Hey ChatGPT, build me a bank…

Over the holiday period, scanning all the reading lists and endless panel discussion shows and haruspicatory pontification, one phenomenon stood out above all others: ChatGPT.

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In very basic terms, ChatGPT is a robot that/who can create stuff pretty well indistinguishable from humans. It can write – very bad – poetry. It’s certainly the highest profile example of Artificial Intelligence and a quantum step forward in technology mimicking humans.

“We view distributed ledgers and digital currencies, such as CBDCs and stablecoins, as a natural evolution of today’s monetary and payment systems.” – Bank of America

But it’s not human. (And this from musician and philosopher Nick Cave is one of the better investigations of ChatGPT and what it is to be “human”.)

Of course, if ChatGPT is that good, it may have written this column and I’ll leave that with fans of Blade Runner to think through ….

The new year is also the period of other regular existential crises, including around the Future of Banking. There’s actually an overlap here with the ChatGPT debate: is something that AI creates, say a poem, a poem just because it satisfies a working definition of a poem? That it employs metaphor, allegory, fabulous imagery? That it scans or rhymes?

So too with banking: what is a bank? A particular institution? Or simply a collection of services? A company which lends, borrows, pays, employs extreme financial leverage?

In one sense, an institution is a bank because it is regulated as a “bank” which typically involves mandated levels of capital, transparency and depositor protection. But then is it more? According to digital banking maven Chris Skinner banks have “unique features around trust and exchange which elevates finance to the same level as pharmaceuticals and flying”.

The debate that has gathered pace as technology – including AI – transforms banking is whether these half-a-millennium-old institutions are really the best way for an economy and society to manage financial intermediation.

Other companies can lend money or take deposits. Thousands of fintechs believe they can handle payments more efficiently and cheaply than a bank, using blockchain or decentralised finance (DeFi).

The emergence of digital currencies, enabled by blockchain, particularly those likely to be issued by central banks, further threatens the incumbency of traditional banks.

Paradoxically, today most currency is actually “created” by private banks, not central ones. Even though central banks issue “hard currency”, that currency is typically used in less than one in 10 transactions.

Most transactions exploit digital payments – issued by and mediated through private sector banks. (For example, when a bank makes a home loan it “creates” money by establishing a deposit account with funds in it for the borrower.)

However, central bank digital currencies (CBDCs) could remove those flows from banks as they could be used directly by borrowers and lenders. A return to a past when all currency was hard and issued by central banks.

According to Bank of America, a large traditional bank, this shift is inevitable: “We view distributed ledgers and digital currencies, such as CBDCs and stablecoins, as a natural evolution of today’s monetary and payment systems.”

In a very sobering cover story, The Economist newspaper analysed the decline of the world’s most powerful bank, Goldman Sachs – under the banner “Goldman Sags” – saying “its pedestrian performance suggests several lessons”.

“The real action in finance is now outside regulated banking, where new stars rule, such as Blackstone in private markets, BlackRock in index funds and Citadel in investing and trading. It is hard for old-style Wall Street firms to compete in winner-takes-all digital markets, where PayPal and Amazon have far more clients.”

So too for retail and commercial banks. They are at risk of being disintermediated. (Although it’s worth bearing in mind this risk of extreme disintermediation has emerged at least once a decade for more than half a century – credit cards in 60s, supermarkets in the 80s, tech giants in the 90s, capital markets for ever….)

The global banking regulator, the Bank for International Settlements (BIS), has just released a report analysing the implications of DeFi, The Technology of Decentralised Finance (DeFi).

“Decentralised finance (DeFi) builds on distributed ledger technologies (DLT) to offer services such as trading, lending and investing without using a traditional centralised intermediary [such as a bank],” the report says.

“The fact that DeFi components can be programmed may open up new possibilities for more competitive financial markets and could bring efficiency gains. However, DeFi introduces enormous technological and economic complexity that makes it increasingly difficult to assess the risks and potential of DeFi financial products.”

This goes to the crux of an issue which potentially provides some reassurance for traditional financial institutions (TradFi).

To repeat a well-known aphorism, modern economies need banking services – they don’t need banks. But banks, for regulators and governments, have a particular attraction: they are well understood, they are heavily regulated and, at least from a financial security perspective, they are trusted by society.

Traditional banks may not have the latest technology – although they are increasingly partnering with firms that do – and they don’t offer the full decentralisation of DeFi. But then governments and regulators, at the moment, don’t actually want full decentralisation as that threatens tax revenues and enables the black economy and criminal activity.

The BIS has made this point explicitly: “The economic forces that allow intermediaries to hold market power in traditional finance might still exist in the DeFi world.

“Moreover, the current design of DeFi applications generates formidable challenges for tax enforcement, aggravates money laundering issues and other kinds of financial malfeasance, and as a result creates negative externalities on the rest of the economy.

“Finally, if the ties between traditional finance and DeFi grow, DeFi could contribute significantly to systemic risk.”

Meanwhile, traditional banks are capable of evolving. Bain & Co note banks are starting to adopt web3 technologies to develop more efficient and innovative products. A Bain survey of senior executives at financial institutions found 60 per cent believe web3 will disrupt activities historically performed by banks – both as they leverage they own strengths and compete with fintech and big tech.

“Customers’ identity is a critical factor in unlocking web3’s potential, and banks have the opportunity to lead the charge in developing persistent, portable digital identities,” Bain said.

Indeed, given their incumbent trustworthiness with financial and personal data, banks are well placed to be instrumental in safeguarding digital identities.

One thing is certain: banking is changing dramatically.

As McKinsey says “the era of the one-stop-shop bank, to which a wide variety of customers would turn for all their banking needs, is over; ahead lies a new era of specialised banks serving distinct customer segments”.

But not that much. Ask ChatGPT “what is a bank?” and we find the AI is remarkably TradFi: “A bank is a financial institution that accepts deposits, makes loans and provides various financial services to its 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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