“We need Banking but we don’t need Banks” – Bill Gates
It’s an acute dilemma. Having spent most of my corporate life working for banks, I still find it tough to defend them. After all, how does one sympathise with an archaic intermediary who offers so little value in today’s connected world- takes your money, transfers or loans it in most inefficient ways, errs on regulations and when you call, makes you hear promos and irrelevant IVR options! And it doesn’t stop there.
Haven’t you heard the story of the gullible old man, looking to park his pension funds in a term deposit but ended up investing in equity linked insurance. Or the naïve Small business owner who signed up for Swaps in 2007, without understanding what he is swapping. All this because their bankers advised them so!
One would expect solid advice on how to manage money from these ‘experts of finance’. However, more bankers you meet, faster you realise that the line between a car salesman and banker is blurry. Their expertise is about closing the deal.
Even more perplexing is the lack of innovation in banking, leading to higher costs, slower TATs and limited transparency. If businesses were measured on their ability to add value and innovate, I guess banking would be a laggard.
It's no surprise then that we see banks with some scepticism. Whether it’s a deliberate strategy to continue the opaqueness or sheer laziness in waking up to the reality, they are guilty all the same.
It’s anybody’s guess why banks couldn’t streamline their product and services. The lethargy is finally catching up with them. The new age fintechs are encashing the opportunity and offering products and services outside the rigid world of banks. Their ideas range from big paradigm shifts to smart simplification of cumbersome processes.
Payments was crying for simplification and the likes of Paytm, Stripe or Ezetap came and reduced friction. Knowing account balance or tracking expenses is a basic value-add and the likes of MTrakr or Happay or Moven offered real-time analytics. The high margin and monopoly on loans had to come under cloud someday and if startups like Kickstarter, Lendingclub, Sofi or closer home Faircent or LendingKart become mainstream, loans and overdrafts may no longer require a ‘favour’ from your friendly banker.It was only a question of time before hefty bank fees, complex documentation and obscene TATs were questioned.
Fintechs have disrupted the banks. But would they be our deliverer from the hegemony of Banks?
This disruption seems to have enthused the pundits to predict a war between Fintechs and Banks! Everyone seems to have a view and the narrative is almost always David beating Goliath, black and blue. I’m no less excited and almost tempted to say “Good riddance banks!” Betting on dark horses gives you an adrenaline high like no other. But there is one problem.
The castle of banks still looks formidable – strategically protected and blessed by the higher powers of the universe. The fintechs may have won a few skirmishes but need more than an idea to break inside.The war with banks is a long haul and breaching the castle won't be easy. In fact, more you look at the odds, it seems this may not be a fair war at all!
The concept of Central Banking has evolved over the last century, through many trials and errors. In his book titled ‘Lords of Finance’, Liaquat Ahamed narrates how the sensibilities and prejudices of a few central bankers shaped the monetary policy templates around the Great Depression in the 1930s. It has evolved ever since but the evolution is far from over. Balancing growth and inflation is still a challenge and they still debate whether socio-economic variables are a causation or a mere correlation.
The monetary policy tools used by central bankers today are a result of this long experimentation to control the money supply. To make these methods predictable, they rationed bank licenses and in the process created institutions that became systemically risky but gave the comfort of control. The fintechs, on the other hand, are an untamed animal.
The very nature of a startup is to break tradition and put consumer needs, instead of the institutional constraints, at the forefront. Concepts like Bitcoin have the potential to make the money flows lassiez faire and make the monetary policy tools irrelevant. It may be too much of a perceived risk for the traditionally trained central banker to junk templates so painstakingly built over decades.
While the license to 11 Payments Banks in India and others like Number26 in Europe, Atom in the UK are good signs, the conservatism on more radical ideas like Crowd Funding, Bitcoin and P2P lending indicates Central Bankers are still divided on how to manage and regulate fintechs. (I fear their ‘regulate’ mindset may be turning some fintechs into ‘banks’ too!)
New age financial services require a ‘facilitator’ in central banks and a vision to see beyond archaic monetary policy models. But till such time we don’t evolve these new methods, they would still need zombie-like institutions, who can play the musical chairs of the money supply.
For now, the blessings of ‘Lords’ (regulators) protects the banks like a divine energy shield.
With ISIS becoming a household name, the dangers posed by terrorism, trafficking and tax evasion have reached the neighbourhood. The 2008 financial crisis also brought to fore the inappropriate practices followed by banks. It’s no surprise that Governments across the globe want close monitoring of money trails.
$300 Bn (approx.) penalties levied by USA and EU on banks indicates how Corporate governance, fair practices, and Anti-Money Laundering (AML) compliance have become non-negotiable. With such world dynamics, need for increased regulation clearly overshadows call for liberalisation.
This compliance focus has a twin impact- firstly, the cost of compliance has increased multi-fold and secondly, complexity in bank documentation has spiraled. For eg., at JP Morgan the compliance team has grown from 23,000 in 2011 to 43,000 in 2015. In the developing economies, the weaker KYC infrastructure and now the burden of additional checks under multilateral agreements like FATCA and CRS adds to already cumbersome paperwork. Most of the banks in India still cannot open an account in less than a week and that’s being optimistic.
Running a financial services business today requires a high expertise on legal and procedural compliance, which varies widely across the globe and pushes up costs significantly. Any templated business run from a centralised office in California or London or Bangalore would sooner or later hit this hurdle. The news of drugs being sold on Bitcoin black market like SilkRoad (now banned) and the scrutiny LendingClub faced for ‘managed loans’ leading to the exit of its CEO, highlight that things can go out of hand in the fintech world too.
Even with best of intentions, it is some task for any technology startup to build highly efficient business in such a dynamic compliance environment, where the bar moves higher every day. Compliance is tricky moat to cross before they can reach the other side.
Bank Branch is dead and the data coming from Europe seems to corroborate it very strongly. Banco Santander’s decision to close 450 branches in Spain last year may only be the tip of the iceberg. Considering digital screens are the window to the world for Millennials and Gen Y, it shouldn't surprise that financial intermediation would change.
But contrast this with the opening of Amazon Go Store, increasing number of Apple Stores and many online players in India augmenting their presence with physical stores. It suggests brick and mortar is not necessarily an antithesis of digital. While branch may become redundant as a distribution point it may still be a competitive advantage for banks to offer enhanced customer experience. The fintechs would find it difficult to build a significant offline presence and be accessible to all sections of the society.
A large section of the socio-economic pyramid will still need some physical network in the medium term:
a. the Bottom of the Pyramid, differently abled or senior citizens would take time to get access and come up the technology curve.
b. High Networth Individuals would require customised offerings and a confidence building measure of a physical setup.
c. Products that require subjective vetting, deviations or high-level expert advisory would still need human intervention. It is still some time before the machine learning reaches the level of human intelligence to vet credit decisions, structure loans and complex derivatives and handle stressed assets.
So while the smarter banks like BBVA and closer home HDFC Bank may ultimately access the technology tools to build a significant digital presence, they would parallelly leverage their branch networks for enhanced customer experience. Fintechs may find that digital presence alone may not be sufficient to compete and building offline presence is not easy either.
It's exciting to see how fintechs have unbundled the banks. Many have simply leveraged the existing infrastructure, layering over bank products with incremental offerings. Take Wallets, for example. They still require you to have a Bank account or Credit card and convenience they offer may only be a transient competitive advantage. The lending startups are still experimental and the resilience of their portfolios and analytics is yet to be vetted over a longer economic cycle. There is still a long way before the fintech products become comprehensive and proven for scalability.
While the banks have faltered on delivery, there is no denying that they have had a long head start in refining their offerings. Bank products have evolved over time and are interlinked to cover the needs over the lifecycle of a customer. It’s a key strategy for customer stickiness.
The challenger fintechs would ultimately need to build a comprehensive product suite of Payments, Investments, Loans, Forex et al. Some may try to re-bundle products through tie-ups (like Number26, a digital bank in Europe attempted) but may risk becoming a selling agent or service providers for banks. This is exactly opposite of the premise they started with- reduce intermediation.
In the interim, the smarter banks are themselves building platforms and Open APIs, while simultaneously leveraging their traditional offerings.
The success stories of mPesa in Kenya and Micro Finance Institutions in India are good case studies to demonstrate that financial inclusion can happen without the tantrums of banks. The excitement created by Fintech’s in last few years is unprecedented and would fundamentally change financial intermediation. Despite the imposing size and formidability of banks, there are still many back doors to the castle and chinks in the armour which the fintechs can exploit.
On the other side, banks are learning the lessons the hard way. This is their opportunity to convince their aging Boards to consider technology as an investment and not an expense. While the real dumb ones (and there are many!) would perish, some smarter ones would emerge stronger and battle ready for the fintech onslaught.
But it’s the Regulators who have the most important role and a tough one at that. Considering the current world dynamics, with a bias towards protectionism and challenges thrown by terrorism and money laundering, we can guess which side their sympathy lies! But they must realise that innovation cannot thrive if they continue to have a tight clutch on experimentation and expect zero risks. They would need to reorient themselves as facilitators.
Just like any other battle, there would be some blood- some fintechs and some banks would die. But in the end, no matter who wins or loses, the customer would benefit from it. Ultimately this is a fight against inefficiency, complacency and too much centralisation.
(from the archives of FrankBanker.com)