserving the two-tiered banking system. The BOJ emphasizes the importance of decentralized data governance and open, transparent, and secure mechanisms in such international platforms.

5.3. Central Bank Digital Currency (CBDC)

The Bank of Japan is conducting a pilot program for a general-purpose CBDC, focusing on technical feasibility and exploring potential use cases. The pilot consists of two components:

  • Proof-of-Concept (PoC): Technical experimentation with a CBDC system.
  • CBDC Forum: Engagement with private sector participants to gather insights and feedback.

While there are no current plans to issue a CBDC, the BOJ is actively researching its potential role in maintaining the safety and efficiency of the payment system in the context of ongoing digitalization.

6. Conclusion

Governor Ueda concludes by emphasizing the importance of anticipating future payment needs and risks, and the need for harmonious integration of new technologies with existing regulations and practices. He acknowledges the path dependency of payment systems, reflecting the unique evolution of each country’s financial infrastructure. The Bank of Japan is committed to working with stakeholders to foster a robust and efficient payment system that meets the evolving needs of society. He expresses his appreciation for FISC’s contributions and encourages continued collaboration to shape the future of payments.


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