The Bankwatch

Tracking the consumer evolution of financial services

Posts Tagged ‘financial utilities

Where will the innovation come from in financial services?


A central question for financial services is this:  “Where will the innovation come from in financial services?”

I read this piece from Dave over at Digital Money Forum, and it highlights a central problem that traditional financial services falls into.

The 50 year plan : Digital Money forum

That sounds like the Greek restaurant will have to give a British cardholder a couple of pages of A4 and make sure that the customers reads them before they punch in their PIN.

Anyway, the point is that for banks, the PSD comes at an interesting time when transaction banking is becoming more central to strategy. The threats from both new entrants and substitutes are, according to Bob (and I agree with him), high. In these circumstances, regulation is turning from a moat that competitors cannot cross into a millstone around the incumbents necks.

The problem is in the complication and diversification of businesses contained within a typical bank.  The problems are surmountable, but first they must be recognised.  The issues arise in part from interpretaion of regulation, and in part from the diverse nature of modern large banks.

Relevance to Bankwatch:

Regulation:

It goes without saying that there is host of regulation that must be complied with.  As the events have occurred over the last two years, regulation has become more of a factor in oversight of banks.   In my three part piece earlier this year, The Great Unwinding, (title refers to unwinding of debt and deleveraging of households and institutions) the point was that as the economic pie decreases is size, and at the same time the role of government increases that the effect will be to produce two types of banks:

  1. Financial utilities; much as you turn on your tap for water, or plug into the wall for electricity, you will plug into these banks for basic services.  Nothing new, nothing extreme, and nothing innovative, unless the government tells them to do it and even then that won’t work – refer back to Daves piece above and SEPA.
  2. Innovators: while in the minority, this group will be comprised of those who keep their heads above the trees and see that rather than a time of crisis, this is a time of opportunity;  opportunity defined as a new market that is diametrically opposed to the market of the last 10 years for banks.

Bank bureaucracy:

Banks have always been bureaucratic but the last 15 years has seen bureacracy become triumphant in many institutions.  It began to be a problem in the mid 90’s when this new fangled thing called internet required that the entire bank be properly represented at the point of a click.  Having spent 100’s of years operating independently, to ask product managers to talk with other product managers, and in the same room as electronic channel managers required new levels of collegialism that was never requested before.  There were no rules nor common norms that could be held up as principles to guide the discussion.

Everyone at the table would claim to be ‘customer centric’ and representing their customer.  Other approaches would say ‘the bank’ owns the customer, but then who represents ‘the bank’ in that conversation – the Chairman?

It also happened that we also saw a rise in regulation for privacy, security, complaint handling, ecommerce laws all of which brought even more partners to the above table.  The result takes us to Daves somewhat humourous, but too close to the truth point above about having customers complete a two page document prior to punching in their PIN.

Market differences:

So in a climate of crisis and regulation, it will be easy for the majority to reduce themselves to financial utilities.  It comes naturally to large organisations, who have not solved the riddles of focus and simplicity.

The innovators on the other hand will see the opportunity because they can see through the morass of problems and zero in on that opportunity with laser like focus.

I blogged earlier about the changes in the economy, and while that post applied to the US context, this equally applies to all western economies, including Canada, UK, France, Germany, and Spain as obvious examples.

These macro factors will play a large role in US banks and credit unions strategy design for the next 5 years.

  1. no consumer purchase driven economy in US – with the implication of extended higher Government spending for some time to counter
  2. US consumers save (increasing savings accounts and paying down debt)

When we think about banking over the last 10 years, the predominant consumer products that saw innovation have been borrowing products.  Lines of Credit, Mortgages, Credit Cards and Consumer loans have been pre-eminent.  If we read and think carefully about Timothy Geithners comments above, and I share his view, the nature of banking products and services that see growth for the next 10 years will be different.

Economic recovery does not mean a return to things as they were.

The dominant products will shift to becoming investment accounts, savings accounts, and money management services.

As consumers seek to save (economic terminology for hoarding cash, or repaying debt) they will be watching every penny.

As money is saved or spending is reviewed the requirement for real time information is added to the mix.  Questions will be asked, such as;  ‘can I afford this purchase this month’  or ‘what if I waited till next month’, or ‘how much have I saved this month’ or ‘how much have my total credit card balances reduced’.  This introduces the need for new payments services, and that are adding value by connection to money management services such as Wesabe, or Wells Fargo spending analysis service.

These questions should drive new and innovative services that banks have not been accustomed to creating.  It requires new thinking and re-alignment of strategic resources.  It is much easier for new entrants to banking to start small and simple in this new environment.  A mix of new entrants and smart existing players will be the innovators, and the winners.

Written by Colin Henderson

June 1, 2009 at 13:04

Enter the Zombie banks: Liquidity fixes for banks will not solve their solvency problem


James Baker of all people sums up precisely why the current government approaches to fixing banks’ problems is flawed.  As you will have gathered I fall in the Niall Ferguson/ Martin Wolf camp that says this situation is not just worse than we think but more importantly it is different than the prevailing wisdom.   We risk fixing the wrong problem in other words.

‘How Washington can prevent ‘zombie banks’ | Financial Times

Beginning in 1990, Japan suffered a collapse in real estate and stock market prices that pushed major banks into insolvency. Rather than follow America’s tough recommendation – and close or recapitalise these banks – Japan took an easier approach. It kept banks marginally functional through explicit or implicit guarantees and piecemeal government bail-outs. The resulting “zombie banks” – neither alive nor dead – could not support economic growth.

A period of feeble economic performance called Japan’s “lost decade” resulted.

Unfortunately, the US may be repeating Japan’s mistake by viewing our current banking crisis as one of liquidity and not solvency. Most proposals advanced thus far assume that, once confidence in financial markets is restored, banks will recover.

To prevent a bank run, all depositors of recapitalised banks should be fully guaranteed, even if their deposit exceeds the Federal Deposit Insurance Corporation maximum of $250,000 (€197,000, £175,000). But bank boards of directors and senior management should be replaced and, unfortunately, shareholders will lose their investment. Optimally, bondholders would be wiped out, too. But the risk of a crash in the bond market means that bondholders may receive only a haircut. All of this is harsh, but required if we are ultimately to return market discipline to our financial sector.

Baker suggests quick and decisive action, and I agree.

This is a crisis of debt and bubble asset values.  The asset values are being re-stated in the equity markets and housing markets as we see evey day.  That horse has left the barn, as they say.  The result is a set of debt around the world on the balance sheets of companies and consumers that is too high relative to the asset base.

The prevailing theme of government and therefore consumer belief is that government stimulus plans will address the economic shortfalls, and return us to growth later in 2009.  But what does that mean, even if successful?

The key is to define “growth” and what that means.  That would mean GDP, that mix of consumer, government and businesss expenditures and investments is no longer dropping.  There are two key points that have to be said here.  Even if growth in GDP returns, that does not mean asset values will return to 2007 levels – no-one can believe that now.  Despite a return to normal patterns of consumer, business and government expenditures sometime in the next 2 years, house prices will not rise by the 25 – 50% that would be required to attain 2007 levels, nor is it likely that the stock markets will grow the 100% + that will be required to return to 2007 levels.  Those things are possible, but we have to believe unlikely in the near term (5 – 7 years)

As Baker states clearly above, this is a crisis of solvency.  A liquidity crisis merely means value is tied up in assets that are not quickly useable as cash.  Solvency means debt exceeds asset values.  The banks have a solvency crisis.  That brings be back to Niall’s point.  This is a crisis of debt.

The delusion that a crisis of excess debt can be solved by creating more debt is at the heart of the Great Repression. Yet that is precisely what most governments propose to do. (Niall Ferguson/ LA Times Feb 6th, 2009)

A crisis of solvency has requires help for debtors and there is some relief coming on that for US people mortgages, although the plans are not yet completed.

But the worry is the banks.  As Baker says above, and Wolf said yesterday on the Fareed interview on CNN banks are frozen in a state of inaction by virtue of potential asset value losses that exceed their capital base.  They also cannot generate new assets, ie lend, because they do not have an adequate capital base to support.  Enter, what I have been calling financial utilities, and Baker calls zombie banks.  Banks that are moribund and merely exist to provide very basic functions under the guidance and auspices of their bureaucrat overseers.  This does not bode well for innovation, nor new and better services.

Relevance to Bankwatch:

The good news is that the opportunity remains for those that choose to accept it.  This timing of this economic mess is not co-incidence and although few predicted the precise date, many knew a day of reckoning was to come [link to The Upside of Down].  When Thomas Homer-Dixon wrote that book in 2005 the characterisations of stress in the world he saw were these.

Homer-Dixon contends that five “tectonic stresses” are accumulating deep underneath the surface of today’s global order:

  • energy stress, especially from increasing scarcity of conventional oil;
  • economic stress from greater global economic instability and widening income gaps between rich and poor;
  • demographic stress from differentials in population growth rates between rich and poor societies and from expansion of megacities in poor societies;
  • environmental stress from worsening damage to land, water forests, and fisheries; and,
  • climate stress from changes in the composition of Earth’s atmosphere.

With the benefit of hindsight it is easy to see he was correct in the assessment.  More imporantly though these stresses point to a systemic shift in the world that requires different and better solutions, if we are to mitigate future crises, economic and otherwise.  For example it is all very well to point to the Keynesian approach of replacing consumer spending with government spending to address the problem, but what ought the government spend its money on, if the target is a different and better system than we have today?

Going back to the banks’ – the information we have just summarised strongly suggests they are not going back to the way things were before.  What better opportunity to rethink strategy.  We are now in a period of an experential economy, powered by customer empowerment.  Internet has seen to that and that change is also systemic.

If a big bank can really, and I mean really, grasp the power of internet, and the associated cost benefits associated with customer empowerment, ie, customers willingly doing the work for them, in return for better value, and banking on their terms. just perhaps a bank could join in the disruption for banking that is surely upon us.

Written by Colin Henderson

March 2, 2009 at 14:09

The Economic Outlook for 2009 and Community banks | Yellen SF Fed


Economists, even good ones, can sometimes state the obvious and leave a sense that the impossible can actually occur, which of course it will not.

    The Economic Outlook for 2009 and Community Banks  Delivered February 6, 2009 in Hawaii | Janet Yellen, CEO, Federal Reserve Bank of San Francisco

    It’s also important to acknowledge that banking organizations find themselves under intense scrutiny and are subject to conflicting pressures. At a time of nearly unparalleled challenges for financial institutions, you find yourselves called on simultaneously to preserve capital, avoid excessive risk, and step up your lending. Policymakers are mindful how difficult it can be to balance those mandates.

    There are some dire predictions in this piece.  In any event it is a reasonable summary of the conditions that Community banks in particular in the US face.  I have pasted fairly extensively but bolded some key highlights for ease in locating points of interest. Note the reference to ‘systemically important” banks, and “removal of bad assets” which point in the direction of the large banks becoming financial utilities.

    1. “Households are hunkering down. The personal saving rate has jumped from around zero early last year to about 3½ percent recently, as people have tried to rebuild lost wealth and some cushion to weather adversities, including possible job loss.”
    2. On residential development:  Unfortunately, there is no end in sight. Housing starts have plummeted over the past year, falling by nearly one-half. It’s hard to see when starts will bottom out, since inventories of unsold new and existing homes remain at high levels relative to sales.
    3. On house prices:  Unfortunately, futures contracts for house prices suggest that further declines are likely this year and next
    4. With regard to credit, many companies, especially those with lower credit ratings, must now pay extraordinarily high rates in the bond market
    5. The market for commercial mortgage-backed securities has all but dried up. Banks and other traditional lenders have also become less willing to extend funding.

    On Banks:

    1. To fulfill our role in providing liquidity, we have crossed traditional boundaries by extending the maturity of loans, the range of acceptable collateral, and the range of eligible borrowing institutions
    2. It will support the issuance of securities collateralized by auto, student, credit card, and SBA, or Small Business Administration loans—sectors where the issuance of new securities has slowed to a trickle. This approach has the potential to be expanded substantially, with higher lending volumes and additional asset classes, such as commercial mortgage-backed securities.
    3. guarantees against losses for several systemically important financial institutions including Citigroup, Bank of America and AIG
    4. A lesson from past experience with banking crises around the globe is that the removal of bad assets from bank balance sheets, along with the injection of new capital, is needed to restore health to the banking system. As long as hard-to-value, troubled assets clog their balance sheets, banks find it difficult to attract private capital and to focus on new lending.
    5. As a result, and given the outlook for the economy, I would expect to see more deterioration in corporate, commercial real estate, and consumer portfolios over the course of this year and into next year
    6. Many community banks have significant commercial real estate concentrations, and these loans are a particular concern in the current environment. At present, the performance of such loans has deteriorated only mildly. But, as I suggested earlier, we can’t count on that situation to continue, since the downturn in commercial real estate construction is just getting started

    Written by Colin Henderson

    February 27, 2009 at 01:33

    A future that has hope for banking innovation only in North America?


    In something that is a bit ironic, the Democratic US government is looking the most conservative in management of banks amongst the G-7 scheduled next week in Italy.  Geithner is also looking the most thoughtful of the finance ministers, alongside Lagarde in France.

    This is seriously not a time for grandstanding as Brown and Darling continue to do too often.  Time to get it right with a sustainable approach that will not relegate banks to becoming permanent financial utilities which I fear is happening when you read this dire summary of the current state.

    Could we have a system in the future that has the private (and presumably innovative) banks existing only in North America?

    Question of control over banks awaits Geithner at upcoming G-7 meeting | IHT.com

    Ireland injected €7 billion, or $9 billion, into its two largest banks Wednesday. In return, it gained the right to appoint four directors, limit executive pay, set lending parameters, require the suspension of home foreclosures, as well as an option to buy a 25 percent equity stake at fire sale prices some time in the future. The government already owns 75 percent of Anglo Irish bank.

    In Britain, four of the most troubled financial institutions — two of them were officially nationalized — are already under the de facto control of a newly formed government holding company.

    Officials are pushing Lloyds Bank and the Royal Bank of Scotland, among others, to pare bonuses and increase lending to British homeowners and businesses.

    Both countries’ actions conform to a growing sense in Europe that the best way to revive banks is to put them on the tightest possible leash. But in an interview in advance of the Friday and Saturday G-7 meetings, a senior Treasury official reiterated that the Obama administration is committed to the proposition that banks must remain in private hands.

    Written by Colin Henderson

    February 13, 2009 at 16:55

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