Banking is dead, well at least it is in its current form. The global banking model will be replaced by technology that connects global clients to local banks and their sources of liquidity in local currencies. The wave of new Fintech firms, who understand that most of banking is about being the middle-man and facilitating buyers and sellers in the most efficient way possible, are ideally placed to be at the front and centre of this revolution. These new Fintech firms have realized that technology is able to fulfill this middle-man role far more efficiently than humans.
An article in Wired magazine by Andy Haldane, executive director for financial stability at the Bank of England, highlights this but only in the context of payments and Lending, in particular technology firms building digital wallets to replace payments and peer to peer lending and crowd-funding firms replacing traditional lending and financing activities.
This trend however, is equally applicable in the trading side of investment banking where the original objective of matching of buyers and sellers was largely replaced by trading-for-profit. This objective-drift was driven by investment banks wanting to profit from visibility of the information flows (the “flow monster”) by taking positions that took advantage of the market moves predicted by these customer flows. It could be argued that this is “front running” although in practice it is very difficult to distinguish it from market making. Market making is still allowed within the Volcker Rule which prohibits banks from doing proprietary trading.
This leads us to another theme, raised by Andy Haldane, of socially useful banking. It may be better to let technology fulfill the market making role as price discovery, liquidity and trust are key parts of an efficient market. These are better provided using automation and open competition that keeps margins down and transparent. The human element of much of the market making has been at the heart of some of the Libor and FX rate fixing scandals where traders try to get a favourable fixing that benefits their book which has been deliberately positioned to benefit from market moves in a particular direction, rather than a pure market facilitator who has strong incentives to “keep a flat book”.
Andy Haldane also mentions how “the financial sector is rooted to the bottom of the trust league table, technology companies, by contrast, are at the top”. The strange thing is that many of the large banks are software companies without realising it. The large Globally Systemically Important Banks (G-SIBS) have as many or more developers than technology companies such as Microsoft and spend billions of dollars on technology every year. This tech spend has been very focused around specific business units supporting the “rain-makers” in building derivative platforms that support pricing and risk management of complex financial instruments and in building ever faster infrastructure to support their black-box algo platforms. This spend has been at the expense of:
- A more strategic view of data across these different business silos
- Investment in spend on the downstream platforms for risk, finance, operations and compliance.
Post financial crisis, the banks are finding that profits from complex derivatives have dried up and that customer flows from vanilla products have slowed, causing them to revise their revenue predictions significantly downwards. The pressure to keep margins and return-on-equity high means there is a drive towards cost-savings. Added to this, there is pressure from rafts of new regulation which all require investment in infrastructure thus creating a perfect storm.
The banks’ reaction to this environment is to cut costs aggressively. Given the large headcount in technology, the approach taken by most of the G-SIBS has been to outsource large swathes of the technology teams to India, Eastern Europe and other low cost locations. In my view, this is a flawed strategy given that technology is likely to be bank’s strategic advantage in fulfilling their role as the middle-man. Many of the banks have very good in-house development capability and talented teams with strong technical and domain knowledge. Unfortunately technology is seen as a cost that needs to be reduced rather than a strategic partner at the “top table” and these teams are seen as expendable. A better approach would be to evaluate, more critically, the architecture and technology duplication across the different business and functional silos. Some of these high quality and perhaps “expensive” resources could re-architect the systems to enable both better re-use and higher levels of business automation. This re-use and automation is where the real cost savings and business benefits lie.
Banking is dead, long live banking. The big banks that understand how technology can give them a strategic advantage and are willing to break from the pack by making the bold decision to use their existing resources better will survive. Those that don’t, will not. It may take a long time, but “death by a thousand cuts” is not an appealing long term future. The continued “dumbing down” of bank technology functions will further accelerate the process of top technology talent leaving. These are exactly the type of people who are likely to join the next wave of Fintech firms who understand that technology is likely to shape the future of banking.