- By Austin Okere
Should Banks be changing?
After centuries of conservatism in receiving deposits and making loans, should banks be changing? There are two main issues stirring the yearning for change: The first being that it is a very difficult Club to join, and hence the large population of unbanked adults. Secondly, even for the members of this elite club, the relationship is acutely skewed in favour of the banks; naturally so, as they have carried on as protected monopolies with no serious challenge or competition, resulting in no significant innovation over the decades.
The biggest threat to the banks has been precisely their seeming success. Centuries of relatively significant higher returns, even in the midst of economic downturns that adversely affect the real sectors has engendered an attitude of invincibility and pomposity, characterized by a loss of touch with their customers. Considered too big to fail, they take it for granted that they will be bailed out with taxpayers’ money in the event of any missteps – a perfect prey for disruption.
Fintech – the new kid on the block
Today, there has emerged a powerful force of challenge from Financial Technology companies or FINTECHs, as they are more popularly referred to. The promise of Fintech is great. It is shaking up a stodgy banking system and helping to build a more efficient one, especially for consumers and small businesses.
Emerging Markets showing the way in Fintech
For years, emerging economies have looked up to developed countries for ideas about how to manage their financial systems. When it comes to Fintech though, the rest of the world will be studying the experience of the emerging markets, embodied by the widely successful MPESA mobile money system, championed by Safaricom in Kenya. MPESA has made it possible for a large swathe of the population to gain financial inclusion by providing the opportunity to transact financial services vide your mobile phone, on a continent where typically 70% of the population is unbanked. MPESA today has more than 60% of Kenya’s 33 million mobile users; not bad for a service which was only launched in 2007. Similar applications have metamorphosed across Africa.
In Nigeria the Yello Mobile Account, jointly offered by ICT giant CWG Plc and GSM major MTN, added over 6m accounts to an early adopter, Diamond bank, within the first year of launch. Mobile Money services are today generating 6.7% of Africa’s GDP.
China is the undisputed World leader in Fintech
By just about any measure of size, China is the world’s leader in Fintech. It is by far the biggest market for digital payments, accounting for half of the global market, according to the Economist Magazine. A ranking of the world’s most innovative Fintech firms gave Chinese companies four of the five top slots in 2016. The largest Chinese Fintech company, Ant Financial, has been valued at about $60b, on par with UBS which is Switzerland’s biggest bank. Today, digital payments account for nearly two-thirds of non-cash payments in China, far surpassing debit and credit cards.
Peer-to-Peer (P2P) lenders in China grew from 214 to over 3,000 in 2015, and P2P loans increased 28 fold from 30b yuan in 2014 to 850b yuan in 2016. Alibaba’s four year old Yu’e Bao fund with $165.6b has emerged as the world’s largest, overtaking JPMorgan’s US government money market fund, which has $150b.
Austin’s Five Forces Model and the future of Banking
There are indeed five major forces at play here:
- The banks – traditional and established, best with cash and ancillary instruments
- Fintechs – the new kid on the block, disrupter, mostly telecom roots, best with digital currencies and mobile services
- Regulators – Central Banks, regulating traditional banks; and Communication Commissions, responsible for telecoms regulation (and thus Fintechs)
- Currencies – traditional, such as cash and cheques; or Digital, such as bitcoin or other cryptocurrencies
- Customers, and the weight of their new found voice. Typically, they clamour for whatever will give them convenience and lower costs.
These forces and their interplay are represented in the schematic below:
A schematic representation of Austin’s five forces analysis of the future of banking. Image by Omimi Okere
Customers are the most significant force, and represented by the outermost sector of the concentric circles. As they tend more towards a preference for digital currencies, the Fintechs will tend to assume a more prominent role in the new face of banking, and the Regulatory regime will inadvertently tend towards the Communication Commissions under whose purview the Fintechs fall.
This will introduce a regulatory imbroglio, as future ‘Huge Banks’ may fall outside the regulatory ambit of Central Banks (as seems to be the case with the MPESA mobile money platform, through which Kenyans transacted $28billion in 2015, representing about 44% of the country’s GDP. Safaricom, the telecoms promoter of MPESA ironically falls under the regulation of the Communications Authority of Kenya rather than the Kenyan Central Bank).
If the customers however, maintain a strong appetite for traditional instruments of financial transactions such as notes & coins, cheques etc. then the current status quo will remain. The face of banking will thus be more of the same, and the regulatory authority will continue to be Central Banks. Between these two positions may be many variants, depending on the appetite and preferences of customers, and the pace at which they are willing to embrace change.
Retailers are jumping into Financial Services
Fintechs are not the only ones challenging traditional banks for turf. Retailers are also jumping into the financial services fray. For instance Amazon has launched Amazon Cash, a way to shop its site without a bank card. The service allows consumers to add cash to their Amazon.com balance by showing a barcode at a participating retailer, then having the cash applied immediately to their online Amazon account. This product is meant to appeal to the those who get paid in cash, don’t have a bank account or debit card, and who don’t use credit cards.
Google is also rolling out a new integration on mobile. Users of the Gmail app on Android will be able to send or request money with anyone, including those who don’t have a Gmail address, with just a tap.
Mpesa is making waves in Kenya
Banking is going Mobile
In most emerging markets and developing countries, the current formal financial system only reaches a minority of the working-age adult population. Smallholder farmers, self-employed households, and micro-entrepreneurs have to rely on the age-old informal financial mechanisms such as rotating savings clubs, moneylenders, and pawnbrokers. These mechanisms can be unreliable and very expensive. In Nigeria for instance 84.6m people, accounting for 47% of the population are unbanked. In sharp contrast, mobile phone penetration is very high at 94.5 percent; a perfect set-up for the Fintechs to exploit in their mobile dominated financial services offering.
For policymakers from the global south, the digitization of retail payment systems and financial services has become an important economic development priority. It offers the prospect of reaching far more people at far lower costs with the broader range of financial services they need to build resilience and capture opportunities.
The 2015 annual gathering of some 300 central bankers and policymakers from 90 countries who have formed the Alliance for Financial Inclusion, dedicated the bulk of the agenda to explore such innovations, which could deepen formal financial inter-mediation of their economies.
Imagine a world where all money is digital. Instead of carrying coins and notes in their purse, people would keep digital currency units in electronic wallets on phones, watches or other electronic devices. All of this could happen digitally the way cash is handed over today; in real time, irreversibly, with no additional fees.
Money is going Digital
Around the world, central banks from England to China have publicly floated the notion of issuing their own national digital currencies. Conceptually, they like the idea of harnessing the upside of the digital revolution; mobile payments in particular, while preserving the existing legal and regulatory set up. Practically, they expect significant cost savings, a reduction of operational and fraud risks in the current payments systems, and a strengthened ability to execute monetary policy.
From a consumer’s perspective, the prospect of total digital money is still mind-boggling. It is more likely that societies would not go completely digital overnight. Instead, central banks could start issuing digital currency units alongside notes and coins as base money, and adjust the mix over time, according to uptake.
Once critical usage levels are reached and network effects kick in, universal adoption could happen very quickly.
What will be the scale of change?
How will this happen and at what scale? The changes coming will be as large as the original invention of the internet, and this may not be overstated. Who would have imagined a decade ago that e-commerce, championed by Amazon and Alibaba will be displacing high street retailers, or that ride hailing will be dominated by UBER, a technology platform. According to Anthony Jenkins, former CEO of Barclays, bank branch traffic has halved in the last five years, and bank profitability could collapse by 60% in the same period. A 2015 Goldman Sachs report estimated $4.7tn of financial services revenue was at risk of displacement from Fintech groups.
Blockchain and Cryptocurrencies
The key to this revolution lies in Cryptocurrencies such as bitcoin. But it is their underlying technology that is proving to be of practical benefit to organizations, the famous blockchain. This technology, which goes beyond financial application, is expected to disrupting global supply chains by boosting transaction speed across borders and improving transparency. Essentially, the blockchain is a shared virtual public ledger where encrypted transactions are confirmed by outside parties. In the bitcoin world, these outside parties are called miners (computers that solve complex mathematical problems to confirm transactions and earn fees). Confirmed transactions are placed in a “block” and added to the chain, hence the name blockchain. It is this technology that the Fintechs are leveraging to disrupt the traditional banks
Image: Financial Times
Regulators are now helping Fintechs
Fintechs are getting a lot of support from Regulators, believing that Fintech firms are small enough for any problems to be manageable, and on the other hand, might produce useful innovation. For instance, the Swiss Federal Council has recently published a public consultation documentation on amendments regarding the Banking Act and Banking Ordinance in the Fintech area. The intention is to lower market entry barriers for Fintech companies. France’s Central Bank has also announced opening up a new innovation lab, aiming to collaborate with blockchain startups.
In December 2015, Nasdaq executed its first trade on a blockchain, through its Linq ledger. The exchange said the blockchain promises to expedite trade clearing and settlement – all the steps needed to transfer the asset from seller to buyer including recording the transaction — from three days to as little as 10 minutes. That’s because the trades remove many manual processes and bypass third parties.
As such, “settlement risk exposure can be reduced by over 99%, dramatically lowering capital costs and systemic risk,” according to Nasdaq. Other stock exchanges tinkering with the blockchain include ones in Australia, Myanmar, Germany, Japan, Korea, London and Toronto.
Security and Compliance
Security is still the biggest challenge confronting the blockchain. “The truth is, once you give someone access to a network, many times, more often than not, they can end up very easily getting blanket access to that network,” said Joe Ventura, CEO of AlphaPoint. “This is a huge security problem.” Regarding compliance, at least regulators could have a node on the blockchain itself in which companies define their access to data, said Sandeep Kumar, managing director of Synechron. As such, regulators wouldn’t have to wait days for a bank to hand over documents for compliance. “They can see it as it is happening.”
The Future of Fintechs
The future of Fintech is bright. Accenture recently released a report which found that investment in Fintech around the world has increased dramatically from $930 million in 2008 to more than $12 billion by early 2015. Many of the entrepreneurs in the industry however, fail to grasp what may eventually lead to the downfall of countless Fintech firms, particularly those that lend money. There is a belief among technology-based lenders that the goal should always be to say “yes.” If someone needs money, it’s less about whether that person or business is a good credit risk than it is about the customer experience and the length of time it will take the borrower to access the funds. The Fintechs however, counter that they employ Artificial Intelligence, Big Data and Machine Learning to glean the credit habits of customers from their mobile usage, and so have mitigated against this risk.
The homepage of LendingClub (NYSE: LC) advertises personal loans of up to $40,000. You can “apply online in minutes” and “get funded in as little as a few days,” the company says. Another prominent Fintech lender Funding Circle claims that small businesses can get loans from between $25,000 and $500,000 in as little as 10 days.
These are innovative services that seek to fill important niches in the credit markets. They enable people who have historically been shunned by banks to get loans in order to expand their businesses or to pay off credit card debt at less usurious rates.
The lucrative Transfer market
The lucrative global transfers markets are major target by Fintechs. International money transfers, which have long been a thorny issue for entrepreneurs, are getting easier as well. For smaller transactions, services like PayPal automatically convert currencies, so it’s easy for a customer to purchase goods from anywhere in the world. Additionally, a service called TransferWise is streamlining international money transfers, disrupting that sector by offering a 90 percent discount on traditional bank transfer fees.
According to the founder, Taavet Hinrikus, the idea was borne out of his personal frustration in money transfers. ‘It typically took 3-4 days to receive transfers, albeit the exchange rate used by banks was exorbitant, leading to a loss of almost 10% of the value of money sent’. In this exorbitant regime, Western Union and HSBC typically earn $600m and $800m per annum respectively in profits from transfers. These huge contributions to their bottom-line will be dearly miss when displaced by TransferWise and their co-travellers. In Taavet’s view Fintechs will command about 40% of the global Financial Services market in the next 10 years.
Banks and Fintechs’ collaboration for mutual benefit
Fintech companies in emerging markets have shown that with the right technology, it is possible to leapfrog to new forms of banking. Truth be told, Banks are best placed to continue to influence the future of Financial Services because of their huge branch network, solid reputations, and risk controls, as well as years of customer cultivation and loyalty. And they seem to have come to appreciate their own strengths. For instance JPMorgan’s $9.5 billion budget on technology, with $3 billion spent just on innovation according to their 2016 annual report is quite a significant pile. Banks however, have to radically change the ‘we win when you lose’ mind-set. Consider that credit card customers who default on payments have their interest rates hiked to the extent of repaying £2.50 for every £1 borrowed as revealed in a report by the Financial Services Authority in the U.K. This hardly fosters an endearing partnership.
Banking is definitely going to wear a new face in much the same way that retail did with the advent of e-commerce. The biggest take away, is that it is not about upstarts versus incumbents, but rather a question of how banks absorb the Fintech innovations blossoming around them to improve the value chain and enhance customer experience.
Austin Okere is the Founder of CWG Plc & Entrepreneur in Residence at CBS, New York. Austin also serves on the World Economic Forum Global Agenda Council on Innovation and Intrapreneurship and on the Advisory Board of the Global Business School Network (GBSN).