- March 01, 2016
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Interview Transcript: “Banks cannot compete with P2P unless they are digital banks"
Chris Skinner, founder of the Financial Services Club in Europe, and writer of Value Web and The Digital Bank, mouths the words banks fear the most: think of the future as one where traditional products make no money. That’s exactly what the P2P lenders are doing—squeezing margins of banks hobbled by traditional structures and products, forcing them to make money other ways.
Emmanuel Daniel (ED): As purveyor of all that is happening in the fintech space around the world, you collect all of that insight in terms of who’s doing what in the fintech space, be it payments, data analytics, peer-to-peer (P2P), etc.What would you say is the general trend that is taking place that banks need to be most afraid of?
Chris Skinner (CS): Banks just need to be afraid of everything in terms of fintech, technology, and change. I think they probably do fear change because no one likes their cheese to be moved, and that’s really where they have to wake up. There’s a lot of things happening; there’s a lot of change taking place very quickly in the markets with technology in the fintech space. A lot of new companies are growing into billion dollar companies almost overnight, and these companies are only 3, 4, or 5 years old.
So really it’s being aware of what those companies are doing, where they’re playing, and what impact that has on the core banking business. And for a lot of this, the impact is negligible; it’s on the periphery of the business. Should any of this start to get to the core of the business, then banks are likely to be acquisition targets.
ED: We’re now having this chat at a time when banks have woken up; it is a boardroom-level discussion. Your books are selling well. Is the empire striking back, and are banks trying to wrap themselves around this nascent development in a way that potentially could reshape fintech into the image of the banks themselves? In other words, they’re not really going to be disinter mediated. The game plan is still up in the air.
CS: For a lot of banks, the issue is actually leadership. It’s all about changing the culture of the bank, and getting the culture of the bank to reflect a technology-led operation and organisation. Most banks don’t have technologists in their decision-making boardroom; they have accounts and risk managers and compliance people. They don’t actually have people who understand technology and technology leadership. There’s only a few banks out there that are really pushing the envelope. Most of them are from Asia, particularly China, such as We Bank and Yes Bank, because you’ve got Alibaba and Tencent.
Equally, banks like DBS are pretty much at the forefront because they are investing in technology-led change. Banks like BBVA, which happens to have a programmer as their chairman, Francisco Gonzalez, are spearheading technology-led change. So it’s technology-led change in banking that’s the challenge, and about two-fifths of banks don’t have the technology leadership to do that change.
ED: Let’s talk a little bit about where banks actually are today. What are the inflection points you are looking at? At which point do you think that real change will take place? Peer-to-peer lending; at which point does it become a phenomenon? Or is it already a phenomenon that’s going to coexist with banks? Do banks have to figure out a way to onboard this way of doing business that’s going to transform what they look like?
CS: Peer-to-peer lending is a good example. Most P2P lending in America is actually institution to individual lending because they source most of their funds from the institutions or investment markets, rather than from individuals, which is the true P2P model. Having said that, you’re now seeing the American lenders becoming quite mature. So you’ve got Lending Club that’s gone through an IPO, which has a partnership with Alibaba, for example. So if American businesses are sourcing components from China, they can just click a button on Alibaba and not even realize they’re getting that loan from Lending Club.
That’s a maturing model. But it’s actually on the periphery of where banks focus. Banks are not focused upon small business lending or student loans, which is where all of the lenders in the United States have grown up in this P2P marketplace. In the United Kingdom, it’s rather different. Because when you say a phenomenon, UK is now seeing a doubling year-on-year in the amount of funding that’s going through P2P lenders. They’ve taken about 4%of the credit marketplace in the UK last year, while being only 10 years old. Now if it’s 8%next year, it starts to get interesting.
ED: What we’re learning from the UK is that on the credit profiling model, and on pricing, they’re actually not very much different from banks. It’s almost like a proof of concept stage, still.
CS: To an extent. Zopa is the leading P2P lending in the UK and they’ve had a very risk-averse strategy. In fact, they themselves said that for the first couple of years, they were turning down loans that banks would have accepted because their risk models were so extreme. But what they’ve now done is they’ve got a behavioral risk analysis model that they’ve grown in house. So rather than just using Experian and FICA scores (credit scores), they’re using behavioural models to risk-assess who they lend to or enable lending to. And their rates are slightly better than banks. As you say, they’re not massively different but they’re better.
ED: So what seems to be evolvingis that proof of concept is a technology; it’s the robustness of the infrastructure behind it. But on the front end, really it’s more the same as it was; it’s just different ways to eat a pizza.
CS: Yes and no. The fundamental difference between Zopa and the banks is that Zopa is doing lending through software and servers. And so all the analysis and all the risk modeling is in the software and servers. Therefore, there are no humans involved in the process. The typical bank credit risk model isn't the same in Zopa. So Zopa would claim—and I agree with them—that they’ve got a very different business model compared to a traditional bank model. Having said that, if you look at a lot of the other capabilities sitting on top of the banking system such as all of the payment stuff, they sit on top of Visa, Mastercard, and the SWIFT bank system. Zopa is not replacing it with a different system.
ED: So it’s still a work in progress in that way. Your book, Value Web, is fascinating because you are suggesting that the business that banks are in should be the same business that fintech companies are in, or anyone playing in the internet space. They have to capture, demonstrate, or create value. And that value is not necessarily the commodity in which they are trading. So it’s not the money, it’s not the merchandising; it’s the trust, it’s the dependency in those ways. Tell us what you mean by value.
CS: The two books go together. Digital Bank was all about how to convert a bank to a digital bank rather than a physical bank. And the reason why that’s important is that we’ve moved from the physical distribution of paper through buildings and humans and branch networks to the digital distribution of data through software and servers on the internet, a globalised network. And that demands a completely different thinking as the foundation of banks. Banks are just data, anyway. That’s what they’re dealing with—bits and bites of information about value.
Value Web is saying when you look at the fintech community, they’re creating a new internet of value, such that we can exchange value in any form. It could be currency, or equally it could be ideas, evenair miles; anything we think of as being valuable. And by using the technologies of embedded chips in everything, and shared ledgers on the blockchain, you can do that exchange of value, store of value, near enough to freely and immediately transfer that information and value between each other.
So on a globalised basis, I can exchange value immediately and for almost nothing. Historically with the banking system, it’s taken days to do this. I got a payment, for example, last year from Brazil. It took 20 days to get through to my account. I got a cheque from America last year. It took 31 days to be credited to my account. It cost me $100 to get it processed. This should be free. It should be immediate. It shouldn’t cost $100. It shouldn’t take a month.
ED: The asymmetry of information, the asymmetry of infrastructure is where banks make money from today. And if you say value is something that the customer values, and you say that it should be free, so therefore what’s the business proposition for the bank or for the intermediary?
CS: I think banks have to think of the future as being one where traditional products make no money, make no profit. And that’s exactly what the P2P lenders are doing with the credit marketplace. They’re squeezing the margins and saying as a bank, you can’t compete with us unless you are a digital bank. And even then, you’re not going to make much money out of your traditional lending structures and products so you’ve got to make money in other ways. And it’s providing far more value about the information that the customer is getting about their currency, money, exchanges.
ED: It could be creating all that value, all that transparency, all that information, all that empowerment. But where’s the money?
CS: You make money out of providing more knowledge about money. So a good example is Bank of America teaming up with Cardlytics to offer coupons and vouchers at the point of relevance, rather than just being a coupon in the post. The customer gets alerted about the coupon as he or she is walking past the store, or about to order goods on the internet, saying “you’ve got this loyalty voucher that you can use for that internet purchase you’re about to make.”
It’s having far more contextual knowledge about the customer; far more analytics about who they are, what they’re doing, and personalizing every transaction and also providing predictive, proactive services around that information so that I, the customer, can actually get something given to me before I think I need it.
ED: Just taking that example of having a cheque take 31 days to clear from the US to the UK, take that and put that on blockchain. That’s the big topic that everyone's talking about. Everyone refers to blockchain like they’re talking about Godot. And everyone thinks they’re seeing Godot; they think they know who Godot is but nobody's ever really described him or put their hands on him. A question I love asking is, on what programming language is blockchain written today? And absolutely nobody has ever been able to tell me.
So someone's doing the programming work and it would be nice to know what’s the real-world description of what they’re working on. There is this fear that when a lot of people talk about blockchain, they only mean taking that cheque processing that you talked about and putting it on a distributed ledger, which means that all of the parties in the transaction get to see each other’s ledgers, or share the ledger. And therefore, have that whole transaction process done immediately, transparently, and in what used to be called straight-through processing, in a way. Is that the correct layman’s understanding or is there something fundamentally different about blockchain and how we should work with it?
CS: I think there’s something fundamentally different about blockchain in terms of what Satoshi Nakamoto launched to the world in 2009 when the Bitcoin whitepaper was released. It’s the ability to transfer anything of value between anybody and record it irrefutably as proof on the internet. And then the programming languages are people taking that protocol of the blockchain technology and developing it into different services. So you now have lots and lots of startup companies—hundreds of them—developing blockchain-based capabilities of, for example, the recording and identification of diamonds as they move around the world for a company called Everledger. You’ve got companies like Ripple creating shared ledgers for the backbone of bank systems. You’ve got R3 creating a new Swiss style shared ledger based system on the blockchain for global clearing and settlement.
You’ve got a lot of clearing and settlement companies growing, like Digital Asset Holdings, along with hundreds of companies developing specific things in banking and financial services as well as generic things in other areas. The UK government, for example, just came out with a paper from the chief scientific officer saying we should use shared ledgers—blockchain—for the issuance of passports, for tax collections, for benefits distribution, for mortgage transfer, house sales, you name it. This is a technology you can use for that capability.
And the real reason why it’s so important, because it’s rebuilding everything, is that the protocol gives you an irrefutable proof of the existence of something, or the value of something, or the store of that value of something, which can therefore be developed as an internet-based proof for any illustration of where you need to record the exchange or the store of value. And that’s why it’s so important.
ED: What’s interesting about this so-called protocol of blockchain is that it doesn’t yet exist. There’s a protocol for the internet, TCPIP; there’s a protocol for bitcoin, and that’s what makes it successful. All of the players entering into developing blockchain models would like to corner this protocol definition. And so a lot of the work is still very much in early days, and that is why I fear that a lot of the work is nothing more than automating what exists in straight-through processing today.
CS: But with R3, you’ve got 42 banks investing in this consortia of knowledge, proof of concept using blockchain technologies. You’ve got 11 that have now committed to using Microsoft Azure and Era 3thru R3 for developing a clearing and settlement system between global banks. That’s what you call shared ledger. It’s shared between that closed environment. Eventually, that shared ledger might become an environment used by all the banks. That’s what SWIFT is; it’s just a shared ledger but it happens to be one built on old technologies. It’s shared by all the banks of the world as a global messaging network, a transaction network.
ED: How should the institution be configured around this way of thinking about sharing ledgers?
CS: To a large extent, it’s saying do you want to get experience and knowledge about this capability early, or do you want to wait until someone's developed it and you just have to take what they’ve developed? Now, the banks at the moment who are leading in this development of blockchain-based shared ledger for financial services are UBS, JP Morgan, Commonwealth Bank of Australia. A number are investing in key startups like R3, Digital Asset Holdings, which have 13 banks investing $52 million in their last round of funding.
You’ve got a lot of developments like UBS with Clearmatics developing clearing and settlement blockchain-based capabilities. And if you just want to wait until they’ve developed it and then you’re forced to use what they’ve developed, then you can sit back and ignore this. Otherwise, you might say actually, I think we should be in a leadership role here as well; we should be investing and getting into this space early. Maybe we should be leading this space.
ED: In all the examples you have mentioned, they are about trading rather than banking; the trading assets of banks, and actually between banks. That’s actually an issue in itself, which is so much of what banks do is between themselves rather than with the customer.
CS: Companies like Wave and Trade Alert are doing trade finance supply chain asset tracking. You’ve got a number of launches offering consumer-based, Bitcoin-based wallets that can store any currency as well as Bitcoin as a currency. Across the whole raft of banking—retail, commercial, investment banking, we’re seeing proof of concepts, experiments that are purely blockchain-based, some Bitcoin–blockchain-based, some not Bitcoin–blockchain based. We’re yet to see one become a winner.
And that’s the real question: which one is going to be the winner in these key spaces? And once they’ve become a winner, are you actually going to be part of understanding and using their network or are you excluded?
ED: That suggests a world where proprietary networks continue to dominate, and assuming that banking continues to be a privileged business—highly regulated and so on. But that’s not what blockchain offers.
CS: It offers the other side, as well, which is the anarchy of the internet, if you want, which is completely unregulated and unbanked. So do you want to be in a completely unregulated market where your stored value might be lost overnight, or would you rather be in one that’s actually banked and trusted with licenses?
ED: Coming back to your issue of value creation and what banks or businesses in general should think about as value, where do you think the nonbanks are heading now, such as Facebook, Twitter, and even the traditional payment networks like PayPal, for example? PayPal is simplistic in that at the back end, it’s still banking in that regard. And in China, you have now WeChat, where you can actually do transactions immediately, instantly. And it also has a stored value, which means you can use it as a purse. Are these developments going to disinter mediate banks? Are they developments that banks should take onboard? And when they do, what is the creation of new value going to be like? Because the fundamental business is something else. It’s messaging, it’s texting and so on. And the basic business of banking is something else. Where is the collaboration point? Or is that all-out war?
CS: We’re going to see some hybrid models emerging, where banks will be integrated into other services. And I think Facebook is a good example of that, where Facebook is going to have a buy button in their messenger app. The buy button will still be going through a bank at the back end, though, because they’re not going to launch a bank. Having said that, they could and that’s why everyone's watching Alibaba and Tencent and saying is the WeBank and Yes Bank going to be something that’s going to become mainstream in China, or is it just going to stay in a particular area, limited by regulation to not compete with mainstream banks?
That tends to be the model that I think everyone's wondering how it’s going to play out, not just in China, but in the US with Google, Amazon, and Facebook as well. Are they going to move into mainstream banking? I don't think so. Are they going to squeeze bank margins by layering on top a lot of friction in the services, like the PayPals did for internet payments? When you get Facebook buy buttons, when you’ve got Amazon coins, when you’ve got Google checkout that’s as easy as using the Amazon checkout and can be plugged and played into anywhere, where’s the bank’s brand going to be?
That’s really the key question, I think; that the bank’s brand becomes a back end and what the consumer sees at the front end are the services. Do they still consider the bank’s brand to be important to them? No because the bank is just a service that’s plugged and played into everything else. And to a large extent, I think that’s where we’re heading. We’re seeing the open sourcing of finance and banks become a group of APIs; anybody can plug into anything. And for the customer, they just want to know they can trust their money will not be lost. And at the moment, the best way to have that trust in terms of value stored is in a bank because it’s regulated.
ED: In your next book, what are some of those catches that you’ve started taking into account?
CS: I think these two books kind of go together so what I'll probably look at next is what’s going to be the next generation of technologies that will change maybe the internet or banking. And what we’re really seeing now is a lot of discussions around data analytics and the ability to use artificial intelligence and deep learning to start doing interesting, new things. We’re seeing this emerging already with things like DBS and UBS, who are both using IBM’s Watson for deep data analytics on wealth management portfolios.
But I think we’ll start to see a lot more deep learning coming out of Google, Amazon, Alibaba, and others, where banks will start to incorporate into their operations for this predictive analytics that I referenced earlier, the contextual knowledge of the customer. And the idea that rather than having to program knowledge about customers into transactions, the system learns your transactions and behaviors and starts to proactively inform the customer on a one-on-one basis.
ED: Do concepts like robo-advisors excite you? Do you think that it’s got some way to go? The reason I ask what you meant by predictive analytics is the learning aspect of machines or software. And we accede to robo-advisors because we just assume they’ll take into account every possible, knowable information and then process it for the customer, and that hopefully, they will learn, as well. Is that something that you buy into? Do you think it’s a possibility?
CS: I think we’re still in its very early days. The robo-advisors out there at the moment, like the Betterments and the Personal Capitals of this world are still having a lot of human interaction behind them. The deep learning capability is not yet even really tried and tested. It’s going to be another decade before we really start to see this come into mainstream usage in finance. And the deep learning that I'm getting at means that you wouldn’t have human wealth management advisors in any form being required, because the system is automating and learning by itself. Therefore wealth management becomes part of its deep learning without any human mind or hand involved.
That is a long way away, at least 10 years away before we get to that stage. The robo-advisors we see today are interesting. But they don’t excite me that much because I think we’re going to see something massively different in a decade.
Categories: Interview Transcript, The Banking Conversation
Keywords: Fintech, Peer-to-peer Lending, Digital Bank, Blockchain, Robo-advisor