25 May 2020
Over the decades, as traditional banks battled new competitors like payment schemes, monoline mortgage companies and software giants, one observation has stood the test of time:
“Banking is essential to a modern economy. Banks are not.”
It was originally made in the early 1990s by consultant Ed Furash in a report for the Bankers’ Roundtable but was picked up by Bill Gates, among others. And it’s true.
"When the banks closed in Wuhan, nobody cared.” – The Financial Times
Modern economies need payments, they need marketplaces to bring borrowers and lenders together, they need the means to create money and manage the risk of funding long term investment with short term lending horizons.
Banks have traditionally done all this. But there’s no universal law giving them that privilege.
As in so much, the COVID-19 crisis has provided an intense crucible for financial transformation and it has tested this maxim. And indeed, modern economies do not need banks.
Digital banking maven Chris Skinner, who has tackled this theme at length, pointed out a great headline in The Financial Times (FT) recently: “When the banks closed in Wuhan, nobody cared.”
He noted during the initial lockdown in Hubei province, where the pandemic originated, the functioning of this modern economy barely felt the closure of banks.
According to the FT: “ATMs remained functional and most banks in the area offered some form of online banking. But many people in Wuhan said the payment applications they use — Alipay or WeChat Pay — were enough to get them through the crisis.
“We don’t need the banks anymore. If they close down, we don’t pay attention,” said one Wuhan resident who works as a driver. Another resident, a woman in her late 20s, said in early April: “I can’t remember the last time I went to the bank.”
This would not be the case in almost every advanced western economy where the traditional banks remain more deeply entrenched in daily financial life. Indeed, in Melbourne where I reside and a new, more intense phase of lockdown has just been brought in, banks are considered an essential service and their role explicitly recognised by state Premier Daniel Andrews.
But just because every function of a bank can theoretically be done by another entity, that won’t mean banks will disappear.
Even in China, banks still have a role. As the FT said: “online payments accounts require users to link to a bank account, and many companies still pay their employees through banks”.
But the FT added the rider this role is not best one. This is the risk that threatens any bank. Not that they will be eliminated but that they will be relegated to subordinate roles, reduced to low margin utility functions, and will lose the crucial direct relationship with customers.
This was actually the threat Furash’s original report addressed. At the time the big fear was payment schemes like American Express or software giants like Microsoft would play the role of Alibaba or Tencent and take over bank functions and, even worse, relationships.
Yet they didn’t. They did take over small banks, to give themselves the required banking licences, but never took on the full roles of banks. Today the most likely giant engulfer in the west is Amazon.
Tech industry analysis site CB Insights has kept close tabs on Amazon with several reports.
The firm analysed how the tech giant has expanded its finance-related reach in 2020 alone:
Most recently, it inked major deals with Goldman Sachs and ING to issue small to medium-sized business loans up to $US1 million.
Amazon however is far from alone. While much attention has focused on the competitive challenge to banks from startup financial technology firms - fintechs - those new players are actually more likely to partner with incumbent banks. They need scale and data, typically.
Big technology companies are different. They have scale, customers - and money.
Trust in crises
But it is not just size or technology that determines whether banks will lose their role at the centre of financial services. And obviously banks themselves are not sitting still. Those banks with a future are becoming digital, they are making better use of their data, focusing more strongly on where they have a genuine competitive advantage. They are making customers the genuine locus of their strategies.
Meanwhile, other factors come into play when a sector is as sensitive as financial services. Trust is one intangible - and during crises customers have historically returned to traditionally strong institutions.
Aligned to that is policy and regulation. As a rule, governments and regulators subordinate survival of the fittest capitalism to varying levels of consumer and social priorities like stability. Going back to the 90s, one reason the non-banks competitors didn’t move in more heavily was they reasoned it wasn’t worth the extra cost of being regulated like a bank.
The International Banking Federation (IBF) and Oliver Wyman have just released a report “Big Banks, Bigger Techs? How policy-makers could respond to a probable discontinuity”.
“Probable discontinuity” would probably have less chance of escaping the jargon filter than “de-scoping non-essentials” but the report makes a strong argument the combination of COVID-19 and the emergence of big techs with powerful networks and deep investment pockets will change the face of banking.
The report does see a status quo with only niche penetration of new players “however, in a few major markets, the analysis highlights how the unique scale and ‘ecosystem’ model of big techs has the potential to fundamentally change competitive dynamics in banking.
“Big tech technology capabilities can bring benefits in customer outcomes and efficiency that can be put to good use for society — to serve inclusion, to fight financial crime, to improve the cyber and operational resilience of our financial system, to name a few,” the report says.
“But they also raise new types of risks and challenge the traditional ‘vertical’ (sector-oriented) model of regulation and supervision, which may no longer serve society’s best interest today.”
The IBF and Wyman make the point two extremes of policymaker response are unattractive:
As always, balance is optimal and that, the report says, will require policy-makers to think differently with respect to competitive boundaries, accept higher uncertainty and faster responses and possibly re-think the institutional architecture that governs the intersection of financial services and technology sectors.
This is no marginal matter. The future of banking has forces on multiple fronts: the innovation competitors are able to deliver; the innovation customers actually want to use; the trust customers are prepared to extend; and the rules policy makers set.
Andrew Cornell is managing editor of bluenotes
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
25 May 2020
27 Nov 2019