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Can you trust the future of banking?

What finally sees off an ageing, ailing business model is not always the most obvious threat. In journalism, for example, the end of print newspapers may not come just because Facebook or the iPhone are now what is read on trains.

Print papers need physical delivery which requires an intermediary, often a wholesale newsagency which historically has made money from handing all the papers for home delivery. It’s laborious: individually wrapping, packing and delivering with relatively high fixed costs like trucks.

"Why would banks be irrelevant? Because someone else can do everything a bank can do but cheaply."
Andrew Cornell, BlueNotes managing editor

That model of intermediation may fail before the papers themselves – but then there is no one to deliver the papers.

Is that the case with banking? Not that some new, non-bank competitor will consume the incumbents’ breakfast, lunch and dinner or a radical fintech the calorie-rich lines. Rather, the fatal blow might be something quotidian – like the cost of legacy systems and processes.

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This soul searching has, it should be noted, been going on for decades. The line often trotted out when a ‘Kodak moment’ is potentially looming is Bill Gates’ when he was chairman of Microsoft in 1994: "Banking is necessary, but banks are not".

That line though is actually a paraphrase of the conclusion of a report Edward Furash wrote for the powerful American Bankers’ Roundtable in 1993: “Banking is essential to a modern economy. Banks are not.”

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The report was commissioned at a time when banks’ share of financial intermediation – their core business – was plunging, particularly in the US. Non-banks had cut the share of household financial assets held by banks by more than half. Mortgages came from mortgage companies, credit cards from credit card companies. Capital markets, meanwhile, had taken over the financing of the corporate sector.

But critically those trends did not develop as much outside the US and the financial crisis of 2008 halted evolution in its tracks. Suddenly banks – because they were protected by governments, either explicitly or implicitly – looked safer repositories for savings and more reliable lenders.

Now new threats are on the horizon and in his valedictory speech “New paradigm in banking: banking is necessary, not banks - really?” R Gandhi, Deputy Governor of the Reserve Bank of India, tackled the problem.

He made a critical point: in the past, the threat to banks for control of banking was either technological – Microsoft, AT&T etc at the time – or institutional – retailers, telcos coming into banking.

What those challengers were offering customers was a faster horse, to paraphrase Henry Ford’s famous quip about why he didn’t ask customers if they wanted a car. Today, customers know they want a car not a horse.

“It is the emerging trends in technology, regulatory changes and consumer behaviour and expectations which are redefining banking and banks' role and even endangering banks' existence,” Gandhi said in his speech.

“Why do I say redefining banks' existence? That's because, as PwC did put it, if the banks were to not take full account of these trends and developments, they would risk emerging from the financial crisis ‘recapitalised, restructured, reformed - but irrelevant’. That's a profound statement in my opinion.”

CHEAPER

Why would banks be irrelevant? Because someone else can do everything a bank can do but more cheaply or simply – customers will pay for a superior experience and in financial services that means an easier, simpler one.

Japan’s central bank governor Haruhiko Kuroda made that point implicitly in a speech at the recent Tokyo FinTech Forum.

“From the perspective of information processing, payments and settlements relieve economic entities from burdensome information management, such as credit risk management of accounts receivables stemming from past transactions,” he said.

“This allows entities to concentrate their resources in forward-looking economic activities. Through financial intermediation, financial resources are allocated to investment in projects with higher productivity.”

In essence, at a fintech forum, Kuroda was saying banks could be “freed” from much of the processing they currently charge for and new players could enter the market.

Or have a look at noted fintech commentator Chris Skinner’s latest take on where the distributed ledger technology blockchain might have its biggest impact: “I’ve talked a lot about blockchain, but not much lately about the use cases, of which four stand out in terms of real activity: Clearing and Settlement, Trade Finance, Payments and Digital Identity.”

Again, all core bank activities. The RBI’s Gandhi spoke of banking being re-defined. Or rather “…not redefinition but de-definition.”

“Banking is no longer what a bank does; it is also what a non-bank does,” he said. “Banks are no longer those entities who do banking exclusively; now others, the non-banks also do banking”.

DEMAND ISSUE

Banking doesn’t have a demand issue – financial services are wanted more than ever as economies develop and populations age.

So too with the media industry. It is not that people have stopped consuming information – indeed, across myriad platforms and formats, they are consuming more than ever. Just not from traditional newspapers, radio and television.

The difference is the consumer. The consumer is now in a position of both having experienced a mode of delivery more accessible and suited to their lifestyle or more tailored customer service and having the ability to choose that superior experience.

Gandhi’s question is existential. Why banks? And actually it deserves an existential answer: what is it in the essence of historical banks which cannot be de-defined?

Theoretically, of course, nothing. But in reality the answer may lie in what made banks so vital to preserve in the financial crisis – the trust placed in them.

It’s long been argued and focus groups have found consumers don’t necessarily like banks but they trust them. Even in the wake of the crisis, and amid myriad scandals which have ostensibly eroded trust in banks (and large corporations), there is little evidence yet of people taking their money out of banks or switching their loans en-masse.

It’s worth noting some of those non-bank competitors from earlier waves are no longer in banking – some because the business model failed, like credit card monoline businesses, but others because they weren’t prepared to pay the price of ‘trust’ – regulation, capital, strict liquidity requirements. General Electric, for example, sold out of GE Capital, then the world’s largest non-bank.

That trust has historically been in the preservation and movement of financial assets. But if the new world of banking services evolves, the most powerful layer of trust may be personal information.

We are only just becoming aware of the power of personal data – as we rapidly give it away to all and sundry and have it stolen. Personal information is extremely valuable – for marketers but in preserving our wealth too.

The BoJ’s Kuroda makes this point: “Financial intermediation, such as bank lending, has made full use of borrowers' information shared through ledgers and corporate accounting.”

Where detailed personal information is needed, what is the answer to security? One answer is banks are institutions with a culture of information integrity. It is one governments and regulators insist upon. It is a competitive advantage.

Being a ‘trusted vault’ was once a physical attribute of a bank, in the new world it may be a virtual one too.

As the RBI’s Gandhi said: “I can only conclude with the idea that if you make yourself socially relevant, not just relevant in economic sense alone, you can have hopes to exist”.

Interestingly, the parallels with media are there too: the most valuable mastheads were ‘trusted’ sources of information. Even as non-traditional players offer the news, images, data, analysis, entertainment once the preserve of media giants, that ‘trusted’ masthead is still valuable.

Andrew Cornell is managing editor at BlueNotes

PHOTO CREDIT: Jennifer Farmer

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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