The Bankwatch

Tracking the consumer evolution of financial services

Archive for the ‘Business Models’ Category

Derivatives remain a dark secret with undocumented risks to economies and consumers

Derivates were a hot topic during the height of the banking crisis and we all remember they were the specific reason that AIG went out of business because they had been speculating in those products to an extent that far exceeded business requirements.  When the markets froze AIG were unable to meet their off balance sheet commitments in the form of derivatives and went under. What followed in September 2008 was an $85 bn bailout.

The level of derivatives in the world was close to $700 Bn.  To place that figure in perspective, world GDP is around $60 Bn.  Derivatives which are in theory a financial hedge or insurance against shifts in markets or currencies are worth an astounding 10 times the value of world trade.

Even when we allow for secondary hedges (similar to re-insurance) there can be no good reason for derivatives at that level other than financial speculation. 

Which brings us to this piece in the New York Times that describes the method being used to manage that global risk in the wake of the crisis.  The regulators have delegated the responsibility to the group responsible for much of those derivatives, and the names will be familiar.

The NY Times piece focusses on the profits that come from the derivatiaves, and the extraordinary efforts to ensure that the trading in them remains with the banks and in a non-electronic form which appears to be related to retaining control of the market.  It refers to similarities with Nasdaq in the ‘90s when it was pressured to become an open electronic exchange and that fees dropped significantly.

A Secretive Banking Elite Rules Trading in Derivatives | NY Times

None of the three clearinghouses would divulge the members of their risk committees when asked by a reporter. But two people with direct knowledge of ICE’s committee said the bank members are: Thomas J. Benison of JPMorgan Chase & Company; James J. Hill of Morgan Stanley; Athanassios Diplas of Deutsche Bank; Paul Hamill of UBS; Paul Mitrokostas of Barclays; Andy Hubbard of Credit Suisse; Oliver Frankel of Goldman Sachs; Ali Balali of Bank of America; and Biswarup Chatterjee of Citigroup.

Mr. Griffin said last week that customers have so far paid the price for not yet having electronic trading. He puts the toll, by a rough estimate, in the tens of billions of dollars, saying that electronic trading would remove much of this “economic rent the dealers enjoy from a market that is so opaque.”

It remains unclear why the C.M.E. ended its electronic trading initiative. Two people with knowledge of the Chicago Mercantile Exchange’s clearinghouse said the banks refused to get involved unless the exchange dropped Citadel and the entire plan for electronic trading.

Relevance to Bankwatch:

There are two points to be made here.  The NYT makes the point that significant profits are being protected by a closed group, and you can bet those revenues are costs that end up costing consumers more for for underlying services and products such as petroleum.

The second point to consider is the larger need for a market that reflects 10 x world GDP.  The lack of transparency means that we cannot really explain that, and I still believe this to be a large and undocumented risk.

I am not expert enough to begin to quantify the risk associated with derivatives, and I am in good company on that score.  What I am qualified to state is the there can be no good associated with management of derivatives that amount for alongside your savings account.  The parts of the new regulation that separate investment and retail banking must have some merit on that score.

But we know regulators will never get it all right, and lobbying efforts to retain the status quo will likely be based on ideas that the tremendous risk associated with another freeze up with the credit markets as we had in September 2008 could re-occur in a heartbeat.

All we know is the risk remains, and in this respect nothing has really changed since September 2008 with one key exception.  The banking system has been guaranteed by governments implicitly since 2008 (explicitly in the case of Ireland) and this guarantee is the only thread holding it all together.  That is why the US in particular is so keen to ensure maximum liquidity for banks (Quantitative Easing).

Why does it still feel that all we are doing is postponing inevitable tough decisions.

Written by Colin Henderson

December 12, 2010 at 15:44

The value of patience | Haldane BofE

This is a remarkable paper from Andrew Haldane at the Bank of England.  There are lessons and direction here for everyone and it is not as dry as one might expect.  It is the more remarkable because it addresses human behavior and relates to economic context.  Not your typical Central Bank speech.  Lessons from Asia are being learned.

The most amazing for me is the HFT (high frequency trading) stat about Accenture in bold.

A few quotes to whet your appetite.

  • Take happiness. Studies have shown that happy people save more and spend less. Happy people also take longer to make decisions and expect a longer life. In short, they are patient.
  • Just as patience can self-generate, so too can impatience. And while patience generates self-improving cycles, its alter ego can create self-destructive cycles. Addiction is the classic self-destructive cycle. Drugs and alcohol chemically alter the balance of the double-self, increasing the value of instant gratification. This shortens time horizons, increasing further the value of instant gratification in a downward spiral. Unless arrested, this unfulfilling equilibrium becomes self-fulfilling.
  • John Maynard Keynes. He quipped: “markets can remain irrational for longer than you or I can remain solvent”.
  • By the time of the stock market crash in 1987, the average duration of US equity holdings had fallen to under 2 years. By the turn of the century, it had fallen below one year. By 2007, it was around 7 months. Impatience is mounting.
  • A decade ago, the execution interval for HFTs (high-frequency traders) was seconds. Advances in technology mean today’s HFTs operate in milli- or micro-seconds. Tomorrow’s may operate in nano-seconds.
  • HFT firms are believed to account for more than 70% of all trading volume in US equities
  • HFT is believed to account for between 5 and 10% of Asian equity volumes. This evolution of trading appears already to have had an effect on financial market dynamics. On 6 May 2010, the price of more than 200 securities fell by over 50% between 2.00pm and 2.45pm.32 At 2.47pm, Accenture shares traded for around 7 seconds at a price of 1 cent, a loss of market value close to 100%. No significant economic or political news was released during this period.
  • So disliking goods price inflation and liking asset price inflation suggests a potential time-inconsistency in preferences. It is leaving as a bequest for your children the mortgage but not the house.

Written by Colin Henderson

September 2, 2010 at 22:10

Mortgage regulation in US has worked judging by dramatic impact on brokers

Here is one set of regulation that seems to have worked. The article recounts one broker who is down from 85 on staff to 3.

What is intriguing is that the bankrate article seems to suggest this is a bad thing. The reasons provided in the quote below just sound like back to basics banking process that provides lenders and customers protection.

In fact it suggests brokers can only operate in a loose credit/ no diligence environment. I do not believe that and surely there is a model for brokers that involves lending discipline.

Credit histories must be dutifully compiled for all borrowers. And any number of new criteria can lead to a refusal to lend. One new practice closes the door on loans to anyone who’s done a short sale — a way of selling a house when the sale proceeds fall below the balance on the mortgage — in the past three years.

Written by Colin Henderson

August 28, 2010 at 14:42

Greece and what it means

I cannot but help believe there is a deeper problem relative to the situation in Greece.

Three people died in a central Athens bank that was set ablaze by Greek protesters on Wednesday during a march against government austerity measures, aimed at saving the country from bankruptcy


At one level it is a financial crisis and it should get sorted out with banks involved taking losses eventually as debt will have to be written off or at least placed on such terms as to make repayment unlikely.

But this situation is altogether different and deeper than Argentinean or Thai defaults of the past decades.  Here we have a population with the same passport as Germans, French or British killing people and blaming the IMF for their own profligacy.

The world is in a state of transition between old style nations (nation states) with finite borders that largely contain their problems internally insulated from the world to a world of globally interconnected market states where responsibilities are much fuzzier and it is all to easy to blame others for ones own misfortunes.  This new market state world has an objective of enhancing the opportunity of individuals versus the previous state that was designed to enhance opportunities of groups including unions, the aged, youth etc.

This new world brings responsibilities and accountabilities with it but the Greeks are at the front end of the change and not liking it much.  The implications for Europe and their responsibilities in all this is also embarrassingly clear too.

All of this makes it hard for banks to operate effectively and responsibly with these upheavals in financial markets which have no clear end game.

Written by Colin Henderson

May 5, 2010 at 10:30

You truly know when a country is dysfunctional when its AIR FORCE goes on strike

The always insightful John Mauldin speaks about the crisis that is Greece and the steps towards another banking crisis.  When you have full countries falling apart this is not good for anyone.  The degree of failure inside Greece is astounding, and will only lead to worse before it gets better. 

The larger impact is on currencies, interbank lending (again) and banking system confidence if it is first Greece, then Spain and Portugal … then?


There are no good solutions here, only very difficult ones. In order to get financing, Greece must willingly put itself into a multi-year depression. And borrowing more money when it cannot afford to pay back what it has will not solve the problem. 61% of Greeks now favor leaving the euro. How has Greece responded? By banning short selling on its stock market for the next two months. That should make things better. Greeks are responding by rioting and going on strike. But you truly know when a country is dysfunctional when its AIR FORCE goes on strike. Yesterday Reuters reported that hundreds of Greek pilots called in sick in protest. The response from government? The Minister of Defense said he was "profoundly disappointed." Now that had to make the pilots feel bad.

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Written by Colin Henderson

April 28, 2010 at 20:49

Posted in Business Models

The Magnetar Trade – otherwise known as ‘The Black Hole”

This is a complex article at ProPublica that in simple terms illuminates all that was wrong with CDO’s and synthetic CDO’s. These instruments allowed investment bankers like Magnetar to circumvent insider trading rules.  The story of Goldman Sachs being charged by the SEC for fraud is only the beginning.  Financial reform is the last thing many financiers and bankers will have to worry about as this story takes hold.

Magnetar involved all the big names and most are listed here.  You will see many recognisable names, eg. Citi, Wachovia, Deutsche, Lehmans, UBS, Mizuho, JP Morgan.  At this point it appears to be only guilt by association, however there is nothing good or right in this tale.  Propublica quote this participant.  “The deal was a disaster. He shook his head at being reminded of the details and said: “After looking at this, I deserved to lose my job.”

The Magnetar Trade

Magnetar’s approach had the opposite effect — by helping create investments it also bet against, the hedge fund was actually fueling the market. Magnetar wasn’t alone in that: A few other hedge funds also created CDOs they bet against. And, as the New York Times has reported, Goldman Sachs did too. But Magnetar industrialized the process, creating more and bigger CDOs.

Magentar founder Alec Litowitz speaks at a private equity conference held at Kellogg School of Management at Northwestern University in February 2007. (Nathan Mandell)

Magentar founder Alec Litowitz speaks at a private equity conference held at Kellogg School of Management at Northwestern University in February 2007. (Nathan Mandell)

What Magnetar were able to do was fund the housing bubble and bet against it bursting all at the same time.  They were able to do this using CDO’s and building them all the while knowing the bubble would burst.  The beauty of what they did was to create cash flow to fund their short selling of their own CDO.

Magnetar’s (Nearly) Perpetual Money Machine

By buying the risky bottom slices of CDOs, Magnetar didn’t just help create more CDOs it could bet against. Since it owned a small slice of the CDO, Magnetar also received regular payments as its investments threw off income.

Written by Colin Henderson

April 17, 2010 at 20:46

The Impact of the Internet on Institutions in the Future | PEW

There is lots of wishful thinking contained in this PEW report which is not one of their better ones imho.  The people interviewed are by PEW’s admission skewed and several silicon valley names are included.  However the views follow the predictable linear thought process, such as, we have social networks therefore tomorrow everything will be social.  Clearly there are themes and directional indicators, but there are competing themes such as organisational inertia, shareholder needs, economic crises and last but not least, human nature. 

Some extracts.

The Impact of the Internet on Institutions in the Future | PEW

Some 26% agreed with the opposite statement, which posited:

  • ”By 2020, governments, businesses, non-profits and other mainstream institutions will primarily retain familiar 20th century models for conduct of relationships with citizens and consumers online and offline.”

Once past the headline, the sense of change remains, but some doubt expressed about the 2020 date and that it might be too early for consequential change. 

While their overall assessment anticipates that humans’ use of the internet will prompt institutional change, many elaborated with written explanations that expressed significant concerns over organization’s resistance to change. They cited fears that bureaucracies of all stripes – especially government agencies – can resist outside encouragement to evolve. Some wrote that the level of change will affect different kinds of institutions at different times. The consensus among them was that businesses will transform themselves much more quickly than public and non-profit agencies.

Many selected the “change” option, but said they were not sure drastic change will occur in organizations by the 2020 time frame. They said the most significant impact of the internet on institutions will occur after that. Some noted this change will cause tension and disruption.

And this final pessimistic note from Andy Oram is one that I can see being true.

The positives and negatives of technological change do battle. Will the result be a triumph of networking or more-concentrated, centralized control?
“I’m sure the survey designers picked this question knowing that its breadth makes it hard to answer, but in consequence it’s something of a joy to explore. The widespread sharing of information and ideas will definitely change the relative power relationships of institutions and the masses, but they could move in two very different directions. In one scenario offered by many commentators, the ease of whistle-blowing and of promulgating news about institutions will combine with the ability of individuals to associate over social networking to create movements for change that hold institutions more accountable and make them more responsive to the public. In the other scenario, large institutions exploit high-speed communications and large data stores to enforce even greater centralized control, and use surveillance to crush opposition. I don’t know which way things will go. Experts continually urge governments and businesses to open up and accept public input, and those institutions resist doing so despite all the benefits. So I have to admit that in this area I tend toward pessimism.” – Andy Oram, editor and blogger, O’Reilly Media.

Thoughts?  What will organisations look like in 2050 say?  Will the enterprise be open and participative with looking more like todays Google, or todays Bank of America?

Written by Colin Henderson

March 31, 2010 at 19:20

Posted in Business Models

The coming media crisis and parallels with the financial crisis

A general thread that has been building for me for some years now is highlighted in a few things I have seen recently. The thread is my hatred of advertising and in particular online advertising. For me it lies in the same category as junk (paper) mail except worse. I can simply throw paper junk mail out as one package, so it is not intrusive. Online advertising is horribly intrusive because it is pervasive. I use lots of things to ensure my online experience is minimally interrupted by ads

In 2004 people were asking about blog business models. Now it is social network business models. I have suggested other ways to deal with business models, but the mob continues to aim directly at advertising as the answer. It will pollute the web, and result in the opposite result than what is desired. It will not bring sustainability for them using advertising.

So what happened this week.

  • twitter volumes are already dropping. Pick any topical topic and search it on twitter – result 80% of the tweets are re-tweets of the topic. Its a gigantic echo chamber. In fact the next question – how many of those re-tweets were someone with a vested interest, a professional marketer, or a PR company? The theoretical value of wisdom of crowds does not allow for gaming the system. The black swan of twitter search.
  • the volume of requests to me at this blog for linkbacks, blogroll links and outright requests for ads is increasing significantly. That will never happen btw. However it is indicative of the desire for ‘social media’ results
  • A good friend who despite my recommendations still uses hotmail (now windows live). This persons entire contact list and archive of emails were deleted and it turns out this person not alone. Some kind of scripting virus inside hotmail launched by making the wrong click and signing up for something let the virus in. The clue was emails to all the contacts notifying my friend was happy with some TV or the like. Needless to say my friend is now using gmail exclusively but its a bitter lesson.
  • techcrunch reported on the real evil of ad networks online and the significant money being made. Its a long post, but the key is that no-one is generating any real value here. Individuals are getting rich and that is all.

So what is the point of these seemingly unrelated observations especially as I am a devout proponent of the value of internet. What I am against is traditional interruption advertising coming online. It pollutes the medium and hinders the genuine creation of new and valid business models.

Today I read Umairs post at Harvard and that solidified it all for me (Umair does that). He points to the coming online crisis that is the online version of the subprime crisis. Readers of this blog get the sub prime crisis. The coming online crisis is one of trust, and realisation that online activities require security and protection yet something more which is still to be invented – control. It will be a crisis and it will be a broad based internet crisis of confidence. The result will be serious and cause serious grief for banks and others who have come to rely on online for servicing.

The parallels with the financial crisis are interesting. The financial system was getting better and better at recycling money and the convoluted networks that were built lost sight of the origin of the credit instrument, and the underlying risk. Causes were lack of transparency, shadow markets, rapid expansion, and mis-allocation of risk amongst others. In the case of the online advertising market, there are similar attributes. Transparency is non-existent in most cases, because there is no way to know who is behind those ads. Shadow markets and rapid expansion – ditto. Mis-allocation is interesting. I avoid online ads because they are interruptive. At a deeper level, they are mis-allocation of resources away from user experience and towards the requirements of a stupid ad server that is busily collecting data on you. The value is highly one-sided – worse the server is gather data that may or may not be of any value. Internet is simply clicks – do clicks imply desire, need and future purchase patterns?

Relevance to Bankwatch:
Smart banks and others will look at the embedded value in the customer base they have and define models that add value to those people, not spam them. What is known about your customer base, and what do your customers actually want. Traditional advertising models assumes customer needs – internet models will (I believe) enjoin the customer to participate in the definition of what they need and in return protect them (the customer) from spam advertising. One example is the promise of VRM. But it is only one – others will be developed, and will be supported by powerful authentication tools.

Innovation is another loser in this coming crisis, or as Umair notes unnovation. In advertising land, innovation is all about finding ways to get inside peoples click patterns and drive ad revenue. There is not value created for the majority of consumers (90% + who do not click), nor for merchants who actually desire long term client loyalty.

This has turned out to be a negative post, but really it is intended to provoke thinking beyond online advertising and ad servers. Which innovations will align customer advocates and merchants in a genuine and trusted manner?

Written by Colin Henderson

November 12, 2009 at 21:57

Book | Business Model Generation: Osterwalder and Pigneur

It was exciting to open the mailbox tonight and see my copy of Business Model Generation.


I first met co-author Alex at LIFT in Geneva. He and his colleagues have performed much work focused on the aspects of business model creation, and in particular financial services. I was fortunate enough to be involved in a small way when Alex opened up the creation of the book online to what became 470 other online participants. The result is fabulous and a different kind of book … its more of a handbook for your business model.

I have been speaking here for two years that banks need to re look at their model. The current mid/post crisis situation for banks is dramatically different for them, when compared to the situation when they entered the crisis. The nature of consumer demand, and the mix of product requirement is different. Consumers are paying down debts, and taking a longer view of their finances. At the same time, Banks are looking at tighter liquidity requirements, and higher capital requirements all of which play into their ability to manage new product volume. Cost cutting will not be enough …. it will require drastic cost elimination in many cases to re-orchestrate the business model for the new normal. In this atmosphere, the old business model with tweaks will not, in my view, be enough. Amongst the financial utilities who are managed by government there is a real need and opportunity to become the innovator in financial services that is recognised by customers for being with them in this new world.

The book covers many aspects:

  • Canvas: definition of a business model
  • Patterns: understanding new models, eg free, open source, multi sided, long tail
  • Design: tools and methods
  • Strategy: evaluation and management
  • Process
  • Outlook and Afterward

It is a differently laid out book, and it is more of a handbook than a reference text. It is the kind of book you will retain on the office bookshelf and pick up often.

This is the perfect time to revisit banks’ business models, and Business Model Generation is in my view a great place to start thinking about that. I recommend it, and there is a complete 1st chapter available to download so you can decide for yourself.

Well done Alex and Yves.

PS .. in deference to the American FTC and their new requirement announced today, that people should believe what they say, ahem, I note that I believe the above and am not remunerated in any way.  Go Alex!

Written by Colin Henderson

October 6, 2009 at 21:14

A Sure Sign that we are at a Turning Point in Mobility and Use of Internet

I noticed an ad on CNN this afternoon, that really shows the gap that lies between old business and new business. The topic here is personal use of technology – how individual managers and executives use it. This reflects personal,and therefore institutional effectiveness. It reflects the difference in things happening over days, versus over months.

The ad was for GotoMyPC that “allows you to access your PC from anywhere in the word”. Its a funny ad that begins with a travelling executive who realises the information he needs is on his PC back at the home office, so he sends some carrier pigeons back to get his PC, and they forget the keyboard. Funny stuff, but there is much larger message here.

An no, the message is not get a laptop. That is a personal preference, and offers an interim solution, but does little for sharing the information, nor deal with hard drive crashes, or ensuring you have the latest version of the information. No this is a message about the ‘cloud’ and having the security of knowledge that you could be handed a blank brand new laptop today, and be up and running with everything you require in hours. That is security.

I have the good fortune to watch how developers use technology (new world) and compare it to the way bankers use it (old world). In both cases, the need is to share and co-operate on information. For developers the information is comprised of a large code base(s) and supporting requirement information. For business executives it comprises things like data, analysis, presentations, and plans.

First lets look at how this works and assume away from home office scenario:

Bank Executive preparing for a HQ meeting tomorrow:

  • opens laptop – can’t access hotel wireless network because of hardware security constraints on laptop. Eventually hooks up using ethernet cable although this forces him to sit on the uncomfortable chair, because the wire is too short
  • once online emails colleagues in different time zone to get the latest powerpoint after he realises his version on hard drive is probably not up to date. Also seeking the latest sales data because all he has is the end of August and now it is October. He has checked into SharePoint but it turns out the latest files uploaded are not the ones he assumed would be there and now he is freaking out.

Developer preparing to present to client tomorrow:

  • opens laptop, while in the comfortable seat, signs in (to laptop) and accesses wireless network. Hardware access security limitations not required because …
  • … he logs into github on the web (secure code repository) using SSH (secure keys) security through a secure tunnel. (incidentally, it is immaterial whether the developer logs in with Windows, Linux or Mac – same result – the consistency is at the code and network level, not the personal hardware level)
  • he pulls down the latest code base updated by developers from multiple locations, safe in the knowledge he has the latest version, and works on tomorrows presentation. Download is fast because it a series of text (xml data) which is not assembled into anything meaningful until on the laptop. Contrast with the bank experience that downloads actual large powerpoints, complete with large images etc.

Lets look at what happened there and the opportunity for business. In the case of the developer, the information base is completely abstracted from the individuals who manage it. Security is maintained through different access levels at github. The control lies in github. Different access levels in github provide some people access to send changes to git, while all can view. Not all can submit (“commit” in git language) those changes.

For the Bank executive it is all as good as he is at last minute changes, and in the hope that folks back in the other time zone get his last minute requests and whether he can integrate whatever he gets.

What is going on here? Well there are a few things at different levels:

  1. bank security is managed by licking down hardware and information. Hardware is locked down to become practically unusable, and often having the ‘smart’ executives use their personal gmail accounts to manage information exchanges (who will admit that method of keeping data in a handy cloud environment for access?)
  2. developer security assumes ant device could access the information, and security is managed by secure key exchanges and digital certificates.

Which of the above is the more secure? Which is more efficient? This is a fundamental question for bank CIO’s. It will turn out that 2) is the more secure, and also cheaper, but …. and I can hear this now … if it is cheaper how can it be more secure?

Relevance to Bankwatch:
Back to GoToMYPC. I hate to pick on them, and if fact they are providing a valuable service that circumvents many of the bank executives problems, but does not solve the intrinsic problem of securely sharing information.

The Github solution solves access, solves version control, and solves information management control. What if someone took the Github example and build a git for information, ie presentations, spreadsheets, documents, data access? Sorry SharePoint but from the moment you insist on proprietary Silverlight to enter you fail. Access must be open to alternative operating systems to access.


A github type solution that retains latest and previous versions ‘in the cloud’ yet still secure would be powerful. Github is not an afterthought, but part of the development process. Developers create on their own desktop, then save to git as they progress. This two step process allows for efficiency of a local desktop but retention of latest information in the cloud.

There has to be a way to shift banks into this type of environment, rather than the current method employed by most that offers security by making it well nigh impossible to do anything.

The challenge for banks and information security suppliers is to do what developers did … go back to the fundamental needs of executives and managers, which at some level is not at all different than developers and revisit the strategy. Yes this will mean throwing out investment in expensive infrastrucuture but if the alternative is better, faster, efficient, and saves money then the opportunity of sunk licence costs is immaterial. Perhaps it is time to move beyond personal pride and seek a better world for all.

Thoughts and experiences of bankers welcome, and feel free to be anonymous on this, if you need to protect the innocent 🙂

Written by Colin Henderson

October 4, 2009 at 15:06

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