Will new technologies change banks or will banks change new technologies?

Financial services companies around the world are signing up for consortia and joint ventures to keep pace with the accelerating digital disruption at a rate not seen… well not seen for a decade or so. Unsurprisingly, most of the latest partnerships orbit around financial technology, “fintech".

Last week R3, operating out of Silicon Valley, New York and London, announced Commonwealth Bank of Australia had joined Barclays, BBVA, Credit Suisse, JP Morgan, State Street, Royal Bank of Scotland and UBS on a project to develop distributed ledgers.

"What role should incumbent institutions assume in developing new technology? And are those technologies genuinely replacing something?"
Andrew Cornell, Managing Editor

This is the protocol behind “blockchain", which supports Bitcoin, and potentially can replace central clearing and settling houses, the traditional way of ensuring transactions are genuine and can be honoured, with a network of participating servers, a sort of “wiki" for clearing.

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The partnership has echoes of the Integrion consortium formed in 1996 by IBM and a dozen or so global banks to exploit the emerging opportunity of then new banking technologies like the internet and chip cards.

Partnering is a smart approach – even though Integrion no longer exists. New, disruptive technologies by their nature are high risk. Multiple iterations typically occur before global standards are settled. Just consider – if you can remember the technology at all – the VHS and Beta battle in videotape.

But underlying this approach are two fundamental questions: what role should incumbent institutions assume in developing new technology? And are those technologies genuinely replacing something – as DVDs did videotape – or simply making an existing process better.

As to the role of incumbent institutions, there are strong arguments for different approaches. Clearly CBA – and Westpac with its venture capital model – believe direct investments, sort of hedged bets, are worth the money. That way there is an ownership stake in the company, technology or protocol if it becomes successful.

Here at ANZ, Patrick Maes, chief technology officer, argues while it is imperative banks team up with innovators – and other more mature institutions – it doesn't make sense to become venture capitalists.

“Personally I don't believe we should be setting up a corporate venture unit," he wrote in BlueNotes. “Not so much from an investment perspective (everybody can throw money around) but more from a capability perspective - like the ability to guide start-ups through the multiple phases of growth, which is the critical skill of successful VCs."

The other fundamental question is what are these new technologies actually doing?

While much of the excitement around Bitcoin is that it is a new, anonymous currency likely to disrupt not only banking services but the fiat and seigniorage powers of central banks and nation states, implicit in the R3 collaboration is the realisation the thinking behind blockchains offer new, efficient ways to undertake existing activities rather than overthrow them.

Interestingly, the US Commodity Futures Trading Commission (CFTC) last week officially designated Bitcoin a commodity like oil or pork bellies.

“The CFTC, for the first time, finds that Bitcoin and other virtual currencies are properly defined as commodities," the commission said.

By this action, the CFTC asserts its authority to provide oversight of the trading of cryptocurrency futures and options, which will now be subject to the agency's regulations.

So while it is a currency which can be used as an exchange of value, Bitcoin traders and manufacturers of its derivatives etc must now abide by the same regulation as oil traders.

If the mythology is correct, Bitcoin actually exists because its enigmatic creator, Satoshi Nakamoto, was annoyed at the fees he had to pay for international currency exchange in buying model trains from England.

For many incumbents, this is actually what a process like blockchain promises: reduce the cost of transactions via a more efficient system while maintaining and even enhancing security.

I recently chaired a conference, Next Generation Lending, in Sydney and much of the focus was, not unexpectedly, on digital disruption, new technologies and particularly peer-to-peer lending.

There were some fascinating presentations but interestingly, whether from new technology players, bankers or attacker brands, the essential elements of the presentations were actually quite traditional: customer differentiation, service, risk management, funding.

Phil Gray, director of Westpac's internal accelerator “The Garage", despite the funky workspace, ideas boards, bean bags – ok, maybe there weren't bean bags – outlined an extremely disciplined approach to disruption beginning with the fundamental question of what problem was being solved.

Kareem Al-Bassam from PayPal argued his firm's advantage with its new merchant working capital credit line was the deep knowledge of the merchant, customers and transactions built from the extensive data of former parent eBay.

That is, PayPal believes it has an analytic and data advantage which translates to superior risk management and more precise pricing.

Stuart Stoyan, founder and CEO of marketplace lender MoneyPlace, an online marketplace connecting borrowers with investors, took an often ignored perspective on P2P – what is the attraction to funders? The questions he addressed were the classics: what is the yield, what is the risk, what is the volatility?

There is no doubt financial services is undergoing radical change, the digital and social revolutions will upend many incumbents and bring in new competitors.

But the world itself hasn't changed: financial services are still about customers, funding, risk. And regulation.

As Maes said on BlueNotes: “The main assets of banks are our ability to provide reliable and secure services for our customers, at scale, together with our experience and, most of all, trust. These are some of the assets we bring to any relationship and especially to start-ups."

Consider the last decade or so of massive litigation and legislation around payments, particularly when it comes to interchange and merchant fees charged by the global networks like Visa, MasterCard and American Express.

Basically what drove this wave of interest was not the technology per se or the role of the networks, it was that their market share and revenues had reached a point where they couldn't be ignored. Merchants wanted some of the revenue, regulators knew they had to respond.

Integrion, the IBM joint venture, ultimately dissolved because the internet became so large and so ubiquitous that no organisation – bank or otherwise – could ignore it and so the role of what was essentially a pilot vehicle to allow risk sharing was no longer needed.

Today, much of what fintech offers and new approaches like P2P are in that place. Interesting, challenging, potentially revolutionary. But still small.

It's when they get big that things really start to change.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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