The Bankwatch

The US government has 800 data centres and one CIO.  He has set a target of shifting 25% of the government’s $80 billion in annual IT spending to cloud computing.

The benefits are associated with cost savings.  These benefits are tempered with concerns about data security, and physical location of the servers within the US.

Cloud Computing’s Tipping Point | InformationWeek

There are few technology trends the U.S. government is embracing with such fervor as the cloud. In his Federal Cloud Computing Strategy report, published in February, federal CIO Vivek Kundra set a target of shifting 25% of the government’s $80 billion in annual IT spending to cloud computing.

I see Government as a microcosm of banks in how they do (will) view cloud services.  If you count each technology instance with its set of unique product focussed applications as a data centre, many banks would count 20+ data centres even though they are sometimes physically located within one building.  It is a fair comparison, because each hardware procurement is driven by the attributes and requirements of the application.

Before we even get to the cost and security matters, consider the banks management of disparate resources and you can see why business users in Banks are frustrated by the time and effort required to make what might appear at first glance relatively simple changes.

Which leads to my point.

Here are six benefits outlined here in 2008.  This summarises nicely what I see as the real prize, that is much broader and organisation changing than merely cost.

• Reduced Cost

• Cloud technology is paid incrementally, saving organizations money.

• Organizations can store more data than on private computer systems.

• No longer do IT personnel need to worry about keeping software up to date.

• Cloud computing offers much more flexibility than past computing methods.

• Employees can access information wherever they are, rather than having to remain at their desks.

• No longer having to worry about constant server updates and other computing issues, government organizations will be free to concentrate on innovation.

Item 6 is probably the most significant here.  It means the responsiveness of technology groups to business and customer requirements will just get better and better.

I believe the security question is a red herring.  Even the BusinessWeek article makes the bald statement that private networks are more secure than cloud networks.  Really?  First of all I question that when I consider the number of open access points in a multi thousand employee bank whether the lock down scenario is that powerful to exclude all threats.  Next if it is that much locked down then I would really question how that organisation is able to function effectively.  How many times did I lose my email at a bank caused by a lack of effective back up right at the time I needed it.  On the other hand I have never lost anything in Gmail apps, never had any consequential down time, and never had to speak to a support person.  In fact why is my browser based gmail faster than the MS outlook application?  Hmmm

Lets go further on the security matter. Ask the 75 million users of Sony Playstation how secure their banking data is.  Information is already out there, and the prize for organsiations has to be to manage the information they control as effectively as possible taking into account all the risks and all the benefits.

Relevance to Bankwatch:

This matters because the technology issues created by multiple discrete data centres within banks create a mammoth hindrance to innovation, effective product development and frankly employee experience.  Government and Banks would be better served to consider multiple benefits to cloud computing that broaden the discussion from just cost.  Whatever number of data centres you have equates to a similar number of fiefdoms that brings the organisational complexity that comes with responsibility for a whole hardware to software environments operation.

Cloud computing allows all the hardware and operating system maintenance to be abstracted out of the equation to the cloud provider thus freeing up internal capacity and mindshare to work on making the bank better for customers.

The big debate at the moment is whether we are into another technological bubble.  This is fuelled by the valuations of FaceBook, Groupon and Twitter.  But there is a deeper issue, and this Bloomberg article by Ashlee Vance does a really good job at capturing it.

His general thesis is the differentiation of foundational technologies and those that sit atop the foundational technologies.  He makes the point that there is nothing particularly new about FaceBook, Twitter and Groupon.  He notes that Groupons legacy for the world is cute emails.

Worse, the smartest people in Silicon Valley are the mathematicians and he write about Jeff Hammerbacher.

As a 23-year-old math genius one year out of Harvard, Jeff Hammerbacher arrived at Facebook when the company was still in its infancy. This was in April 2006, and Mark Zuckerberg gave Hammerbacher—one of Facebook’s first 100 employees—the lofty title of research scientist and put him to work analyzing how people used the social networking service.

But …

Hammerbacher looked around Silicon Valley at companies like his own, Google (GOOG), and Twitter, and saw his peers wasting their talents. "The best minds of my generation are thinking about how to make people click ads," he says. "That sucks."

The article speaks about the billions in revenue that are being generated by these new companies and many of the ‘me toos’ that show up every day. 

Perman is a successful entrepreneur that sold web tv to Microsoft many years ago, so he understands add on technology.  When asked about the outcome if the bubble pops;

So if this tech bubble is about getting shoppers to buy, what’s left if and when it pops? Perlman grows agitated when asked that question. Hands waving and voice rising, he says that venture capitalists have become consumed with finding overnight sensations. They’ve pulled away from funding risky projects that create more of those general-purpose technologies—inventions that lay the foundation for more invention. "Facebook is not the kind of technology that will stop us from having dropped cell phone calls, and neither is Groupon or any of these advertising things," he says. "We need them. O.K., great. But they are building on top of old technology, and at some point you exhaust the fuel of the underpinnings."

Relevance to Bankwatch:

After reading this article, you are left to wonder if the real end game of internet is no more than fancy ways to make you click ads.  Will be another foundational change or shift that will be driven out of a bubble popping failure of the current race to ad supremacy, that will be replaced by something we have yet to understand.

There is much talk of big data and Hammerbacher’s new company Cloudera is taking that one step further with an operating system approach to understanding patterns and clues within enormous amounts of disparate information. 

A thought provoking article, definitely worth the time to read.

I can’t say it better than the final paragraph:

There have always been foundational technologies and flashier derivatives built atop them. Sometimes one cycle’s glamour company becomes the next one’s hard-core technology company; witness Amazon.com’s (AMZN) transformation over the past decade from mere e-commerce powerhouse to e-commerce powerhouse and purveyor of cloud-computing capabilities to other companies. Has the pendulum swung too far? "It’s a safe bet that sometime in the next 20 months, the capital markets will close, the music will stop, and the world will look bleak again," says Bridgescale Partners’ Cowan. "The legitimate concern here is that we are not diversifying, so that we have roots to fall back on when we enter a different part of the cycle."

More information today on the US NSTIC strategy.  (National Strategy for Trusted Identities in Cyberspace). 

http://www.nist.gov/nstic/

I was sceptical about the initial promise although who cannot appreciate the concept.  There is more

in this doc just released.  The document is all about the benefits of being able to be known anywhere online and reduce passwords down to one password.  Those benefits are easy.  The core question remains as to how identity is proven by the Identity Provider (IDP).  The document says the right things here, but the devil remains in the details of how this will be achieved.  How would I, Colin Henderson, be personally identified and associated with my online ID such that a bank would trust it?

An identity provider (IDP) is responsible for establishing, maintaining, and securing the digital identity associated with that subject These processes include revoking, suspending, and restoring the subject’s digital identity if necessary

The identity provider may also verify the identity of and sign up (enroll) a subject Alternatively, verification and enrollment may be performed by a separate enrolling agent

IDPs issue credentials, the information objects used during a transaction to provide evidence of the subject’s identity The credential may also provide a link to the subject’s authority, roles, rights, privileges, and other attributes

For the record.  Links to both the reports below.  Enjoy.

A banking crisis is a terrible thing to waste

Last week, the banking world was gripped by the findings of a probe into the financial crisis by a powerful US Senate committee and the interim report of Britain’s government-appointed Independent Commission on Banking, led by Sir John Vickers.

Here are the reports:

Vickers Independent Commission on Banking (UK)

Levin US Senate Report (US)

InterimReport110411.pdf

The forecasts and predictions that Niall Ferguson was making last year are coming home to roost.  This is an early warning shot across the bows of the US lawmakers.  S&P kept the rating at AAA but the door is now open a crack for that to change.  S&P and the other rating agencies looked like Pollyanna lemmings before the credit crisis, so you can bet they will not let that happen again if they can avoid it.

S&P cuts US credit outlook to ‘negative’

“We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns,” the rating agency said in a statement.

The banking /credit crisis seems so long ago now when we look at the dates in the US Levin/ Coburn report …

…  but it is fascinating reading  – all 650  pages.  The American media have been all over the lack of regulatory overview of Wall Street, but I am more interested in the complete disregard for banking principles and good governance.  Blaming Wall Street is like blaming schools for bad kids.  This is a family problem, and when you read this section it is obviously wrong.

To summarise what you can read in this extract, WaMu had a subsidiary that bought mortgages with no WaMu diligence or adjudication by either WaMu or the subsidiary Long Beach.

This section from Page 55 talks about WaMu and their mortgage origination practices. [emphasis mine]

But in 1999, WaMu bought Long Beach Mortgage Company,114 which was exclusively a subprime lender to borrowers whose credit histories did not support their getting a traditional mortgage. Long Beach was located in  Anaheim, California, had a network of loan centers across the country, and at its height had as many as 1,000 employees. Long Beach made loans for the express purpose of securitizing them and profiting from the gain on sale; it did not hold loans for its own investment. It had no loan officers of its own, but relied entirely on third party mortgage brokers bringing proposed subprime loans to its doors.

Long Beach’s most common subprime loans were short term, hybrid adjustable rate mortgages, known as “2/28,” “3/27,” or “5/25” loans. These 30-year mortgages typically had a low fixed “teaser” rate, which then reset to a higher floating rate after two years for the 2/28, three years for the 3/27, or five years for the 5/25.

Long Beach typically qualified borrowers according to whether they could afford to pay the initial, low interest rate rather than the later higher interest rate.118 For “interest-only” loans, monthly loan payments were calculated to cover only the interest due on the loan and not any principal. After the fixed interest rate period expired, the monthly payment was typically recalculated to pay off the entire remaining loan within the remaining loan period at the higher floating rate. Unless borrowers could refinance, the suddenly increased monthly payments caused some borrowers to experience “payment shock” and default on their loans.

From 2000 to 2007, Long Beach and WaMu together securitized tens of billions of dollars in subprime loans, creating mortgage backed securities that frequently received AAA or other investment grade credit ratings.120 Although AAA securities are supposed to be very safe investments with low default rates of one to two percent, of the 75 Long Beach mortgage backed security tranches rated AAA by Standard and Poor’s in 2006, all 75 have been downgraded to junk status, defaulted, or been withdrawn.  In most of the 2006 Long Beach securitizations, the underlying loans have delinquency rates of 50% or more.

Payfone is an interesting new service and I like their security model.  They are able to take unique features of the phone from the SIM card and the phone itself to generate a unique fingerprint that is used in the security of the payment transactions.  This is similar to the methodology used by RSA for two factor authentication of online banking.

But it is the more interesting that they have just received $19 million in funding, and will be using the Amercian Express Serve platform.  The details are outlined in this NY Times piece.

The other investors in this $19 million round led by AmEx include Verizon Investments and Rogers Ventures, both venture capital arms of their respective mobile carriers. Payfone’s existing shareholders include Opus Capital, BlackBerry Partners (RIM) and RRE Ventures.

Payfone will combine its mobile authorization and payment services with American Express’s recently announced digital payments platform Serve

Payments might just be getting interesting with mobile being front and centre. Note that Rogers Ventures (part of Rogers Communications) are part of the Payfone funding round.  This was a recent announcement from Visa on mobile payments.

Relevance to Bankwatch:

Where are the banks?  It has long been speculated that telco’s would be a significant part of the competition felt by banks, yet they continue to let it happen in front of their eyes.  Somehow banks cannot internalise that payments are a potential service and should be viewed accordingly.  This debate has been going on internally for years.  I can recall a large consultancy performing an internal analysis of the potential for payments as a line of business.  It was a great report that I can only say was greeted by a classic ‘dead cat bounce’.

Banks see everything as an account, whether it be a loan, a deposit or a mortgage.  The model is to associate a service fee with that the deposit account and handle items such as transactional activities as a bundled service captured by the service fee.  They created this model and they are bound by it. 

Customers see the bank through the lens of the one fee they pay and therefore associate the value of their bank to them through the lens of the monthly bundled fee.  This has become a straightjacket for banks in their strategic view of new services, and I believe is part of the reason that payments have not been taken on as a strategy.

Meanwhile the telco’s are not exactly moving at lightning speed in the payments space. Predictions of their owning that space go back more than 12 years, and yet in 2011 even Rogers are seeing this as a strategic investment only now.  But at least they are doing it.

Where are the Banks?

This from 2006 Social Money and Payments is a large market

This from Japan 2009 DOCOMO to laaunch mobile remittance service

Wells Fargo have been just a little pre-occupied with merger and post banking crisis activities so its nice to see they decided to have a little fun when they they celebrated the return to New York today resulting from the Wachovia merger.

Enjoy some very talented folks doing an impromptu in Times Square.

Digging a little deeper into the Commission report over lunch, and I am now coming to the funny bits. 

The laudable objective on pages 123 – 124 is that one way to promote competitiveness is to smooth the account switching process between banks.  They note that very few people switch banks each year and speculate that future improvements would speed the process and encourage more people to switch banks.

To encourage this, the tactics they suggest are as follows.  They are listed in increased ascendancy of humour factor:

1. Greater transparency of each banks benefits over the other
2. Mandate switch must occur within 7 days
3. A “redirection system to transfer debits and credits from the old (closed) account automatically to the new account without inconveniencing the customer”
4. Full account number portability

Independent Commission of Banking or here on my blog

Beyond improvements to the existing system, full account number portability would enable customers to change banking service providers without changing their bank account number. This would remove the need to transfer direct debits and standing orders, which remains the main area where problems may arise. In the past, portability has been rejected as overly costly, but if no other solutions appear effective and practicable, it should be reconsidered to see if this remains the case given improvements in IT and the payments system infrastructure.

Where do I begin.  One of the beauties of internet is that everyone assumes when they see all their accounts, investments, and loans in one place that the flick of a switch here or there will permit anything to be accomplished.  At least the Commission recognised that these things might take a couple of years.

Ask anyone involved in SEPA what the real time frames are involved!

Banks’ systems are horribily un-integrated within each bank, because while internet allowed a pretty face to be placed on top, the reality is underneath are disparate systems of different vintage, type, connectivity, and capability.  There is also the reality that those systems were created at different times, so each, generally speaking, contains all the customer information including name, address etc.  The result  each system each customer looks unique to each system. 

I am very aware of a large bank in Canada who were unable to provide account number portability between their own branches in Canada.  The notion of such a thing across banks, given different account number lengths, different ways of handling Sorting Codes etc … words fail.

Relevance to Bankwatch:

With my serious hat back on, the only way true competitiveness will arise is by allowing new competitors.  The solution for that cannot be from within Lloyds and RBS, yet one almost senses this part of the report was written mostly for them. 

New entrants can develop technology solutions that will allow modern information architecture and produce extensible frameworks which will make the Commission objectives seem pedestrian.  Account switching on the same day should be one objective for example;  another is that account number portability is a given.

On the Direct Debit and Credit ‘redirection’ facility that almost sounds like it needs a utility which resides outside each bank.  That could be accomplished by using perhaps the Central Exchange near Milton Keynes which handle cheque clearing, but with less and less cheques, this could be a place to house such a capability.

Good luck with this one.  Those are laudable objectives but will require something beyond technology solutions from within the banks.  What will be required are encouragements to new entrants, and independent review of which things should stay inside banks and which could to be centralised to maintain a competitive environment in the future.

The report begins by summarising the impacts of the financial crisis on the UK banks.

The overall impact is summarised here:

Despite recent de-leveraging, the total balance sheet of UK banks is more than four times annual GDP. More than 80% of RBS and more than 40% of Lloyds are in state ownership. Competition in UK banking has been seriously weakened as rivals to the largest retail banks have left the market or been absorbed into others.

The general approach has three objectives

Making the banking system safer requires a combined approach that:

• makes banks better able to absorb losses;
• makes it easier and less costly to sort out banks that still get into trouble; and
• curbs incentives for excessive risk taking.

Too big to fail:

Banks ought to face market disciplines without any prospect of taxpayer support, but systemically important banks have had and still enjoy some degree of implicit government guarantee. This is the ‘too big to fail’ problem. Unless contained, it gives the banks concerned an unwarranted competitive advantage over other institutions, and will encourage too much risk taking once market conditions normalise. It also puts the UK’s public finances at further risk, especially given the size of the banks in relation to the UK economy.

On the ability to withstand shocks:

Banks must have greater loss-absorbing capacity and/or simpler and safer structures. … The Commission, however, believes that the most effective approach is likely to be a complementary combination of more moderate measures towards loss-absorbency and structure.

While Basel 3 suggests a minimum capital ratio of 7% the Commission suggests 10%.

In the Commission’s view, the available evidence and analysis suggests that all such banks should hold equity of at least 10%, together with genuinely loss-absorbent debt. That would strike a better balance between increasing the cost of lending and reducing the frequency and/or impact of financial crises.

And on the topic of international banks the Commission is sympathetic to the need to remain competitive;

Subject to that safeguard for UK retail banking, and recognising that wholesale and investment banking markets are international, the Commission believes that the capital standards applying to the wholesale and investment banking businesses of UK banks need not exceed international standards provided that those businesses have credible resolution plans (including effective loss-absorbing debt) so that they can fail without risk to the UK taxpayer.

And the first novel suggestion to rank depositors ahead of other unsecured creditors in a wind-down situation.

Loss-absorbency and stability might also be improved by ranking the claims of ordinary depositors higher than those of other unsecured creditors.

But the key question was how they would treat investment vs retail banking, and indeed as predicted they will not propose break ups, rather ‘ringfencing’  those parts of large banks.  This is an important paragraph, which leaves questions as to how it might work in reality.  (emphasis mine)

Ring-fencing a bank’s UK retail banking activities could have several advantages. It would make it easier and less costly to sort out banks if they got into trouble, by allowing different parts of the bank to be treated in different ways. Vital retail operations could be kept running while commercial solutions – reorganisation or wind-down – were found for other operations. It would help shield UK retail activities from risks arising elsewhere within the bank or wider system, while preserving the possibility that they could be saved by the rest of the bank. And in combination with higher capital standards it could curtail taxpayer exposure and thereby sharpen commercial disciplines on risk taking.

The report notes that retail and wholesale/investment banking can be distinguished, which is interested, since Martin Wolf who is on the Commission has been quoted as noting this is not feasible.

Separation between retail banking and wholesale and investment banking could take various forms, depending on where and how sharply the line is drawn. While mindful of regulatory arbitrage possibilities at the boundary, the Commission believes that there are practicable ways of distinguishing between retail banking and wholesale and investment banking.

…

For the most part, retail customers have no effective alternatives to their banks for vital financial services; hence the imperative to avert disruption to the system for their continuous provision. Customers of wholesale and investment banking services, on the other hand, generally have greater choice and capacity to look after themselves.

The Commission recognises the ultimate firewall would be to separate the types of banking into separate structures, however it notes the benefits of universal banking would be lost.  It is not clear what that means, and I will leave that for later analysis.  However it will require overall capital and loss-absorbing debt rules for universal banks, as well as for the sub division retail bank.  This will make for interesting reporting and also for definition of the rules between reporting periods.

The Commission is therefore considering forms of retail ring-fencing under which retail banking operations would be carried out by a separate subsidiary within a wider group. This would require universal banks to maintain minimum capital ratios and loss-absorbing debt (as indicated above) for their UK retail banking operations, as well as for their businesses as a whole. Subject to that, the banks could transfer capital between their UK retail and other banking activities.

The report then goes on to discuss improvements to competition.  One proposal in particular will drive bankers nuts.  They note that Lloyds has 30% of all UK current accounts.  So they are proposing a ‘quick switch’ methodology be provided within a reasonable timescale.

This Interim Report suggests that it may be possible to introduce greatly improved means of switching at reasonable cost, in which case the industry should be required to do this within a short timescale, and that barriers to entry may be able to be reduced.

Relevance to Bankwatch:

I got this summary from their length Executive Summary which reads more like a report, because I wanted to get an overview.  Now I have a better idea of what they are suggesting, I will dig into the main report, and have a better idea what I am looking for.

Meantime a couple of items to note;

1. Ringfencing will be a bureaucratic reporting nightmare
2. The quick switch idea to move accounts to a different institution is a non-starter in my view
3. UK banks will be safer as a result of the increased capital requirements but so what – they are already nationalised.  Where is the direction to un-nationalise them.  That is what I am looking for.