I like shape very much. A novel has to have shape, and life doesn’t have any — Jean Rhys
When the two brothers from Ireland founded Stripe, Patrick and John Collison wanted to change the behind the scenes plumbing through which individuals and companies could receive payments online. As per the Tim Ferriss show, their goal was to make accepting payments on the internet simpler and more inclusive. When it comes to the world of banking and financial services, their vision is shared by thousands of Financial Technology (FinTech) and pure play technology companies. In a joint venture with Goldman Sachs, Apple recently announced its foray into the credit card business. This is a move by a technology company to leverage its user base to diversify its revenue stream.
These technology companies are trying to improve the world of banking one element at a time. The incumbents also have woken up to the fact that their archaic systems need an overhaul if not for anyone, for their clients.
It is hard to imagine what the bank of the future will look like because the players in the financial services arena (incumbents, FinTechs and TechFins) are changing the business one piece at a time. Therefore, what you see changing is one scattered piece at a time and not a holistic approach. Second, while FinTechs have garnered early success, they are yet to match the scale, reputation and trust that systemically important banks (mega banks) enjoy. Thirdly, the ubiquitous branch (physical infrastructure) refuses to die especially when it comes to garnering deposits. Branches are becoming more compact and digitized. Many banks are using Artificial Intelligence (AI) to find the ideal branch location.
This article presents arguments why the bank of the future is being built one scattered piece at a time. It concludes with a different take on what the future may look like.
When India famously demonetized its bank notes to crack down on black money and the underground economy, one of the biggest beneficiaries was a startup called PayTM. PayTM enables its users to make cashless payments using its app and open Application Programming Interfaces (API’s). Open API’s are the glue that allows applications to connect to other applications seamlessly. In a very common use case, a FinTech startup uses open API’s to connect its application to the users digital bank account. PayTM now has grand ambitions to entering into the traditional banking space by gathering deposits, lending and offering other lifestyle financing schemes. PayTM has garnered investments from the likes of Alibaba and even Warren Buffet.
It is not alone. Across Europe and the UK, the Payment Services Directive (PSD2) has inspired many FinTech startups to evolve into a bank. Atom Bank and Starling bank in the UK and N26 in Germany are good examples. China is famously known to use QR codes and messaging apps to transfer billions in payments. In the US, players like the online broker Robinhood want to expand into other avenues of banking. What follows is an incredible battle to reshape and recreate the way traditional banking is conducted.
The Ship Of Theseus
In the metaphysics of identity, the ship of Theseus is a thought experiment that raises the question of whether an object that has had all of its components replaced remains fundamentally the same object.
Now, let us place the paradox in the context of banking. It is a reality that the fundamental business model of banking has not changed for centuries. In any economy, a bank mobilizes the savings of people in that economy and lends it at a higher rate to the other constituents in that economy. That is the core of banking — gathering deposits and making loans. A bank does its business using a simple trick called ‘maturity transformation’. A bank converts funds (deposits) that are of a short term maturity or repayable on demand (by incenting the depositors by paying them an interest rate on their savings) into long term loans that are repayable over longer periods and charging the borrowers a higher interest rate. It can perform this trick because the likelihood that all the depositors will withdraw their deposit in a short time is near zero.
What has changed is the emergence of an alternate universe powered by the internet, the personal computer (PC) and now the mobile phone. Clients have extended their presence from the physical world to this alternate virtual world en masse. However, much of the plumbing and the last mile of client service in banking has not changed at the same speed as the evolution of the internet. This has given technology companies and FinTech players an opportunity to redefine and in most cases significantly improve the client experience. These players are busy creating the banking experience of the future. The catalysts on this journey are exponential technologies such as the Blockchain, AI and Quantum Computing.
Piece By Piece
The future of banking may well be ‘software’. What I mean by that is a back end Operating System (OS) to which can be plugged different pieces of software depending on your place in the financial services ecosystem ie a community bank, a big bank, a FinTech player or a tech major entering the financial services arena.
The Front End
As I said before, nobody knows if and when branches will disappear but they will certainly get more digitized. As 5G rolls out, the last mile to the client becomes more amenable to digitization. With the progress of machine learning particularly natural language processing, you can expect a humanoid to do everything except offer you sophisticated financial advice.
Soul machines is just an example of automating the front end. The front end today is either a mobile app, a voice assistant or a humanoid but it could very well be a virtual branch accessible using VR. The other issue with the front end and a constant source of friction is KYC or Know Your Client.
One of the weakest links in the chain is identity verification especially for clients who are international. The problem with KYC is a bit like Facebooks’ dilemma with privacy — there is a thin line between knowing your clients well and invasion of privacy. Money laundering and identity fraud remain one of the key challenges facing banks today.
There will be a need to create a global consortium to store identity on a blockchain. Banks could then access this identity on a need to know basis to onboard or monitor their clients. Once again, there a plethora of players working on solving the KYC conundrum.
As I write this, Facebook has unveiled Libra — a stablecoin (a crypto backed by actual fiat currency). It is also the shape of things to come — digital currencies operating on a blockchain to enable instantaneous money transfers at almost zero cost all around the world.
The payments infrastructure especially cross border payments is archaic and it takes a lot of time and costs a lot of money to remit payments internationally. The Blockchain is helping democratize money transfers globally.
Amongst the many players is Ripple which already has a slew of products rolled out. It also offers interchangeability of cryptos with fiat currencies. There are many unique players vying to remake payments in their own image not least of all the networks — MasterCard and Visa themselves.
On a macro level, chat softwares such as WeChat in China and actual payments companies like PayTM in India have a massive network of people using their apps to make payments. The logical next step for these payment companies is to branch up to being a bank.
Irrespective of the players involved, payments rail that is the Blockchain and stable-coins on the Blockchain appear to be the immediate future of payments at least if Facebooks foray into payments using the Libra project is any indication. UBS also recently announced its own settlement coin.
The Back End As A Service
One of the reasons I wrote this article was a unique startup called SynapseFI. Synapse aims to make financial products available to everyone by creating a platform that allows developers to automate back office functions, issue cards, open savings accounts, send wire payments etc. among other things. It recently raised series B funding from a16z, Trinity and Core which amounted to a little over $33M.
SynapseFI offers systems that developers can plug into using API’s to service their clients. One of the most remarkable takeaways from SynapseFI is that it provides an early indication of how the backend operations of a bank can become a service with various front end applications glued on using API’s. For instance, once the back end is ready, a FinTech player can simply glue on a licensed front end, a KYC application and a deposit software all licensed from a variety of players to create a plug and play bank.
Of course, it sounds ridiculously simple but it is very hard to pull off especially considering the challenges around KYC/identity verification and money laundering.
The Way Forward
One of the ways to think about the future of digital banking is to use the IBM PC and MS Windows analogy. While the hardware is still under construction, one likely scenario is a farm of commercial quantum computers on the back end with the storage and processing power leased out using cloud computing. If such a scenario materializes, there will be a need to create a universal Operating System (OS) for a digital bank a la MS Windows style. This OS would operate on the cloud and its basic function would be to serve as a platform on which various ‘programs’ or modules from different service providers can be installed and uninstalled. For example, one program to handle portfolio management and another to manage mortgage lending etc. This OS will give its licensed user to lease software from the best in class provider and not really get tied to one system as in the case of many legacy systems that traditional banks are unable to do away with.
All the recording of transactions would be performed on the Blockchain. The really fun part would be the front end which could be a humanoid robot with which users can converse in natural language. The humanoid could use multi factor authentication including biometrics (retina scans) to authenticate the user. The user can then instruct the humanoid to execute routine banking transactions using natural language processing. For more complex tasks such as wealth management, Virtual Reality (VR) can offer access to a human advisor seamlessly.
In the end, what technology offers the world of banking is an opportunity to put the ‘fun’ back into banking using gamification, innovative front end experiences, online learning and collaboration.
As I alluded to before, putting together the jigsaw will entail the creation of a universal Operating System (OS) — a digital backbone for banks. The real magic will lie in making the world of financial services more inclusive, fun and human again. Nobel laureate Amartya Sen says:
Human development, as an approach, is concerned with what I take to be the basic development idea: namely, advancing the richness of human life, rather than the richness of the economy in which human beings live, which is only a part of it.
As the battle to remake banking rages on, let us hope all this disruption results in a worthy outcome for all especially the under banked and the unbanked. If not, why go through all the trouble?