Cyber Risk, Financial Stability and the Payments System

Cyber risk remains at the top of the list of risks to the financial system, and the financial system is well known as the primary target for hackers (see here, here and here). In response, financial institutions expend huge resources on protecting their information systems—by one estimate, well over $100 billion. Yet, private sector actions to prevent cyber losses fall short due to a glaring externality: since the damage is likely to spill over to other financial firms and to markets, individual firms cannot reap the full benefits of preventing cyber attacks.

To get a sense of the financial stability risks associated with cyber fragility, we need to understand the financial system in some detail. Unfortunately, financial networks are highly complex and vary significantly across markets and functions. They also evolve meaningfully over time. On top of these enormous challenges, assessing network vulnerabilities frequently requires institution- or transactions-level information that is normally not publicly available.

This brings us to the important recent work of Eisenbach, Kovner and Lee (EKL), who study the vulnerability of the U.S. large-value interbank payments system, Fedwire, to a cyber attack on one of the principal nodes of the payments network—namely, one of the top five banks. In this post, we highlight EKL’s analysis as a model for the assessment of cyber-driven network risks. We suggest how central bankers should react to a cyber attack on the payments system, and speculate about what is needed to prevent, as well as mitigate, cyber risks….

Modernizing the U.S. Payments System: Faster, Cheaper, and more Secure

When it comes to domestic payments, the U.S. financial system still lags the efficiency in several advanced economies. The reasons are easy to find. First, other countries have leapfrogged outdated technologies. In the United States, checks remained dominant well after their technological sell-by date partly as a result of government support. The other key factor delaying a shift to alternative payment mechanisms is the importance of what economists call a network externality. That is, the more people who use one form of payment, the more valuable that method is to the people who are already using it. And, by the same token, the more expensive it is for someone to move away from the prevailing mechanism.

With these considerations in mind, two years ago the Fed convened the Faster Payments Task Force (FPTF), a group of more than 300 experts and interested parties from a wide range of backgrounds with the objective to “identify and evaluate alternative approaches for implementing safe, ubiquitous, faster payments capabilities in the United States.” Earlier this month, the FPTF issued its second and final report, which contains a set of 10 recommendations for making the payments system faster, cheaper and more secure....

Virtual Frenzies: Bitcoin and the Blockchain

Bitcoin has prompted many people to expect a revolution in the means by which we make and settle everyday payments. Our view is that Bitcoin and other “virtual currency schemes” (VCS) lack critical features of money, so their use is likely to remain very limited.

In contrast, the technology used to record Bitcoin ownership and transactions – the block chain – has potentially broad applications in supporting payments in any currency. The block chain can be thought of as an ever-growing public ledger of transactions that is encrypted and distributed over a network of computers. Even as the Bitcoin frenzy subsides, the block chain has attracted attention from bank and nonbank intermediaries looking for ways to economize on payments costs. Only extensive experimentation will determine whether there are large benefits.

Again, however, we are somewhat skeptical...

Commentary

Money, Banking, and Financial Markets