Banking on the future

British banking is celebrating its 1,000th birthday. Essentially it is still simple, but has never felt more complex or undergone such changes.

British banking is fast approaching its 1,000th birthday. The first bank is thought to have been formed by the Knights Templar, operating out of the Temple Church in the City of London. They took deposits in from pilgrims and crusaders on their way to Jerusalem and paid it out when they arrived, releasing funds via a letter of credit.

They then moved into lending when King Henry III wished to borrow to buy the island of Oléron off the west coast of France, securing the annual payments against his gold and jewels. 

The Italians took things further, issuing credit notes and dealing in foreign exchange to allow their merchants to trade freely with the world from their ‘banchi’ (benches). The margins must have been pretty good as the Medici rose to become one of the richest families in history. New entrants came in of course over the centuries, but fundamentally banks did not change that much – they took in deposits, made loans and helped facilitate trade.

According to historian Niall Ferguson, for much of the twentieth century banking was really very boring indeed. Bankers, he claims, used to live by the 3-6-3 rule. You paid 3% interest on deposits; charged 6% interest on loans; and were on the golf course for 3 o’clock. 

As technology developed and globalisation increased, banks developed insurance products, credit card services, online banking and derivative markets. Some attempts to get ‘more interesting’, such as the sale of services like Payment Protection Insurance and the trading of Asset Backed Securities, ended in disaster and the Global Financial Crisis significantly increased the regulatory and capital costs of running a bank.

Technology advances have allowed a raft of simple, cheap start-up banks to take market share and interest rates at historic lows have reduced banks’ margins. 

As they have grown bigger in recent decades, they have become massive human cost bases centred around the handling of cash and foreign exchange, the granting of loans and the clearing of cheques. Technology has become extremely complicated due to mergers and new products. Furthermore, financial technology (‘fintech’) companies are encroaching on these areas, offering new services from mobile payments and digital wallets to online advice. Finally, in a world of interest rates near zero (and negative in Europe and Japan), is the current banking model sustainable, especially given the much larger costs relating to IT and regulation required since the 2008 crisis? 

The younger generation’s use of banking is led by their phone. They want to be able to pay for items via apps and don’t feel the need for hard currency or the intervention of a person. What they will need in the future is connected services and tools that help them monitor and manage their finances. They want their finances administered for them in a connected way. It is these services that banks will need to supply if they are to not merely become the infrastructure over which payments are made, with little added-value.

Traditional banks can, of course, take advantage of what new technology offers, and are ‘disrupting themselves’ by creating their own digital bank brands, such as RBS’ “Mettle” in the UK. They can also effect their own digital transformation from within. This can take time, but banks globally have been addressing the challenge of modernising their technology and their online banking offering has improved immeasurably.

“Whilst banks are moving to the A, B, C and D of technology – Artificial Intelligence, Blockchain, Cloud and Data – the E for Experience will continue to be hugely important as with other customer-centric businesses.”

There are still growth areas to develop. The rise of not just entrepreneurs and the super-rich, but of the middle classes with investment needs, especially in Asia, has led to a focus on wealth management by many banks. It does not require much capital to advise clients on how to conserve and invest their wealth, and the returns on equity are much higher than for simple banking transactions.

In banking, small is rarely good. Big can cope with the increasing cost of regulation; big can diversify away from single products and risky customers if run properly. But big can also become too complex and unwieldy and, as we saw in 2008, can be ‘too big to fail’ with disastrous ramifications on a global scale.

Also, importantly, banking remains a trust business, and regulatory trust is hugely important. The regulatory reaction to Facebook’s proposed Libra digital currency project highlights this. The traditional banks have long established relationships with the regulators which will be difficult to replicate. They have the trust of their customers as well as their security and identity to safeguard, which will become ever more important as more banking is done remotely.

Finally, banks need to make money to be sustainable businesses and to continue to be allowed to operate by the authorities. Even the big fintech startups will need to stop giving away their products for nothing and make a profit, and the issues at Metro Bank are an illustration of what can happen when your finances deteriorate and you fall out with the regulator.

Whilst banks are moving to the A, B, C and D of technology – Artificial Intelligence, Blockchain, Cloud and Data – the E for Experience will continue to be hugely important as with other customer-centric businesses.

The bottom line is that it is likely that the consumer will emerge the winner from the battle to provide our future banking needs.

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