The issue is this: revolutionaries, be they fintech, big tech, neo-banks, non-banks, challenger banks, promise to upend the centuries old model of banking institutions. The catch is, as they do this, how do they avoid becoming banks themselves?
"The average US technology firm deals with 27,000 government regulations. The average bank meanwhile deals with 128,000.”
While these would-be disrupters may not want to become banks, regulators may demand it – because once any revolutionary achieves sufficient market size, governments and regulators start to fret about systemic risk, deposit safety and consumer backlash should something go awry.
Bank of America Merrill Lynch published a fantastic stat which goes to the heart of this: an analysis of regulations in 2018 found the average US technology firm deals with 27,000 government regulations. The average bank meanwhile deals with 128,000.
This reflects something fundamentally different between industries. As far as tech goes, people look for convenience and service. But with money they want something more, security. Even where security is a tech issue, it is usually because a breach may cost money.
An increasing number of banking revolutionaries have recognised the catch and are adopting various strategies to avoid it, increasingly by partnering with incumbent institutions or even selling out to them.
Now we’re also starting to see some more tangible evidence of revolutionaries electing to become “banks” themselves.
The Hong Kong regulator, the Hong Kong Monetary Authority, will award six new digital banking licences to non-banks:
- Ant Financial (a subsidiary of Alibaba);
- Tenpay (Tencent);
- Xiaomi (smart phone manufacturer);
- Standard Chartered (traditional bank);
- Hong Kong Telecom (telco); and
- ZhongAn (insurer in partnership with traditional bank Ciitic).
The challengers are targeting a retail banking sector currently dominated by traditional banks (including Standard Chartered).
This is perhaps the biggest assault on established markets to date although banking licences are being issued around the world to non-traditional players like Atom Bank and Starling Bank in the UK or Korean messaging group Kakao or Australian startups including Volt, 86400 and Judo Capital.
Meanwhile, on another front, Goldman Sachs, which built its storied reputation (and sometimes popular infamy) as an investment bank, is entering the retail banking field. Goldmans have never issued a credit card but has just done a deal with Apple to offer such a card linked to Apple Pay.
It’s important to remember actual customers in the real world don’t actually care about business models and institutional arrangements; they care about the ends, not the means. They care about buying a house not a mortgage. They care about buying shoes online not whether the payment goes through Visa, PayPal, NPP or UnionPay.
For the banking revolutionaries, an inverse logic applies. They don’t – or they shouldn’t – care about being a “bank”. The key question is what are they trying to do for their customers or potential customers and what is the most cost effective way of doing it.
As the BOAML research implies, approved banks face an enormous and growing regulatory burden in order for governments to be comfortable they are safe for taxpayers and so if they fail they are not too big – hence the “too big to fail” conundrum of moral hazard.
One technology giant which is most frequently mentioned as challenging the banks (like IBM or Microsoft before it) is Amazon.
As the British banking commentator Chris Skinner notes: “Amazon comes up almost once a month as the beast that will break into banking, and I’ve regularly covered them on the blog as an interesting example of adjacency”.
“They will move into any space that grows online business but not full, deposit account banking (in my humble opinion),” he says. “The reason I feel this is what does it add to their business model? Nothing. Payments and lending for sure, as that helps merchants, but the over-regulated deposit account marketplace. Nah.”
Skinner references a CB Insights takedown of Amazon’s financial services activity which supports the view the online giant is opportunistic rather than imperialist.
“Amazon has been experimenting with financial technology that could widen its reach,” CB Insights concludes. For example:
- In India, Amazon is offering thousands of loans to e-sellers so suppliers can expand their operations and manage seasonal spikes.
- The acquisition of Emvantage Payments has also made it easier for Amazon’s India-based customer to pay online, which is always a key focus for the e-commerce giant.
- It is expanding its financial reach by launching Amazon Cash, which allows users to add to their Amazon.com balance by showing barcodes at brick-and-mortar checkout locations.
- It has improved its own line of credit cards, partnering with Chase to release the Amazon Rewards Visa Signature Card.
- Amazon’s investment in Greenlight Financial allows parents to issue and manage smart debit cards for their children. Parents can control spending limits and reload the card with the use of a mobile app.
From the days just a couple of years ago when people were constantly talking about the Uber of banking or the Airbnb of banking, of drastically disrupting the establishment, increasingly the discussion is around how startups, fintechs, big tech and banks will work together.
At the heart of this strategic shift is the recognition all sides have distinct advantages and disadvantages.
For the challengers, the absence of legacy costs, an ability to start from a blank sheet of paper, the marketing edge of customers dissatisfied with the status quo, innovative cultures and rapid technology implementation are all advantages.
But they typically lack what banks and established institutions have: large customer bases, large data pools, the scale to afford the huge regulatory and compliance burdens and established regulatory relationships.
At the heart of this tension is the idea customers may not “trust” banks with their relationship but they do “trust” them with their finances and privacy. It’s that second kind of trust that is very difficult to build from scratch.
This new wave of banking licences will test the emerging equilibrium. In taking banking licences, these new institutions are in affect “buying” the regulatory imprimatur established banks own.
It’s not cheap: the new banks in Hong Kong have to carry the same capital base as normal banks - $HK300 million – which affectively rules out many startups.
As the Reserve Bank of Australia’s assistant governor (financial system) Michele Bullock said: “Traditionally, payment services have been provided by regulated financial institutions through transaction accounts. These institutions are prudentially supervised to ensure that the public can have confidence that they will be able to meet their financial commitments under all reasonable circumstances.”
So once again we bump up against the paradox of how much revolutionaries have to become like those they are revolting against in order to be successful….
Andrew Cornell is Managing Editor of bluenotes