Innovation in Banking
Oct 25, 2012

There was an interesting thread on reddit about money. It is not about investing or the moral values of money, but the fundamental concepts behind money. If you have not read it, I urge you to go and read it. I will wait.

Over the weekend, I read the book “Ascent of Money” by Niall Ferguson. As a Scot, he has a unique historical perspective, that comes from the local history, including Adam Smith. As a person from the erstwhile empire, he understands the role of capital in creating the empire. I did not like the book much, but still would recommend it for some amusing anecdotes that might have to be complemented with some other serious reading.

When I see lot of main stream news I think there is a chance that banking is ready to be transformed. For a long time, banking has been impervious to changes. Sure, there have been periodic busts and booms (remember S&L? Home mortgage collapse?), but the same banks have come up again, with very minor changes in the way business was done. This is entirely unlike other industries, which have gone through rapid changes (when was the last time you went to a travel agent? Or, referred to yellow pages?).

Of course, there have been some changes. Rise of discount brokerage, paypal as a payment mechanism are a few of those changes.

But, that all seems to change. While there are no fundamental drivers, the momentum of change seems to have picked up. The three trends I see are:

  1. Make it cheaper
  2. Make it convenient
  3. Disrupt fundamentally

Making it cheaper

Lot of banking services are costly. For example, if I have to wire some money, it costs $35. If I want to send an overnight check, it costs me $20. That is in the highly competitive markets like US, let alone places like Australia.

Of course, they pay me 0.5% interest for the money I keep with them. If I borrow, they lend at 5% or even more.

Any such highly inefficient market lends itself to disruption. Unfortunately, two things are helping financial institutions keep their edge: one is regulation. For good reasons, it is very difficult to start a bank or an insurance company. The second is the large amount of capital to start an institution. It takes credibility, history, and deep pockets to start one.

Let us see how this market is being changed, through some examples:

  1. Payment network disruption. What it does: It facilitates person to person or person to small bank payments at very reasonable cost. It still uses ACH (I haven’t understood the details, yet). It costs just 25c to receive any amount of money. Sending is always free (as is receiving under $10).
    For more details on how it is using ACH, see this:

  2. Lending club; Prosper: They make P2P lending possible. Compared to banks, it is riskier, but gets you around 10% or so rate. Historically, banks too had similar risks which were addressed by FDIC. I suppose someday, this kind of lending will be well graded, bonded, insured and all that.

  3. Gocardless: London-based company that allows small businesses to set up monthly payments to suppliers at a fraction of the cost that banks charge.

  4. Short term loans (think serving the bottom of the pyramid or the long tail).

  5. TransferWise: acts as an intermediary for the money , in particular into European currencies.

If you notice the trends, making it cheaper does two things:

  1. Identify and reduce the market place inefficiencies : The inefficiencies were not attacked before for multiple reasons. May be it was the long end of tail; may be the consumers were not ready; may be the capital was not available. But, now, the situation seems to have changed for addressing the inefficiencies.
  2. Remove the middlemen and provide only needed services : On the face of it, it looks bad. Are we getting fewer services? But, then, lot of services are as useless as a fax machine. Why do we need lot of investment in the local branches? Why do we need high priced advisors, when most research is available free?

That is how lot of companies are changing the business processes and practices to alter the banking services.

Making it easier

The other class of changes in banking services are not so fundamental; yet they impact lot more number of users. They do that by combining disparate processes, tools, opportunities (a horizontal integration) to make it convenient for users. For example, what if you can deposit a check from you smartphone? Of course, it is not a fundamental change, but still very convenient. Now, multiply those kind of conveniences several folds and you start seeing lot of changes.

Some of the examples include:

  1. Credit card payment disruption. Here, this site makes accepting payments via credit cards very simple over the web. It is not like Dwolla (which sets up its own ACH etc…). It makes it merely convenient for programmers.
  2. Square: Location based payments.
  3. Google wallet: Coupons + google services + payments.
  4. A new kind of bank, where they will offer the experience, and keep the money at a traditional bank of their choice. So, they are creating a new value-added intermediary.

As you can see, lot of this ease of use is addressed through adding new kind of technology. It often adds a new intermediary, but it does so, by cutting away at the traditional players.

Disrupting fundamentally

It is in this context, I am referring to Niall Ferguson’s book. The history of money is replete with examples of places where different kinds of money has been created. While I am looking to see how the monopoly of the state on money can be broken, there are interesting trends:

  1. Bitcoin: A fundamental way that money is created and used as a currency. Where there have been some problems, the idea is refreshingly new and takes advantage of the concept of leverage, currency, and notes.

  2. ???: I see lot of ways bypassing money fundamentally, but none of them seem to be big enough. Please leave any observations in the comments.

As a famous net.person famously said, Software is eating the world. I hope that it will eat the financial institutions. And, we should understand it so that we can participate in it.

What does it mean to us, software developers, architects, and managers:

  1. We should understand the ways the industry is being disrupted.
  2. We should create propositions around how these institutions can address these threats. Easiest is to focus on the category “making it easier”. On “making it cheaper”, we do not have the mandate to propose new business offerings.
  3. We should create some POV papers so that we can start having right conversations with the customers.