BANKING

Why change in banking is accelerating 

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By Renier Lemmens, Visiting Professor of Fintech and Innovation and Senior Advisor on Digital Education at The London Institute of Banking & Finance 

Fintech has been around for a long time. Few will remember the pantelegraph, invented in 1860. A precursor of the fax and used predominantly to verify signatures over telegraph cables, the pantelegraph took almost two minutes to transmit a sheet of 25 handwritten words. Or the early days of the Federal Reserve Wire Network, which relied on a variant of Morse code from 1918 until the late 1970s. (The Fedwire Funds Service is now the Fed banks’ real-time gross settlement system.)

Closer to home, Barclays installed the first ATM at its Enfield branch in North London in 1967. Money was withdrawn with a specially produced cashiers’ check, later to be complemented with a four digit PIN-code – setting a trend for decades to come. Credit cards, debit cards, online trading, online banking, PayPal – are all examples of fintech innovations that were launched long before the term ‘fintech’ was coined. In those days – like today – customers did not really care about the technology that enabled the innovation. IBM, Cobol, AS400, or AWS – they were just part of an alphabet soup. Incidentally, even today – more than 50 years after its first standard – an estimated $3tn worth of transactions is transacted ever day on systems that use the Cobol computer programming language.

Yet, despite the fact that most consumers (rightly) do not care how an ATM works, or what programming languages banks use, and despite the fact that financial services is a huge and highly regulated sector that is usually slow to change – something has shifted over the last five years or so. According to Statista, there were around 12,000 fintech start-ups globally at the start of 2019, of which around 5,700 were in the US and around 3,500 were in Europe. Deloitte estimates that around US$26bn was invested in fintechs in 2017, up from US$0.3bn in 2012. More importantly, consumers are engaging with the new technology, which may explain why most of the funding goes to payments and deposit and lending technologies. What is it that has triggered the change?

A rocket in your pocket

Apple’s iPhone, launched in 2007, was not the first smartphone. Nokia, for example, had already launched the Symbian. The iPhone was, however, a step-change in mobile computing. (Nasa points out that an iPhone 5 with 16 gigabytes of memory has about 240,000 times the memory of a Voyager spacecraft.) The iPhone revolutionised not only mobile processing power and the form factor, but also user interaction with handsets. It is, arguably, the reason why, in 2012, 39 per cent of UK adults had a smartphone and now 78 per cent do. It is probably also part of the reason why data access has become cheaper. Though the average mobile data consumption in the UK has increased five-fold since 2013 the weighted average cost has gone down by 11.5 per cent, according to Ofcom (2018 figures).

As that upsurge in use suggests, consumers are very engaged with their smartphones. The average Briton now checks a mobile phone every 12 minutes and is online for 24 hours a week, according to Ofcom.[1] What is interesting in all of this for financial services companies is that the computing power, fast connectivity and ease of use of smartphones put a bank, an asset management company, an insurance company, or a lender all just a tap or a swipe away. Mobile bank logins in the UK are forecast to top 2.8bn next year, compared to only 200 million branch visits. Branches still play a useful role for some segments, but the direction of travel is clear. People prefer the ease, immediacy and personalisation of using their phone for most financial services. Unsurprisingly, most retail fintechs have a mobile-only presence. In that way, they can avoid the cost of running branches but still target customers right across the country.

Know your customer

Using online data, of course, also allows fintechs to segment their customer base in ways that old-style bank branches never could. Large data platforms like Google and Facebook have brought a seismic change to marketing. It used to be said about traditional advertising that half of it was wasted – just that nobody knew which half. Fintechs analysing mobile data, in contrast, can pick off just about any segment they want – and leave the incumbents with the less profitable customers. That could have major repercussions for incumbent banks that often rely on cross-subsidies – eg, overdraft charges paying for ‘free’ accounts.

Hunt for yield

The core of retail banking is maturity transformation. Banks borrow short (deposits) and lend long (loans) and manage the risk that comes from the mis-match. The social utility of that is, of course, one of the reasons why large banks are rarely allowed to fail. Until the 1980s, banks also did very little else. Then, they started to build a suite of other financial products around being the place where people hold their current account – and to increasingly fund themselves in wholesale debt markets. By the end of 2006, according to the FCA, the ‘customer funding gap’ in the UK that was filled by short-term wholesale lending had reached £500bn.

When the wholesale debt markets froze, banks like RBS were, effectively, insolvent. Since the crisis, banks – and in particular systemically important banks – have been required to have much more equity funding. That means their costs higher and, often, that they are lending less. However, the advent of ultra-low interest rates and quantitative easing has led to an overall “hunt for yield” and made cheap capital for new ventures very widely available. (That was, in part, the aim of quantitative easing – that money should be driven out of ‘safe’ securities into riskier growth assets.) Low interest rates mean that a fintech with a good idea is very likely to be able to raise capital to build it out – and at scale.

Time to market

Gone are the days that it took weeks or months to set up a company, order an expensive computer, organise accounting/HR/marketing systems, design a website etc. Every support activity or system can now be insourced from the web in no time. Any committed entrepreneur can have the rudiments of a business set up in a matter of days, scaling with ease as cloud services – often open source and free – seemingly seamlessly keep pace with growing business needs. And, of course, wide availability of these cloud services not only makes it much faster but also much cheaper to start a new company from scratch.

Regulation – when ‘push’ creates shove

While the burdens of regulation and compliance have become more onerous – especially for large institutions, we should not forget how much innovation has been enabled. Take e-money as a case in point. It has spawned hundreds of innovative offerings. Post-crisis, European regulators also seem very minded to encourage more competition.

The EU’s Revised Payment Services Directive (PSD2), and its UK equivalent Open Banking, for example, require banks to set up interfaces that enable customers to share their account data with other firms. PSD2 removes the monopoly banks once held over their customers’ account information. It means that third-party providers can start to use that data to offer new services that undermine existing market structures. For example, consumers can now make ‘push’ payments direct from their account – goodbye debit and credit cards if consumers decide that ‘push’ is more convenient than the existing four-party model.

These forces have come together to create a wave of new banking start-ups. Currently, there are at least 100 challenger banks active around the world. Not all of them are banks in the formal sense, in that they may not have banking licenses. But to their retail or business customer, that does not matter: they provide the financial services they need. The factors described above enable them to scale fast, without the encumbrance of legacy systems and other infrastructure. So fast, that many incumbent banks are now opting to create their own ‘internal’ challenger banks from scratch.

[1]https://www.theguardian.com/media/2018/aug/02/fifth-of-britons-feel-stressed-if-they-cant-access-internet-ofcom-report

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