The next 500-year plan for banking

Some kind of banking is known to have existed more than two thousand years ago but the modern bank as we know it commenced operations more recently, just over five centuries ago in Italy.

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There’s some dispute but the oldest ongoing bank is usually considered to be Banca Monte dei Paschi di Siena, founded in its present form in 1624. Even back then, Monte dei Paschi and its ilk would have been familiar to us - taking short term deposits, making long term loans, facilitating and guaranteeing payments.

" “It is underappreciated just how much traditional banks are already in partnership with bigtech on the core elements of the banking “tech stack”.”

Banks pretty much do the same stuff today. But the question the digital age has forced us to ask is whether the traditional bank has another half a millennium in it. Be it from bigtech, like Tencent or Google, or fintechs like Afterpay or Square, or non-banks like insurance companies or wealth managers, with such threats does the model of a “universal” bank still stack up?

What does the bank of the future actually look like?

Denis Beau, First Deputy Governor of the Bank of France, recently outlined a neat sketch of possible futures.

“It seems to me that instead of eliminating bank intermediation, the competition exerted on banks by non-bank financial players and by tech companies, as well as banks' reaction to this new competitive environment, will probably lead to a redistribution of the cards of financial intermediation,” he said. Intermediation broadly being the taking of deposits from one party and lending to another while managing the risk.

He reckons several models remain viable:

  • The traditional bank intermediation model
  • The non-bank financial intermediation model implemented by the asset management sector
  • A so-called "re-intermediated" model in which fintechs and bigtechs play the role of intermediary for banks, in particular vis-à-vis retail clients
  • A completely disintermediated model based on blockchain technology

Shaped by regulation

Beau was smart enough not to predict which model would win - and indeed they are all viable. However, he did make the critical point profitability and technology were not the only huge challenges in this age “but also on the fight against climate change”.

He didn’t say it straight out but the bank of the future will also be shaped by regulation – as it is today. One of the fatal flaws which allowed the 2008 Global Financial Crisis (GFC) to metastasise was a decision in the US to repeal legislation which had prevented high risk investment banks from pillaging the capital and revenue streams of lower-risk, highly-regulated retail banks.

According to Beau, the transformation of banking models “will have a positive impact on the efficiency and stability of our financial system, provided they are accompanied by better user experiences and more diversified financing of the economy”. [editor’s note – my italics.]

“They also carry risks, which must be managed,” he added. “This implies reviewing the scope and content of certain regulations to ensure that the regulatory framework is favourable to innovation and neutral with respect to technologies but also guarantees an appropriate and homogeneous treatment of risks throughout the financial system according to the ‘same activity, same risk, same rules’ principle. (e.g. non-bank financial players, technology service providers, issuers and managers of crypto asset trading platforms).”

Again this is a well-established principle of regulating the activity not the institution which again was forgotten in the GFC and allowed regulatory arbitrage and the transfer of risk not to those who were willing to bear it – for a price – but to those who didn’t understand it.

Playing out

We are already seeing each of the four models proposed by Beau play out. Obviously the traditional intermediation model remains the central pillar of the financial system. Meanwhile, the financing of business directly from capital markets rather than via bank intermediation has long been a feature of American banking.

It is the latter two models which are most interesting.

We already have completely disintermediated models relying on blockchain, notably some neo-banks, but they are small and not obviously scaleable – at least not to the size that would overthrow the traditional banking system. Moreover, incumbent banks are also looking at blockchain solutions, notably in high value corporate and Institutional banking.

It is the third model, hybrids of banks, bigtech and fintechs, which is both the most interesting and the most advanced. As much as any of this is predictable it is almost certain universal banks will not be “universal” in the future in the sense they not will do everything themselves.

In order to best serve their customers and meet regulatory requirements, they will shift to what are called ecosystem models where products, services and collateral features are provided by other organisations. This will entail the ability for banks to manage partnerships, something they haven’t historically excelled in.

Push and pull

This subject was well covered at the recent Fintech Week in London with plenty of focus on the tension between competing and collaborating with bigtech.

In The Global Treasurer, 10x Future Technologies Chief Client Officer Leda Glyptis was quoted as saying “[In corporate banking], the line between competitor and cooperator doesn’t exist”.

“In the back-end banks will do business together or sell to each other here and compete elsewhere. There is absolutely no issue with both managing that and keeping the compliance and risk separated.”

It is underappreciated just how much traditional banks are already in partnership with bigtech on the core elements of the banking “tech stack”. More and more of the banking system is now run on the Cloud and managed by third parties like Amazon.

At the same conference, Kate Rosenshine, Global Cloud Lead at Microsoft, noted “it’s no longer, a vendor saying, ‘I’ll sell you something and I’ll see you in five years or I’ll hear about it if you’re not happy.’ It’s more ingrained.”

Here at ANZ, as with many major banks, ecosystems and partnerships are a growing part of the core business. ANZ last year formed a major partnership with Worldline, a global payments specialist, to run what historically was a proprietary part of a big bank, the merchant services side of payments.

ANZ also undertakes services on behalf of other banks – it cooperates with rivals if you like – and is the market leader in Australia for managing payments on the real time New Payments Platform (NPP) for about a dozen other financial institutions.

Renting banking systems

This is a global phenomenon. In the US, global giant Citi has a digital lending platform designed to help small and medium-sized businesses connect with regional, local and community banks.

In the old world of banking, helping other banks win customers would seem illogical but this model of “renting” capacity on a bank’s systems makes financial sense.

Citi says for many SMEs securing a loan involves manual processes that can be time consuming. Meanwhile, local and community banks have limited access to digital tools to reach potential borrowers.

For a bank of Citi’s size, seeking out these local SMEs would not deliver a viable return on investment but providing a service to a much bigger client – a regional bank – does.

Ultimately the banks of the future need to know the answers to a few key questions – and be adaptable enough to implement them.

  •  Who are its customers?
  • What is it actually good at?
  • How can it best support and engage those customers with products and services it can’t deliver itself?
  • How does it choose and manage partnerships?
  • And should it consider one-time rivals potential partners or customers?

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.

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