Beyond Banking – the Digital Breakdown

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Banking has been going on in much the same way for perhaps a thousand years – with banks that securely hold money, lend money, and transfer money to enable transactions. Historically it made sense for each bank to do all three of these functions, as they were mutually enabling. However, today’s – and tomorrow’s – digital technologies are challenging some of the assumptions underlying the idea of the bank as a natural composite institution.

That these functions are separating into more specialist, technologically-enabled institutions is not news. Lowell Bryan’s seminal book ‘Breaking Up the Bank’ (Dow Jones Irwin, 1988) advocated breaking up the lending and deposit taking functions of banking – though the securitized credit it proposed could be seen as the root of the 2008 banking crisis.

The Brand Finance Banking Forum last Friday had some very interesting speakers, talking about how and why banking is changing. As Alderman Peter Estlin of Barclays put it “Evolution or Extinction?” It was interesting that while the forum was the launch of Brand Finance’s Banking 500, a report on the world’s biggest, most valuable banking brands, much of the debate was about the role and impact of much smaller new entrants to the banking world.

New challenger banks like Atom Bank, Starling and Monzo are using technology to deliver more personalised services to their customers, (and even the TSB sees itself as a challenger bank), but the bigger challenge to the sector seemed to come from outside.

The new competitors aren’t traditional banks, they are other sorts of organisations that happen to do some of the functions of banking, often faster and cheaper, and generally with more customer trust than banks. Phil Mochan of Koine talked persuasively about how the core functions of banks are being taken over by digital businesses, sometimes without banking licences, and often not seen as part of the Banking sector.

Peer-to-peer payment systems with distributed multi-currency capability can increasingly offer faster and more secure transactions than the legacy banking systems. M-Pesa is the leading platform for transactions across parts of Africa, and has evolved out of mobile telecoms.

Online retailers such as Amazon and Alibaba are major transaction platforms and also becoming important sources of credit for other businesses. It was said that banks are now responsible for only half of all credit – putting a significant proportion of the money supply outside the banking system.

The deposit taking function of banks is increasingly seen at risk as the level of exposure grows and the public trust in banks declines.  The Edelman Trust Barometer 2018 showed Banking to be the lowest ranked sector for Trust, which is worrying and ironic, since banking is, more than any other sector, dependent on trust, and cannot work without it.

When banks look shaky, people don’t worry so much about who their loans are with, but they care enormously about the security of their savings. It was suggested that the HNWI and UHNWI who comprise perhaps 60% of the world’s deposits are currently more concerned about safety than yield – which is understandable when their deposits greatly exceed the £85,000 limit of the UK bank deposit guarantee scheme.

Phil Mochan expects that deposits will migrate to new, digitally enabled reserve banks (like his Koine Bank) that hold 100% reserves, with liquidity matching and increased transparency, and that these will steadily win the competition for deposits over traditional leveraged banks. This is possible – or the existence of such new reserve banks may induce further changes in the existing banks and capital markets.

So what does this mean for all the current players in the financial services market? There will undoubtedly be critical roles within the economy for banks for the foreseeable future – but whether the current model of major multi-functional banks remains the dominant one remains to be seen.

I believe that as the banking market unfreezes for change there will be myriad opportunities for institutions large and small to reposition themselves - to take a fresh look at their future customers, at the way that new technologies take away boundaries and assumptions about their businesses. And to successfully realise these opportunities will not only require new ways of working, but to change the expectations of customers, staff, investors, regulators and other stakeholders. There will be many new winners - only those that fail to change will fail.

Hensley Partners