Disruptive Finance Huffing and Puffing Won’t Blow Big Bank Houses Down

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Prepare to break out your smallest violins, but the arrival of Spring brings the return of the reoccurring pain in the ears that befalls those of us in finance – conference season.

For those of you who are lucky enough not to be part of the big finance industry, instead of listening out for the first cuckoo or maybe planning a backyard hot dog cookout, Spring signifies the time our email inboxes get carpet bombed with invitations to shindigs, forums and events laid on by the usual suspects – consultancy firms and industry bigshots. Or, at least, would-be industry bigshots and their paid PR boosters.

Mainstream media outlets and various other hangers on hoping to get some crumbs from the lavish buffet that is the financial services industry provide uncritical coverage aiming to then have the ear of big finance’s so-called leaders, such as managers at the Too Big To Fail (TBTF) banks. Even politicians and academics get in on the act. Perhaps wanting to get out the blocks early, here we have Yahoo Finance, for example, wasting pixels on its listicle “10 Disruptive Forces In Payments For 2018

Despite – or maybe it is because of – the industry not really changing the basics of what it does in nearly 40 years, the top management of the TBTF banks along with industry-watchers then goes through the usual motions of latching on to the latest shiny thing which is being dangled in front of it. Eventually, the idea filters down the organisation to some humdrum apparatchik (such as your humble writer) who has to explain why it is a load of half-baked nonsense.

Ever the optimist, this post is written in the hope that the current flag waving for this year’s contender for the Disruptor Most Likely to Succeed award Alibaba – which featured as #1 in Yahoo Finance’s list — can be debunked early on in the season thus preventing it gaining any further momentum.

I do have some sympathy for what Yahoo Finance is trying to do, because the big banks a) exploit their influence to distort the market for banking services, b) have to – always – have implicit (and, in times of a crisis, explicit) government backstopping and finally c) are generally offering poor and expensive services to their users. So everyone piles in offering what seems like sensible alternative solutions in the form of “disruptive” new entrants or financial services technology (FinTech). And the management of the TBTFs know how atrocious they are, so are ever-vigilant and readily lap up articles like Yahoo Finance’s, just in case the latest disruptive player does, in a stunning reversal of the usual form, turn out to actually be disruptive.

The problems arise as a result of critics and industry-watchers coming up with magic fixes and never thinking about – because they don’t really understand — two essential elements of what a bank needs to first do in order to offer the facilities it provides. These are, namely, product design and operations for servicing.

Taking each in turn, what exactly is a bank account and the payment system which links them? The bank account is a product. It therefore has to be designed. Someone needs to think about what features it has (or doesn’t have). Some are obvious — all bank accounts must keep a tally of the current balance on the account. And they must all have an identifiable account owner or owners. But then it becomes much hazier. Can you have a line of credit on the account? Do you offer checking? ABA routing permissions? Access to a counter service for paying in cash? Card Payments?

Now, when asked, customers would probably reply “yes please” to all the above, plus throwing in other niceties like telephone and online servicing, an iOS or Android app, maybe ForEx (if only for vacation spending, but not ordinarily resident customers might need this for remittances back “home”). And more besides. But each of these comes with costs attached. How does the account provider decide what to offer, how much to charge and who pays?

And there most definitely is a cost associated with these product features. This is because each requires the second element which is completely overlooked by people outside the industry — the operational activity to provide the various services an account requires for its features to function. Honestly, I sometimes wonder if those commentating from outside the industry think that everything that happens in a bank is done by an unseen army of mysterious workers – like the Oompa Loompas in Charlie and the Chocolate Factory. If only.

Right from the start, you need operations — checking identity for Know Your Customer requirements is demanded before you even offer an account to a prospective customer. Then there’s inevitable processing for things like changes of address, marriages and divorces. Even the simplest of account product designs needs to be able to handle situations where the account has to change its details. Deaths are another big admin area – national and local laws are very specific about how money is handled in an estate where there is a will to be executed and it is even more complex if you die intestate; it’s not an option for the account provider to simply say “oh, we never thought of that, we don’t know how to handle that sort of situation”. Changes of address must also be actioned and, again, you need to validate the details the customer is providing.

There’s more. The moment you move away from a strictly cash-only product design, you must support money transmission (payment systems). These not only bring the operational demands like clearing checks and ABA routed payments but they also present credit risk for the payee and the sender of the payment. Even online real-time payments can have transactions interrupted and cannot guarantee to roll back infallibly. The second that happens, one party is exposed to non payment.

It is even more complex than just the parties involved in the payment itself — the institutions providing the bank account to the parties has to assume the credit risk because one party to a payment system transaction might end up owing money which it doesn’t have. Turning momentarily back to a cash-only account, even with such a constraint you then get a huge overhead for cash management and cash handling.

And there’s still more… bank accounts don’t exist in a vacuum. They store individuals’ assets. So law enforcement needs to have the ability to monitor and seize funds where there are questions about their sources. Accounts might need to be blocked (think Trump’s missive on Russian citizens he wants to rough up a little – someone has to suspend their US accounts and put a stop on money transmission lest they try to repatriate their liquid cash). Courts issue subpoenas (they’re referred to as Court Production Orders here in the UK) for documentation and records so these not only have to be actioned, they must be followed to the letter.

I’m sure at this point, some bright spark would pipe up something about automation, IT and even daydreaming about AI coming to the rescue for all of these manual operational activities. And to a degree, it is possible to automate an awful lot of the routine and repeatable processes and processing. But that then lands you slap-bang into another unavoidable overhead – IT system design and maintenance. Bank IT is a train wreck. While you can move away from office buildings stuffed with clerks and data inputters, you merely squeeze the balloon and move that (in a different form) to data centres, software developers, testers, code versioning and release management, capacity planners, security and firewall systems (and their patching), virus checking, data loss prevention, backups and backup testing, disaster recovery sites and disaster recovery testing – on and on and on it goes. None of this is frictionless or zero cost.

Regulators and politicians have for decades mulled over how to answer the conundrum of how to achieve financial inclusion that doesn’t land the entire population into the maws of the banks. They usually start with the product design — and arrive at a conclusion that a basic bank account is the answer. Probably at some stage, a post office bank account is mentioned. In many ways, this approach is logical. But it is also completely wrong. You have to start with what you are willing to tolerate in respect of the quantity and complexity of the operations for servicing — because this determines your costs. Even the most straightforward of bank accounts products presents a demand for operational capability and capacity (for the reasons explained above). You then need to answer — and answering it is unavoidable, someone has to do the admin work — who pays for this and on what basis? What is your source of revenue to cover your operational costs?

If you’re not in the business of credit creation, then you have a big problem on your revenue side if you are trying to offer a full-reserve bank account. You still have a cost of goods (or services) because of all that operational overhead. The minute you start trying to charge – even on a not-for-profit basis – for the costs of providing the bank account service, you’ll deter the poorest in society unless you subsidise them in some way. And you’ll face some pretty unwinnable competition from traditional banks who can provide a subsidy on their bank account product by being willing to run some credit risk on the asset base they’ll accumulate through funds held with them on deposit. If the basic bank account provider limits the quantity and complexity of their operations (to keep the bank account product costs as low as possible), they’ll also lose out in terms of their service offer because the traditional banks can offer gewgaws and cover the costs of those through high profit credit products like loans and credit cards.

And any new entrant is just that – a new entrant. They’ll have all their start up costs. The competition (the established banks) have depreciated their IT and design costs decades ago. And, too, it is a bizarre notion that the Fed or the post office can set up a basic bank account then freeload on the traditional banks’ legacy infrastructure without paying even the marginal cost for utilising it.

For a start, bank systems have been value engineered to within a inch of their lives – there is little slack in the system to accommodate additional transactions on any serious scale. It would also amount to appropriation of private property. For instance, an ATM service is likely to be within the product feature set of even the most basic of basic bank accounts. But an ATM is a piece of property sitting in a fixed physical location for which it needs to either own the ground it sits on or pay rent. It also has its own servicing and maintenance costs, of course. No court would tolerate anyone — even the Fed or some other “social” enterprise – using these assets for free. In the same way as just because you’re hungry it doesn’t mean you can come round to my house and stick your hand in my biscuit tin (sorry, cookie jar for US readers), just because you don’t like the traditional banks doesn’t mean you can take their assets, just like that, with no compensation.

Returning to our original topic of Alibaba, but – you might say – Alibaba has a mass payment system, so surely they or someone else like them could do that, too? This was the inference in the Yahoo Finance article about how Alibaba would be the most disruptive entry in to the financial services industry in 2018.

No, all Alibaba have got is a walled garden Money Transmission system. But that’s not an interoperable Payments System. You have to sign up to Alibaba’s service – and then you’re limited to Alibaba’s pool of other service users.

As soon as you set foot (or you want to send your money) outside of their platform, you need to interface to the legacy players. I don’t see any Alibaba teller windows to pay my cash or checks into. I don’t see an Alibaba ATM I can get my money out of. Even if I did, I don’t have an Alibaba card to put in it. An Alibaba check book? Oh wait a minute, you mean I have to use their app because they don’t offer them – and so does the person I’m sending my payment to? How do I get my money into Alibaba in the first place – can I route my salary payment into my Alibaba account – no, only if my employer is also signed up to the Alibaba service too. Oh, unfortunately, Alibaba don’t offer payroll bulk clearings… so that’s fine for a Mom and Pop store and their couple of employees, but what about if I’m China National Petroleum – or social security? And who is doing Alibaba’s Identification and Verification / Know Your Customer? It looks like anyone can open an account in any name on their service, no questions asked. I’ll bet if I try to set myself up as Xi Jinping, I can do – so they’ve outsourced the fraud and money laundering checks to the legacy players. And can I have a joint account to pool money with my spouse and see what they are up to? Nope.

These are all basic use cases for any bank account type of product and Alibaba doesn’t support any of them. You need bolt-ons or you need the traditional banks. Okay, Alibaba could enhance its service offer to include these things – but then how does it do the charging for them? And how, if it moves from a low-cost no-frills service, does it compete with the credit creators (the traditional TBTFs) who can cross subsidise?

Anyone can start a service and throw money at it to try to unseat incumbent players (such as Uber is trying to do). But if it doesn’t have a viable business model, it’ll only last so long. And let’s not forget, the competition (the established banks) have very deep pockets and monopoly positions of their own to keep them afloat.

Unfortunately, and sorry Yahoo Finance and Alibaba, the big banks aren’t going anywhere anytime soon.

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  1. The Rev Kev

    My sympathies Clive on you and your colleague having to go through your ‘conference season’. Maybe you could liven it up with a sort of bingo card but instead of numbers, have the use of words like ‘disruptive’ instead and see, after listening to one of the speakers, who gets to call bingo first.
    Somehow, I am not a fan of ‘disruptive’ forces in payments myself. It sounds too much like “I’m sorry, but we just can’t locate where your pay packet went to. Maybe next week?” I have been there, done that, and gotten the t-shirt.
    To tell you the truth, I find myself a fan of big banks if the alternate means Silicon Valley (FinTech) moving in and offering their version of a banking service and getting their dirty mitts into our financial lives. I am convinced that they have no idea of what they are doing and after reading of Musk breaking his teeth on trying to be ‘disruptive’ of the automobile industry, I can only imagine what they would do with our banking services.
    After reading your article, I am reminded of the military field where it is said that dilettantes study tactics, amateurs study strategy while professionals study logistics. It sound like here in the field of banking that dilettantes study bank account design, amateurs study payment systems while professionals study infrastructure – both physical and IT.

    1. Clive

      Thank-you, but we deserve about as much sympathy as the residents of the Palace of Versailles when the peasants were at the gates demanding bread!

      1. notabanker

        Enjoy these pieces Clive. Brings back a flood of memories discussing shiny new technologies with Front Office and IT execs. Really enjoyed working with the “good” ones that actually knew how their businesses and teams work and what they are capable of. The “bad” ones could make life a living hell tho.

  2. doily

    Thank you Clive. Yes please, bring on the disruption of finance. Rational systems of finance in the US, UK, and elsewhere will not likely come into existence without disruptive social revolutions which fundamentally alter both the organisation of and public expectations of banking sectors. Wall Street and City asses need to be kicked. Large populations need to come to the realisation that banking is a public utility, its products and the operations for servicing them need to be paid for just like schools, roads, and health services. The products may be boring and transaction costs might stop going down. Fine.

    How to get from A to B? Clive says “just because you don’t like the traditional banks doesn’t mean you can take their assets, just like that, with no compensation.” The “appropriation of private property” is inappropriate. Is private property is sacrosanct, even when its value falls below zero, because TBTF? I don’t agree. What Bernie said: “If a bank is too big to fail, it is too big to exist.”


    To Bernie’s modest proposals I would add: Let’s stop using the acronym TBTF, because it is a lie. Replace it with TBTE.

    Another modest proposal: You don’t have to be a Stalinist to get from A to B. The German economy seems to do fine with a large, local authority based, inefficient, and unprofitable finance sector. A couple of quotes from this study of the German system suggest what might be possible:


    “Judging profit- and cost efficiency comparisons on an international level, one has to keep in mind that a large part of the German system consists of cooperative and savings banks that are not aiming at maximising profits. Hence, profit efficiency may be lower than for countries which have only profit oriented banks. Savings banks use part of the surplus to promote community activities and are also obliged to provide financial services to all customers, regardless of the profitability of the business relationship. Additionally, it seems that savings banks lend below market rates and therefore provide subsidised finance to firms. Cooperative banks, in turn, try to benefit their customers and members. In particular, studies that do not integrate those differences in their estimation models will overestimate cost-inefficiency and underestimate profit efficiency.”

    “The savings bank sector consists of the primary savings banks, or Sparkassen, the regional Landesbanken, and the Deka Bank. The Sparkassen are owned by local city and county governments. They are required to serve the public interest in their local community and, although they are required to avoid making a loss, profit maximisation is not their primary aim. They act as bankers to small and medium enterprises, with which they have close local contact, and they are required to meet all requests for a bank account. Most working-class and many middle-class citizens have their accounts at the Sparkassen, which enjoy a high degree of public trust.”

    1. Clive

      A huge missed opportunity (which sounds much too passive because it was quite intentional) was for the state to be able to acquire at fire-sale prices existing big finance assets including their distribution networks and back-end infrastructure. The entire industry threw itself into a pit and needed state aid (Citi was, for example, basically insolvent).

      Obama and the Fed were quite happy to give ostensibly unlimited bailout funds, extending indefinitely and then be contented simply to get paid back at par (“we made money on TARP” being one of several ginormous whoppers which were told, the reasons for which are a little too complex to go into here, they’re in the Naked Capitalism 2013/14-vintage archives).

      Of course, nationalisation would have made the industry the government’s problem (a pivotal factor, if not the pivotal one) and — as the past couple of weeks’ posts by Yves on CalPERS show — there is absolutely nothing that came down from a mountain written on a tablet of stone which says that QUANGOs or SOEs must always be paragons of virtue.

      And even if a government starts with a jewel in the crown such as the U.K.’s National Health Service, governments are perfectly capable of ruining these through crapification, “market-based reforms” and good old-fashioned incompetence. I think US-based readers can think of similar — the postal service being one, if I recall correctly.

      But at least getting natural monopolies out of private hands are, alternatively, effectively regulating them as such would make a start on improving the current position. As you say, it’s not like there’s viable alternative approaches which are at least worthy of study. Nonsense about so-called disruption is merely an excuse to perpetuate our present worst-of-all-worlds situation.

  3. Louis Fyne

    yes, clive always posts a quality mix of the view from 30,000 ft + the dirt in the trenches.

    Infinitely better than much of the academic or get-off-my-lawn blogosphere.

    Interestingly Amazon thrown out hints that it wants to get into everything except payments processing. Maybe even Amazon doesn’t want to touch payments with a 10-ft pole.

    1. Clive Post author

      Amazon Pay is a very interesting adjunct to this. Yes, Amazon kicked the tyres of this segment, made a bit of noise in the industry but then appears to have slinked away. Wise move.

      For a start, all they would be doing initially is trying to cannibalise PayPal who have a very mature offer and a large customer base who would be bound to ask why should they bother moving to something else. And trying to widen their service offer hits the same issues as I’ve highlighted with Alibaba.

      There’s nothing to say Amazon Pay couldn’t still become something Amazon make further attempts to give a bit of a shove to. But apart from being a Bezos vanity project, I simply cannot see how the numbers would ever add up.

      1. vlade

        If every Amazon client was automatically signed to Amazon pay, and send money with that to your Amazon account, that would actually give Amazon quite a large installed base right off the bat (i.e. large walled garden, and Amazon is already processing quite a few payments outside).

        Question is what would be Amazon’s angle, and I can’t see one TBH. Too much regulation for too little gain.

        1. Clive

          I’d be willing to be Amazon considered mandatory or automatic opt-in enrolling. But the service requires users to agree to the Terms and Conditions in force (this is primarily for Amazon’s benefit as it can do stuff to users without the users being able to sue, such as for reasons of denial of access to the service when they do something not to Amazon’s liking — but users also gain certain rights).

          A non-volitional sign up to the T’s and C’s would be ruled unenforceable if Amazon were to try holding users to it. So they’re unlikely to risk it. I would not, though, put it past Amazon to try it, if they really are allowed to take a position which abuses their dominance.

          1. vlade

            You could click “agree T&C” before you first time send money – to receive it, nothing needs to happen (legaly I believe it’s easier to deal with money received, especially in a walled garden).

            Then they could start with that instead of the current gift vouchers (where a user of Amazon UK can’t give a voucher to Amazon US user.. go figure)

  4. Thuto

    I’m not sure what value fintechs, operating as they do at the very top of what constitutes the banking technology stack, add to the customer-facing banking service proposition. As Clive alludes to in the post, the sort of back-end bi-directional interfacing with legacy systems needed for a fintech to offer even a modicum of value to a banking customer flies in the face of these claims that they’re “disrupting” the legacy players. Fintech is much like online music, very sexy to have in your portfolio as a VC, but dig a little deeper and the unit economics of both just aren’t that enticing if you’re in the business of investing in businesses whose value creation is foundationed on more than just Silicon Valley hype but (of course there are plenty of public markets mr moneybags you can offload to at a premium, to say nothing of private dumb money).

    What’s more, the big banks also have their own offerings at the top of the banking tech stack so i’m not sure how this combination of dependence on supposed victims of your disruptive market influence, said victims having their own offerings in the only layer of the tech stack you can operate in, and unsustainable business models owing to poor unit economics is supposed to bring down the big banks.

    1. Rates

      Cost savings i.e. absence of legacy cost. Peer 2 peer is able to reduce the interest rate charged to consumers because they are leaner. No brick and mortar, no legacy IT systems. Interfacing with legacy IT systems of the big banks is a separate issue.

      I think the Silicon Valley hope is that one of these fintechs might get big enough that they can afford to rewrite the OS of the banking systems i.e. in the future it’s the big banks that will need to interface with the new winner’s systems.

      Chances of that happening absence of the big banks imploding is zero.

      Is there hope then for fintechs? Yeah, suppose the next time the big banks are not bailed out …. er…. never mind, no hope.

  5. Synoia

    I worked in Banks. Here’s what I learned:

    2-4% of the Expense budget was spent on Software, from about 1964 to now.
    Lets call it 3%.
    Lets assume 1% of the code was re-written over time, leaving 2% of the expense budget as legacy code.
    Legacy code = it’s not broken, don’t fix it.
    1964 to now is 54 years
    Now there is 2% x 54 invented in legacy code, or 108% of the total expense budget.

    Good luck replacing that without a much larger budget.

    I also worked on Customer Facing call centers, and had to connect legacy system to a Customer Service rep.

    In one major US medical provider, the non-medical side had over 50 legacy system from which we had to pull information. God alone know what was on the medical side of the business.

    And this is what I deduce:

    1. Expertise in legacy systems is a stable job for life.

    2. The F35 software is the milirary’s new legacy Airplane operating system – currently late, bloated, full of scope creep, hard to test, eventually irreplaceable, and will be paying its support staff for life.

    In the UK? Receive pay? – you’ve used my code.
    Used an ATM? You’ve used my code.

    1. notabanker

      I think your math is reasonable, but even if it’s +/-50%, the point is still spot on. As long as it works it’s not going to get fixed. Banks aren’t full of legacy software for lack of new banking OS’s, the conversion costs are astronomical and disruptive. And there’s not any M&A 1x expense to bury these kind of projects like back in the Naughties.

  6. chuck roast

    Thank you Clive.
    Recently, I wanted to give a small donation to a pol. in the mid-west that has always kept the faith. However, I did not want the pol. to know my actual name and address because of the endless abuse that this information could produce. So, I figured I would send the pol. a money order with bogus name, address and occupation. Kind of like the Kochs do, only on a smaller scale.
    So, I go Bank of America and they tell me that they don’t do money orders, they only do cashiers checks. They also want to know if I have an account with them They want see ID and want $10 for the “service”. I told them that they weren’t providing me with any “service” and walked out. The same thing happened down the line at another bank.
    I finally wised-up and went to the USPS where they promptly took my cash plus $1.50 and gave me my money order.
    A US Post Office Bank please!

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