The Bankwatch

As it became clear in 2009 the influence of Government on banks that the took control of that year had to become a consequential factor in how those banks operate.  My hypothesis at the time was that those banks would lose the innovation incentive and in effect become utilities that provide a basic banking service.

I am surprised it took this long, but David Cameron has made the first consequential step by setting a very low limit on bank bonuses on RBS and it appears to also impact all government owned banks so Lloyds and HBOS too.  The piece is headlined in reference to the Knighthood Gordon Brown gave to Sir Fred, but while amusing that is not the point here. 

PM signals ‘Fred the Shred’ could be stripped of knighthood | The Times (subscription)

He also said that the cash element of bonuses paid this year to staff at RBS, which is 83 per cent owned by the taxpayer, would be restricted to £2,000, the same as last year.

Relevance to Bankwatch:

The larger point is that this signals a sea change in how banks operate and the first consequential change since the banking crisis.  I firmly believe there needs to be a solid banking system available for those who are risk averse.  This used to be provided not just by banks, but by Trustee Savings Banks and those days are well gone.  A shift that encourages utility banking will bring that back.

Wells Fargo is doing a great job and has publicly announced getting back to basics, as has Lloyds Bank.

This will result in natural competition which will arise from newcomers and prospective customers can make their own educated estimates of the risk and reward with those newcomers.  In fact there is no reason newcomers cannot re-use utility banks as their safe and secure ‘engine’ for access to bank accounts, and payments systems, while they provide innovative and flexible front ends.  We are already seeing beta testing of such operations (Movenbank).

In any event things are not the same following the intervention of Government, but it might just germinate the customer focussed creativity that never came from the big banks.

This piece in the FT talks about the FSB (Financial Stability Board).  I had to remind myself that the FSB is the G20 designate to fix the banking system, and not the KGB successor. 

The quote in the title indicates the goal of the group but the reality of the need for this piece indicates that it is not being taken too seriously yet, hence we must remember … FSB.  The good news is that the FSB has one of the better and clear thinking Central Bank governors in Mark Carney.  The challenge that is faces is critical for the world.

There are several hints that the mobile payment acquiring space is getting interesting. 

1. Square
2. Intuit GoPayment
3. SimplyTap

These new offerings bypass traditional payment networks and thus eliminate (or replace) merchant discount charges for those accepting credit cards.

While we await banks being disrupted, this payment space could just be the next big thing.

A nice summary from McKinsey of the fundamental problem facing banks in any country, that reflects the zero appreciation in bank stock value over the last 20 years.  McKinsey state that banks need a new model.

Why US banks need a new business model

Many commentators blame Europe’s sovereign-debt crisis and fears of a double-dip recession. But three additional factors also weigh heavily on investors: the new bank capital requirements introduced under the Basel III international-banking regulations, the impact of new US banking regulations responding to the financial crisis, the Dodd–Frank Act, and the unwinding of consumer debt. All three undermine banking’s traditional business model.

This is an obvious point despite investors lack of appreciation of it. 

This next point is my favourite.

By business model, we mean how banks actually operate—how work is done, the degree of automation, the pricing and design of products, and underlying compensation systems. In the market’s view, the threats are so strong that it won’t be enough to trim the sails, refocus investment, or cut costs a bit here and there.

There has been an unfortunate mixing of what I would call banking, that is accepting deposits and making loans; mixing with investment banking that is far removed from traditional banking.  But that is a self made problem so no excuse.

Lets break this down using the McKinsey model approach:

1. how work is done,
2. the degree of automation,
3. the pricing and design of products, and
4. underlying compensation systems

1. How work is done:

Banks approach the market with a sales force that generally speaking has no idea about products or technology.  I don’t mean this to sound as harsh as it does but it is not the fault of the front line. 

The technology and product people (I am generalising here) are generally not allowed to speak directly to customers.  The model is designed to provide features and benefits descriptions to front line staff.  This is a good design for selling but a bad design for quality service and answering questions.

2. The degree of automation:

If you ask a bank technologist they will describe an amazing amount of automation, with incredible sophistication of system integration.  However the very statement is evidence of the degree of internal focus required to make the systems work together at all.  This in contrast to what customers need. 

3.  The pricing and design of products:

Pricing and product design for banks generally follows the telco and airline models by creating complexity with a host of extra fees embedded in that complexity.  There are some standouts such as ING who try to break through that but not a lot of innovation here. 

5. Underlying compensation systems

Not much to be said here.  Many bank employees have made a lot of money, yet the value to shareholders over the last 20 or 30 years for the average bank is zero.

The title says it all in this McKinsey piece from earlier in the year.  While it is fashionable, expected and admired to multitask the reality is that it is counterproductive.  The piece expands into a personal strategy to focus, filter and forget.  It’s a welcome reminder for time management principles.  It underlies the thinking with a new aspect to multi-tasking that is addictive and physiological. 

This drug like effect generates company inefficiency, errors and missed opportunities.

Always-on, multitasking work environments are killing productivity, dampening creativity, and making us unhappy | McKinsey

We tend to believe that by doing several things at the same time we can better handle the information rushing toward us and get more done. What’s more, multitasking—interrupting one task with another—can sometimes be fun. Each vibration of our favorite high-tech e-mail device carries the promise of potential rewards. Checking it may provide a welcome distraction from more difficult and challenging tasks. It helps us feel, at least briefly, that we’ve accomplished something—even if only pruning our e-mail in-boxes. Unfortunately, current research indicates the opposite: multitasking unequivocally damages productivity.

An increasingly obvious observation from this Economist piece on the value of social media for commerce.  In particular the original promise was that social media would allow companies to infer and interpret customer preferences in a particularly granular and specific way, by associating customers buying preferences with their friends and their buying behaviors.

Too much buzz – Social media provides huge opportunities, but will bring huge problems | Economist

Most commentary on social media ignores an obvious truth—that the value of things is largely determined by their rarity. The more people tweet, the less attention people will pay to any individual tweet. The more people “friend” even passing acquaintances, the less meaning such connections have. As communication grows ever easier, the important thing is detecting whispers of useful information in a howling hurricane of noise. For speakers, the new world will be expensive. Companies will have to invest in ever more channels to capture the same number of ears. For listeners, it will be baffling. Everyone will need better filters—editors, analysts, middle managers and so on—to help them extract meaning from the blizzard of buzz.

I remain skeptical about how social media might create value for commerce, beyond advertising and awareness.  The original promise (above) has faded.  It has largely been replaced for now by attention to social media for advertising and negative customer opinion awareness.

I would cite two large problems within the data problem that The Economist mentions above:

1. If any commercial value did appear, it would be instantly gamed by advertisers using fake users
2. Beyond the ubiquitous ‘like’ or ‘+1” buttons, people generally focus on the negative rather than promote the positive.  The qualitative product comments are definitely something to be closely monitored.

Don’t get me wrong.  Trends and new stuff will surface in social media.  In fact one study quoted here in Quora suggests that 71% of tweets are original and ignored, with 6% being retweeted.  This suggests that the 71% may well hold some new knowledge and startups are frantically working to assess that data from Twitters feeds.  Mind you, what percentage of those original tweets are ‘what I had for dinner’ or ‘links to web news’.  There is clearly an emerging value around the immediacy of news that is game changing for media.  There is also value in keeping family and friends updated on news.  There might be some user social and personal behaviour inferences that can be inferred.

Time will tell what other value might appear from that data.  But for now, Social Media’s value to commerce is becoming just another media buy to generate awareness and promote purchasing.

There is a brilliant collection of essays in the Jan/Feb issue of Foreign Affairs.  There is one lead piece from Francis Fukuyama entitled the Future of History (premium) which borrows from the title of his earlier book The End of History. 

The broad theme is the failure of politics and the problem with the rise of economics over politics that has led (his words) to the end of left wing idealism as a counterweight to the right. 

Foreign Affairs:  He closes with this statement on what is needed:

It would have to have at least two components, political and economic. Politically, the new ideology would need to reassert the supremacy of democratic politics over economics and legitimate anew government as an expression of the public interest. But the agenda it put forward to protect middle-class life could not simply rely on the existing mechanisms of the welfare state. The ideology would need to somehow redesign the public sector, freeing it from its dependence on existing stakeholders and using new, technology-empowered approaches to delivering services. It would have to argue forthrightly for more redistribution and present a realistic route to ending interest groups’ domination of politics.

He got there by reviewing a host of historic movements and how they arrived. 

• the introduction of the rights of property owners
• the concept that government can only tax when voters agree
• the power to vote for non property owners (an American invention – Andrew Jackson)
• that technology carries some of the blame for driving efficiency that requires fewer workers and provides for greater income generation for well educated, something that supported the growth of middle class.

He moves us quickly through the history of democratic movements which he notes fall out of demographic movements.

• socialism and rise of unions
• communism and its failure
• rise of middle class which through passing of relative wealth to people in large numbers that displaced the earlier two movements
• latterly the flattening of middle class incomes over the past 40 years, and finally
• more recently the rise of a new group of culturally disenfranchised (immigrants, gay, less/uneducated, etc) which has itself displaced the power of the middle class, and further displacing the worker power of unions, by creation of a large third franchise.

Even the Arab Spring he notes can be rooted in a new Arab group that is better off, better educated, that can clearly comprehend the Dictators are firmly between them and a better life.  See this in Russia too now.

But he ends on a note of pessimism that with inequality and friction between these broad groups, each of whose opposing needs broadens, the solutions and endgame are not clear.  In the US, the top 1% of families take home 23.5% of income he notes.

Relevance to Bankwatch:

With this backdrop, we can see clues in the political quagmires we see in the Euro zone and in the US.  The governments are torn about which franchise to follow because it is just not clear.  In fact the structures of governments was designed for a different time and place with much different citizen structure.

We have the additional shift from demographic aging in western countries.

These factors exacerbate the mismatch of the structure of government to the requirements of the population.

This blog is not about politics, but I believe requirements for the design of banks is as dependent on the requirements of the population.  One thing we can see from the last 4 years, is that banks’ design are based on a different set of requirements and not around making them inherently useful and of value to the broad base of people.  Unfortunately, all people cannot successfully claim to be in the top 1% that make 23.5% of income.

As a follow up to my ‘Failure of Politics’ post, here is succinct piece from Francis Fukuyama, Stanford Senior Fellow.  In particular this paragraph caught my eye.  We often hear of the divisions of power amongst the various branches, and the immobilising effect of lobbying in US politics.  However this was a new one to me, that any of the 100 Senators can place anonymous holds on work proceeding for entirely selfish purposes. 

Talk about designing a political system to fail!

Oh for a democratic dictatorship and not a vetocracy | ft.com – Francis Fukuyama

In addition to the checks and balances mandated by the constitution, Congress has added a host of further opportunities for legislators to use their veto power to blackmail the system, such as the anonymous holds that any of 100 senators may place on executive branch appointments. A particularly egregious example of this is taking place today. The Obama administration has wanted to appoint Michael McFaul ambassador to Russia, but the foreign relations committee has put off action indefinitely due to the objections of certain unnamed Republican senators. Mr McFaul – formerly a professor at Stanford (and also a longtime friend) – has been senior director for Russian and Eurasian affairs at the National Security Council for the past three years and is widely regarded even by the Republicans as well qualified for the job. Foreign Policy magazine has reported that one of the holds is due to a senator wanting the federal government to build a facility in his state. As a result, the US may not have an ambassador in place in Moscow next March as the Russians vote for a new president.

The banking and economic crisis of 2007 has touched many aspects of our lives and a now a clear trend and fallout, is the failure of politics. 

I am biased but I look at Britain and believe there is still a hardy attempt there to keep things moving.  I watched David Miliband (Left) and Bronwen Maddox (Rightish journalist)  today being interviewed by Fareed Zakaria.  While they commented on the UK economy and the arguments for and against austerity and stimulus aspects to budgets, it was notable that they do not paint themselves into a corner that cannot be exited.

Now lets look at three other countries;  Greece, Italy and US. 

Taking the last first, we hear today that the Congress ‘super committee’ cannot agree on a new budget to get themselves back on track following the rating write down from AAA.  This hot on the heels of the budget decision failure in August.  Members of the committee on todays Sunday talk shows noted that the <insert party name> would not come forward with a <insert party line in the sand on taxes or medical care> therefore it is their <the other guys> fault.

In both Greece and Italy we learned a new word that was previously reserved for communist Chinas government – technocrats.

Italy forms cabinet of technocrats | ft.com

Mr Monti, appointed last week as senator for life, unveiled a cabinet list made up exclusively of un-elected technocrats after the main political parties refused to take up cabinet posts on offer. The new slimmed-down team includes three women and is dominated by academics and civil servants.

Greece is similar with an academic approved by both political parties to run things while the country takes the actions required by the Euro countries to get the support required to avoid sovereign collapse.

Relevance to Bankwatch:

Aside from general interest, this matters here and to banks but perhaps in a good way.  I have written before about how banks survive at the grace of the governments of their respective countries, but don’t listen to me.  This is my review of Taleb’s comments. 

It is clear that US politics have polarised to such an extent that the government is unmanageable. 

This only matters though when a figurative gun is held to the countries head as is the case in Italy and Greece, and in those countries the politicians backed off rather than allow their future be tainted by decisions required to fix the country’s problems.  They backed off to allow ‘technocrats’, unelected officials to make the hard decisions and they will no doubt swoop back in once debt and financial management is back under control.

What happens to America when the inevitable decisions required become inevitable.  Will we see some kind of technocrat intervention in the US so solve the apparent freeze in Washington?

This Europol criminal threat assessment (pdf document – OCTA 2011: EU ORGANISED CRIME THREAT ASSESSMENT) is fascinating.  It covers everything including drugs, smuggling, human trafficking and weapons. 

But the financial section is what caught my eye.  I have been vocal for years that it is time for banks to offer payment cards with only a chip and with no magnetic stripe.  The detainment of the stripe is a classic case of building a compromise product based on the needs of the minority.

First the financial impact:

The EU is the world’s largest market for payment card transactions. In 2009 organised crime groups derived more than 1.5 billion euros from payment card fraud in the EU.

Now that we are almost in 2012, and 3 years later it is a safe bet that number will be higher.  In my view it is unconscionable that banks permitted this to occur while the solution to a large percentage of that crime lies in their hands, while they hide behind regulations created by the card companies (ie themselves).  That cost is a net cost and loss to society in some way, and it has to be covered by consumer and social costs at some point.

Some more statistics that are astounding but not at all surprising.  (non-EMV compliant means countries that have yet to adopt chip cards.)

Since such data cannot be misused in countries in which chips are required, organised crime groups have deployed cells to non-EMV compliant regions. As a result, half the fraudulent withdrawals made with cloned EU payment cards are currently made outside the EU.

Around 80 per cent of non-EU fraud against EU payment cards is committed in the United States.

This means that in effect, Banks are allowing the country that retains miles and gallons to drive their payment card strategy. 

Relevance to Bankwatch:

I want my bank to give me a chip only card.  The implication is that I cannot use it at some (fewer and fewer) merchants and third party ATM’s.  I can live with that inconvenience.