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Fusty old retail banking faces its biggest shake-up in 200 years

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