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Counter revolution
May 19th 2012 | from the print edition
FINANCE has seen plenty of dramas over the years. But one thing has remained
constant for a century at least: the branch banking system. Across most of
Europe a handful of large banks, each with thousands of branches, stand astride
their national markets. In America Depression-era legislation constrained the
growth of big national banks, but at the state level the bricks-and-mortar
architecture is pretty similar. While the rest of the sector innovated,
expanded and collapsed, retail banking has been staid and reliable.
Now an upheaval is coming, driven by technological changes the growth of
internet usage on smartphones, the rise of big data computer processing and
the increasing willingness of customers to do complicated things online. These
developments have long promised to transform the way banks do business and
organise themselves. As our special report this week argues, they are starting
to do so.
Really smart phone
The revolution will be most visible on the high street. Branches will become
less important and there will be far fewer of them. Those that remain will look
quite different. Instead of walking into one to deposit cheques or get
statements, most people will do this on the fly from their mobile phones.
Instead of opening wallets in shops and being confronted with a choice of
whether to pay by cash or plastic card, they will wave a phone at the checkout.
On it will be a virtual wallet provided by a firm such as Google, PayPal,
Square or some company that hasn t been thought of yet. If you have forgotten
your phone you will type in your phone number and a secret code (or simply
speak your name) and carry on shopping.
If this was just a more convenient way of paying, the banks would probably
shrug. But it also promises to overturn your existing financial relationships.
Instead of reaching for the first card that happens to be in your wallet to pay
for a $2 cup of coffee (and risk being charged a $35 penalty by your bank for
exceeding your overdraft limit), your phone will choose the best method of
payment. Credit cards with the highest rates of interest, or the meanest
rewards schemes, will be shunted to the back of this smart wallet. Repayments
will automatically be channelled to pay off the most expensive loans first.
Penalty fees for inadvertent overdrafts will become things of the past.
These changes will give bank customers more clout, allowing people effortlessly
to find the best deals, mainly at the expense of banks profits. Some of the
biggest beneficiaries will be migrants, who have been failed by a banking
system that charges them up to 20% of the sums they regularly send to support
their families at home. People with bad credit scores will also surely no
longer have to pay interest rates of 1,000% a year to payday lenders. But
virtually all customers should gain.
This will undermine the old model of retail banking. Pricing will become more
transparent. It will be harder to pretend that banking is free when in fact it
relies on customers giving banks virtually interest-free loans in the form of
deposits; harder to profit from the disorganisation or sloth of customers who
slip into unauthorised overdrafts or roll over balances on high-interest credit
cards while leaving cash in low-yielding savings accounts. Banks will probably
have to accept lower margins on credit cards, personal loans and mortgages.
Yet there is a big opportunity for banks, too. They will cut costs by closing
many of their branches. Banks will also tap into new sources of revenue by
mining their enormous troves of customer data. A bank that knows what you have
just bought or where you have booked a holiday will be able to offer real-time
discounts on related products (much as Google targets advertising at people
based on their searches). The retail revolution will also offer the best banks
the opportunity to gain new economies of scale through their IT platforms.
In most retail revolutions politicians have had to do little other than move
out of the way. But banks are different: their central role in the economy
means that governments have to make sure that they are both accessible and
safe.
In terms of access, some worry that as banking moves further online, the old,
the poor and the computer-illiterate will be excluded from the financial
system. But the simple, low-cost mobile-banking systems that operate in
countries such as Kenya, India or Brazil suggest otherwise.
The issue of safety is a tougher problem. Oligopolies that generate fat profit
margins and leave banks with little incentive to take risk actually suit
regulators. They have a built-in safety cushion; and if it comes at a cost to
consumers, so be it.
That cosy world will disappear as banking goes truly digital, and new
intermediaries emerge between the banks and their customers. Many regulators,
fearing that change and competition will bring greater risk, will be inclined
to smother some of this innovation, by stifling start-ups or keeping foreign
rivals out of their home markets.
They should resist that temptation. The basis of financial stability remains
ensuring that banks have enough capital and liquidity to stay in business when
times are tough. As long as they do, banks should be left to compete as hard as
they can.
from the print edition | Leaders