The Bankwatch

A brilliant and insightful few minutes with Niall Ferguson on the precipice we face today.  ht Zerohedge.

http://www.cbc.ca/video/watch/News/TV Shows/Lang & O’Leary Exchange/ID=2239470660

Who knows if the audience in this survey is accurate but the sentiment certainly rings true.  A large proportion of bank customers would happily do everything online if it was available. 

Half of Americans want to do all banking online | Finextra

Of just over 1100 respondents, 52% say that their provider’s Web site is their primary method of banking, with 48% revealing that they would do it all online if it were possible. In contrast only a third of respondents consider the branch their primary method of banking.

Currently, Web banking is used primarily to check account balances and recent activity, make individual bill payments, transfer money between accounts and obtain financial information.

The Economist has a special report on international banking, and the section entitled Retail Renaissance was a trip down memory lane.  Then some lessons learned for banks.

First the memory lane part.  I was with mbanx in Canada since 1996 and then Wingspan in Chicago emulated in 1999 (ok my opinion)

Retail renaissance | Economist

“IF YOUR BANK could start over, this is what it would be,” trumpeted the marketing campaign for the launch in 1999 of Wingspan, an internet bank. The following year the bank was gone. In September 2000, a few months after the dotcom bubble burst, it was absorbed by its boring American bricks-and-mortar parent, Bank One (now part of JPMorgan).

First the painful assessment of bank performance during this time and how they had little incentive to innovate.  I remember quite clearly the dramatic shift away from internet banking and towards increased branch presence during the aughties.  It made no sense to me.

In retrospect, the years in the run-up to the financial crisis were a golden age for banks. Even the dullest of them could earn high returns by taking big risks. And few really bothered to try to cut costs when their revenues were being massively boosted by a debt-fuelled bubble. Since the mid-1990s Europe’s big retail banks have managed to cut their costs relative to income by an average of just 0.3% a year, reckons Simon Samuels, an investment analyst at Barclays.

Yet even that modest figure flatters the banks. He calculates that costs over the period increased by an average of 8% a year. The only thing that saved them was that revenues increased a little faster.

Finally the lessons learned:

The effect of the debt bubble was more insidious than it appeared at first glance. In encouraging universal banks to build up their investment side, and some retail banks to dabble in exotic instruments that they did not always understand (demonstrating that even boring retail banks can blow up), it made them take their eyes off their bread-and-butter business.

Yet basic retail banking was, and remains, their main engine of profitability. McKinsey, a consulting firm, reckons that it accounts for more than half banks’ worldwide annual revenue, which in 2010 amounted to $3.4 trillion (see chart).

It (ed:  retail banking) has also proved, in the longer run, to be the most reliable generator of consistent profits and high returns on equity. A ranking of the world’s biggest banks by return on equity correlates closely with the proportion of revenue they make from retail banking, rather than from racier investment banking.

Relevance to Bankwatch:

Quite simply how many banks are capable of learning.  Most large banks have replaced bankers with investment bankers to run the business.  How will that hinder the renaissance, or can they learn ‘back to basics’?  Jamie Dimon is definitely right in the midst of that firestorm.

A simple chart from Deutsche Bank shows the current commitment of funds to Euro countries that need or will need assistance falls far short.  The next few weeks will be pivotal.

This from  courtesy of ZeroHedge.

I have covered here since the banking crisis the scale of ‘notional’ derivative activity in the banking economy.  That last time I saw a number was Dec 2010 and world derivatives totalled $600 trillion.  To place in perspective that number is 10 times world GDP.  That number has grown since the banking crisis by 10%.

According to Fortune Magazine (below), the derivatives at JP Morgan account for more than 10% of all world derivatives, and might well account for a chunk if not all of the growth in notional contract amounts.  Growth in all derivatives since 2009 is $43 trillion, while JP Morgan holds $ 73 trillion.  We know JP Morgan have been aggressively accumulating over the last 2 years.

JPMorgan’s trading debacle: why $2 billion is just the start

By far what makes JPMorgan the riskiest bank on Wall Street, and one of the most profitable, is the bank’s derivative trading book, which is far larger than any other bank in the world. JPMorgan holds derivatives contracts with a notional trading value of just over $1.6 trillion. (Update: Notional value is much, much higher: $73 trillion, but that’s just the size of the debt being insured not how much the bank might owe if the bets went bad. (h/t bbmoney)) That’s enough to wipe out the bank’s capital nearly 10 times over. Of course, JPMorgan says its derivative bets aren’t nearly that big or as risky as they appear.  Factor in hedges and collateral, and the bank says its actual exposure is just $66 billion. But we have just seen how well JPMorgan’s hedges can work.

The Canadian Bankers Association have released an important document outlining standards for integrating mobile payments into the Canadian Payments networks.  Its reasonably detailed at 133 pages. 

Page 40 outlines Square requirements for electronic receipts, suggesting some reasonable new thought has gone into this.  It has flow charts for standard payments, refusals, and even loyalty points treatment.  There is some security stuff including key management.

The flow charts that outline how cards would integrate into the current payment networks are well laid out.

http://www.cba.ca/en/component/content/category/89-mobile-payments-in-canada

http://www.cba.ca/contents/files/misc/msc_20120514_mobile_en.pdf

Back in April there was much talk about Bruno Iksil, Head Trader at the JP Morgan CIO (Central Investment Office) and how they were moving into proprietary ‘house’ trading. 

Egan Jones Downgrades JP Morgan

The iconoclastic rating agency, and fully recognized NRSRO to the dismay of some tabloids, which just refuses to play by the status quo rules, and which downgraded the US for the second time last Friday, to be followed soon by other rating agencies as soon as US debt crosses the $16.4 trillion threshold in a few short months, has just done the even more unthinkable and downgraded Fed boss JPMorgan from AA- to A+.

That has now come home to roost.  The untouchable Jamie Dimon  has now to fire Iksil’s boss Ina Drew because of a mark to market trading loss of $2 Bn or more.

JPMorgan probe into London role in loss

Ina Drew, the head of the CIO, Achilles Macris, head of the London-based trading team, and Javier Martin-Artajo, another member of the team, are all set to depart, according to a person familiar with the situation.

It was just a week ago when I wrote an open question to banks; “Banks – Why can we not have same day money transfer?”

Well today I came across new Dwolla offerring they name FiSync.  They characterise the new service as real time money transfer through their cloud service and are oferring it free to banks.

Unfortunately, and sorry Ben, but I predict this will not succeed at least not as currently offerred.  The reason banks won’t accept as offerred is one word – float.

The post notes the value of ACH transactions annually at 33.9 trillion.  If we run that number at the NY overnight rate of 0.16% for 2,3,4, and 5 days the value of that money to the banks’ is large.  If we increase the overnight rate to more historic values, it increases rapidly.

Unless one bank blinks, the rest have no incentive to take on the FiSync.   What would change that would be a Wells or similar taking it on then the rest would have to follow.

Relevance to Bankwatch:

There is another more subtle difficulty confronting FiSync and one that I suspect is why they are offerring free to banks.  The real stranglehold that banks have on payments is the shared systems they all operate on.  These include ACH and the credit card networks. 

The only way for a start up or a legacy bank to take those on is to go live with FiSync or something like that.  However they have no ‘network effect” while operating alone.  Customer A with money in a Wells account wants to send money to a customer at BofA.  In order for a startup to offer that service they could keep Customers A & B happy, but the startup would be required to fund the transaction until the ACH transactions clear with Wells and BofA.  The old banks retain a lock on their customers money and one of those locks is ACH. 

Its also worth noting that ACH has its roots in cheques which are declining rapidly in value.  That decline is being replaced to some extent by automatic debits for loan payments, bill payments and nascent debit card.

Another angle to attack which is ripe for competition is the incredible lucrative (to banks) merchant services business.  This is the fee revenue derived from credit card payments.  For every transaction banks charge the merchant anything from 1% ~ 4.5% +/-.    What is interesting to me in this space is that we have a relatively small group of merchants who would be highly motivated to move a portion of that merchant service fee to their bottom line.

Anyhow, kudos to Dwolla for trying to shake up the payments infrastructure.  I truly hope I am wrong and wish them well.

America has introduced a JOBS act designed to remove many of the truth and informational requirements that funding requests must address under securities law.  The title here is the final phrase in Esthers piece and it is a deep one.

This article is a highly insightful piece from Esther that captures the essence of the role and responsibility of government as it applies to the free marketplace.  The words “unintended consequences” leap off the page here.  It is far to easy to design a solution that apparently attacks the problem directly but in fact has effects that were not even considered.

The reference to the US mortgage crisis driven by the apparently common sense desire for pervasive home ownership is an example of clear thinking that is lacking in government.

Markets of Magical Thinking | Project Syndicate – Esther Dyson

Unfortunately, the JOBS Act is as likely to be successful as the US government’s earlier attempts to ensure that American families could buy their own homes. Low down payments, deferred interest, and other enticements made it attractive for people to buy their own homes (or to speculate with second homes) whether they could afford to or not.

Mortgage brokers were happy to get in on the act. Some were driven by an honest mission to expand property ownership; others were driven by greed. Some knew that the people to whom they were selling houses could not afford it; others simply did not want to know. Some played by the rules; others forged documents. The banks that originated mortgage loans sold their portfolios to investors who didn’t really understand what they were buying.

In the same way, the JOBS Act will ease life for some deserving people – and most likely attract many more who are less deserving.

FSA managing director Martin Wheatley spoke at the Chartered Institute of Bankers May 4th, 2012 and it is something of a clarion call to the financial services industry everywhere.  He raises gaps in bank service levels based on complaints received at the FSA.

But there is nothing new here and the example of sending money for receipt by next day exemplifies his speech.

Rebuilding trust and confidence in banks and bankers | FSA Martin Wheatley

Even where we have brought issues to the attention of industry, such as the requirement to ensure payments reach the payee’s account by the end of the following business day, some firms failed to engage early enough to ensure that they were compliant.  I cannot understand why something as straightforward and helpful to the customer as this, is so hard to do.

Before electronic banking and electronic payments such as SWIFT between banks there were clearing houses to manage interbank cheque clearing with physical cheques.  That was 40 years ago and earlier.  The time taken to move the cheques back to the drawer bank took up to 3 – 5 days depending on the size of our country and the number of banks.

Fast forward to today.  We have electronic networks that are instant.  When I post this blog post, it will be on the internet immediately.  Same with email.  And it could be the same with money.

Bank choose to hold on to money that is ‘wired’ because that float as it is known in the industry is very lucrative.  The funds are invested overnight(s) and so long as all the banks co-operate by not unwinding that practise they retain that unearned profit.    Sure all the excuses are rolled out (ensure funds are cleared, reduce potential for fraud, allow for funds recall) but it is a smoke screen.  The profits generated by float need to be replaced by exemplary service that warrants a suitable fee.

Instant funds transfer could be here today, as with many of the other points Wheatley makes.  In time these areas that reflect 40 year old thinking are where we can expect to see transformational innovative start ups change the face of financial services.

hat tip to finextra for the reference to the Wheatley speech.