You Can Find Silicon Valley in a Bank, Not a Bank in Silicon Valley

Exploring the Interplay of Banks, Regulators & FinTech Leaders

Idea in brief

While the United Kingdom, Europe and SmartDubai have actively encouraged completely digital banks, the US is yet to. Then, there are countries like India, China and others in Africa which may just skip the intermediate evolution of banks to leapfrog to pure play FinTech banks. The unbundling of banks may be great for FinTech but from the end users perspective, a full stack approach or rebundling may make more sense.

To be fair, there are banks in silicon valley but what I meant was that a pureplay FinTech player out of silicon valley that is yet to reach the scale, sustainability and legacy of systemically important banks or banks classified as ‘too big to fail’. Also, while Silicon Valley history can be traced to the 20th century (1980's), the history of existing banks can be traced back to the fifteenth (Monte dei paschi di siena in 1472)

Until then, rivalry seems to have given way to a complementary partnership. However, as I write this -in June 2017, SoFi applied for a de novo bank charter (application open for comments on the FDIC website). So, the change has already started. Notice the rate of acceleration of growth.

This three part mini series is aimed at exploring the intricate relationship between banks, FinTech players and regulators across the world. The idea is to envision the future of financial institutions through the three lenses of scalability, sustainability and leaving a legacy.

I start with a historical perspective to understand the origins of financial institutions and to some extent money itself. On to the present state of affairs that reveals rapid disruption and technologies with the potential to shape the Future.

It is hard to imagine one version of the future because of the myriad possibilities. Therefore, different scenarios are visualized in order to guide thinking about the most likely outcome.

Peripheral developments such as the Blockchain, quantum computing, open API’s, standards such as the PSD2, machine learning and AI, Augmented Reality as well as digital identities will act as catalysts to create the bank of the future.

It is worth noting that usage of cash has not been eliminated despite predictions of its demise. Similarly, there have been discussions on eliminating money as a store of value but an alternative is yet to be developed. Could it be cryptocurrencies?

What this means is that the future may not be binary but rather quantum in nature. There could be pureplay FinTech lenders, a hybrid of banks and FinTech plays and pureplay banks that have embraced technology until human nature chooses the fittest. For now, there seems to be room for all three.

In some senses, the story of Finance and Technology (InsurTech, RegTech, FinTech etc.) will involve re-thinking the human story.

A Short History of Money

Money can be anything — shells, coins, cutlery. Its not the form it takes, it’s the value people place on the item that gives it the epithet of money. In that sense — money is anything that is a store of value, medium of exchange and a legal tender.

Initially, barter was followed by shells and cattle. Later in 600 B.C., Lydia’s King Alyattes minted the first official currency. In Roman mythology, Moneta (Latin Monēta) was a title given to two separate goddesses: the goddess of memory (identified with the Greek goddess Mnemosyne) and an epithet of Juno, called Juno Moneta (Latin Iūno Monēta). The latter’s name is source of numerous words in English and the Romance languages, including the words “money” and “mint”.

The Chinese then took over by using paper money instead of coins.

Cash has never been eliminated. Different forms of currency such as digital payments, cards, apps and cryptocurrencies have supplemented cash but not replaced it.

Marc Andreesen

Marc Andreesen (founder of Netscape and a VC) once remarked:

“We have a chance to rebuild the system. Financial transactions are just numbers; it’s just information. You shouldn’t need 100,000 people and prime Manhattan real estate and giant data centers full of mainframe computers from the 1970s to give you the ability to do an online payment.”

With the advent of the Blockchain which essentially relies on mathematics (cryptography) to secure transactions, Marc’s statement doesn’t feel far fetched. However, for Financial Services to be reduced to mathematics stored on a Blockchain ledger, winning over society’s trust is crucial. It could happen in 5 years or 50 years but the debate has already begun.

Also, while the Blockchain is more secure, it is not the most efficient use of computing power. Consider the debate around Block sizes. Regulation and identity verification are two other questions that need to be solved. Also, there is a possibility that we can have a hybrid of a Blockchain managed by a federation. In June 2017, The World Economic Forum released a white paper on ‘Realizing the Potential of Blockchain’ exploring this concept.

The Omnipotence Paradox

One of the offshoots of the omnipotence paradox is the irresistible force paradox which can be simply stated as: What would happen if an irresistible force were to meet an immovable object?

Let’s conduct a thought experiment and think of the irresistible force as technology and the immovable object to be the traditional banking system.

The answer could very well be a fusion of the two i.e. traditional banking performed through the Blockchain without intermediaries. So, if you wanted to pay someone, it would involve almost zero transaction fees but the infrastructure could be maintained by a federation of banks.

An Enduring Legacy: Policy Instruments

Banks have always been regulated. As per Mohammad El-Arian, Central banks today are the only game in town. In other words, in the absence of changes to fiscal policy, monetary policy has been the only lever used to influence economic growth. Quantitative Easing (QE) gave new life to the US economy as it recovered from the financial crisis. It is hard to imagine such influence wielded by a single FinTech player.

In simple economic terms, a $1 of money introduced into the economy by the central bank can go a bank when the central bank buys bonds from the bank. Let’s say a central bank (the Fed) buys a bond of $1 from a bank, it pays a $1 to the bank so that the bank can lend it to say a small business. This cycle can repeat many times and in economic terms is known as the multiplier effect.

Therefore, big banks have a great power to put the multiplier effect into motion. FinTech players have to reach that scale.

Scale in financial terms means funds to lend. Funds can be in the form of capital or deposits raised from general public. While FinTech players have garnered capital in the US, they have to yet become depository institutions. Therein lies a challenge.

Once Bitten, Twice Shy

With great power comes great responsibility. In case of the US, the burden of being the leading economy is that if it sneezes, the whole world will catch a cold. As the play out of the 2008 financial crisis aptly demonstrates, greed gave way to needed but restrictive regulations such as the Dodd Frank Act. As a result, creating a new financial services enterprise will entail overcoming many more hurdles and getting approvals from many other regulators than is the case with other countries such as the U.K. and the UAE.

The Most Important Lesson

The essential thing to remember is that a regulated legacy inspires trust. Every startup — be it Uber, Airbnb and even Amazon is in the business of selling trust. Trust arises out of years of scale and consistency.

FinTech players have struggled to acquire scale to the magnitude of banks. People would REALLY need to trust startups for a long time before entrusting them with their hard earned savings.

Secondly, assuming a FinTech player does get a license, long term consistency is far from given. The strongest argument yet in favor of a continued and strong partnership between banks and FinTech players is this:

While it is foolhardy to predict a future where Black Swan events are the new normal, it would seem that gaining trust is much harder to do.

Ultimately, though, it is all about putting a simple smile on a face while being ubiquitous and always present.

It is the difference between thinking of humans as ‘clients’ and as humans aspiring for better experiences. It doesn’t matter what it is. It just has to be a ‘wow’ experience each time. It could be saving time, delighting people, reducing cost or all of them.

It also doesn’t matter whether you are visible through a GUI or you are in the middle or back of the stack as long as that position is to your competitive advantage and that advantage delivers a better human experience than today.

In my opinion, the word client should be past tense. It should be replaced by the word humans. it should be a ‘human’ experience as opposed to a ‘client experience’. The word client almost excludes people who are not your clients.

It can be incredibly difficult to homogenize humans. For strategic reasons, you can create segments but the mindset has to turn towards looking at a broader set of variables that affect human life in general — Money being a huge part of it.

Having set the stage for a debate, in the next chapter, I will discuss various models of banking such as Atom bank and Monzo existing today.

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Disclaimer: This article reflects my personal thinking and does not in any way reflect the opinions of other institutions or entities.