Sean Park Portrait
Quote of The Day Title
Be so good they can't ignore you.
- Steve Martin, Comedian (on how to succeed)

Articles tagged 'banking'

The end. And the beginning.

Re-inventing industries is hard. There is no getting around this. The days are long. There are many uncertainties. There are many challenges to overcome. And yet. Just at those moments when you begin to question yourself, the industry you are trying to disrupt does something so incredibly stupid that your batteries are instantly recharged. Better, if the industry is banking or finance, the incumbent players do this over and over (and over) again. They’re lovely like that.

At the risk of wasting even more time (I’ll try to keep it short), I’d like to give you a wonderful example of this amazing ability these institutions have to shoot themselves in the foot. Not with a pellet gun but with a powerful automatic rifle. This is a story about NatWest, but if you work for one of their traditional competitors, I’m sure your institution is equally dysfunctional. Hubris is a dangerous thing.

We all know that governments and regulators everywhere are focused on tightening up KYC and money laundering rules. Whether to “combat terrorism” or “tax avoidance” or simply in a manic attempt to hold on to sovereignty in a post-sovereign digital world, it matters little. Fair enough. But the big banks, despite having spent billions on technology, have historically been pretty slipshod in ensuring compliance and so are now feeling the heat all the more and – queue giant pendulum – have been panicked into “cracking down” like there is no tomorrow. (Funny that…”no tomorrow”, but I digress…)

So now they increasingly not only make it nearly impossible to open a new account but are starting to do their level best to alienate their existing customers too. I can only imagine that, based on the rearview mirror that seems to be their primary management tool, they figure they have nothing to lose: market shares are static and customers never leave. This paradigm is especially acute in the oligopolistic UK banking industry but is present to some degree in all (developed country) banking markets. Ah but inertia is a powerful thing and they are forgetting the second part: things at rest tend to stay a rest BUT things in motion tend to stay in motion. And they themselves – through hubris? blindness? stupidity? – are ironically the ones now putting in motion the tectonic plates of customer behaviour. The wonderful thing – at least for a disruptor (or true “challenger” as they like to say in the UK) – is that the initial movement is slow, possibly imperceptible from the towering heights of the executive suite, and so gives plenty of time for these newcomers to sneak up and eat the incumbents lunch. (cf. Christensen)

NatWest Business Banking

So here’s the story. After having banked with them for 4 years, NatWest decides that it will refuse to allow our company to continue to instruct transactions unless they have a completely new set of certified documents with regard to the company directors (including me) and just to make it interesting – not sure if this is related – rejects some inbound payments coming from a sister group company (that by the way has been making similar inbound payments for over two years) causing all sorts of pain and anguish.

Just to make it even more stupid, I have been a personal customer of NatWest for well over a decade and they have all my address, identity etc. details. Nevertheless, I had to spend an hour this morning (not to mention the hours spent by our finance team dealing with this mess) going to a notaire to get a certified copy of my passport and 3 copies of 2 different bank or utility statements, in order to comply with their new, rigid, damn-the-consequences KYC policy.

Wait. It gets better. The notaire refuses to certify the statements as they are not “original” – ie they are printed out. Of course this is because banks (and utility companies) – intelligently for once – have spent the best part of the last few years getting rid of “paper” statements and so I don’t have any “original”, printed-by-some-printer-that’s-not-mine-and-put-in-the-post statements that can be notarised! And just to complete the surrealism, one of these statements comes from NatWest who politely, but firmly, “asked” me to stop receiving paper statements a couple years ago. Folks you can’t make this shit up. Hell, Kafka couldn’t make this shit up.

Anyhow I now have some certified, notarised paperwork – at a cost of CHF65 – that I hope NatWest will accept and that will allow our company to continue to be a customer. Oh goody. A customer that only runs positive balances, pays them fees and unless their policies force us otherwise, only uses online banking. A customer they would laugh at if we asked for a working capital line. Basically a one-way relationship in their favour. We can’t change our corporate bank account in a day. We have to suck it up and play their game. But, if it isn’t already obvious, we are shopping for a new bank in the UK. It’s just unfortunate timing as Fidor Bank isn’t in the UK. (Yet…) We’re looking at Silicon Valley Bank and Metro Bank. If others have suggestions, we’re open to considering them. We’re realistic. We know NatWest won’t give a damn if we leave. Even if we grow into a giant, they won’t have any institutional memory and so won’t even have any regrets. And of course maybe we don’t grow into a giant. But their risk isn’t losing one smallish corporate client. Especially one who is knowledgeable enough to push back when they act like muppets. In fact they might be saying “good riddance.”

If you don’t have customers, you don’t have a business.

But if you work in the world of startups, this approach, this cavalier attitude to customer acquisition and retention is nothing short of shocking. Beggaring disbelief. And this is not because startups are special, it’s just because they are closer to the hard reality that if you don’t have customers, you don’t have a business. Yes, Virginia this fundamental truth is lost in the jobworth-ian bureaucracies of too many big, fat, happy incumbents. And that is your opportunity.

Now some of the devil’s advocates out there might be saying: “that’s well and good but rules are rules and big or small, incumbent or startup, all banks need to comply with robust KYC and anti-money laundering regulations.” Indeed. I agree. Only – and especially in the digital age – there are dozens (if not hundreds) of more robust, intelligent, customer-friendly ways of being compliant. Compliant in actually knowing your customer. Compliant in actually combatting money laundering. Not compliant in the six sigma application of an obsolete set of procedures that were designed in a different age to facilitate compliance to the actual rules. Subtle but crucial distinction, completely lost on NatWest and other banks of their ilk.

So goodbye NatWest and thank you for giving me (for the low, low price of just CHF65) a renewed energy and determination to keep working with the amazing people who will build the institutions that nibble by nibble will eat your lunch. Q.E.D.

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Why is capital still chasing (bank) branches?

Anyone who is at all interested in innovation and disruption in banking and financial services will have noticed that the world is seeing a Cambrian explosion of startups targeting this industry. It’s an exciting time for us at Anthemis Group, as we have been working to position ourselves for this wave of change for many years. “Skating to where the puck will be” as they say…

The explosive growth of new entrants in financial services – both of individual companies and the universe of such companies – is of course exciting for us, but does pose some challenges, most of which arise from resource constraints, notably time/bandwidth and capital. We are working hard to address and overcome these challenges as we grow our unique “meta-company” model, however it continues to puzzle me how much new capital continues to be ploughed into “industrial age” business models, particularly in banking. Two (unrelated) articles that surfaced in my news stream this weekend inspired me to ask the question out loud.

The first highlighted the huge investment that has so far been required to get Metro Bank in the UK up and running – over £100mn (!) The second talks about a couple different investor consortia vying to spend anywhere from £500mn-£1bn to buy a portfolio of branches from RBS (Project Rainbow.)

While I think that Metro Bank has a (much) better approach to traditional branch banking than most incumbents, and I can believe that it is plausible that the Rainbow branches could be better managed as a “clean”, independent entity, I fail to see how either of these strategies will lead to long-term, sustainable success and strong investment returns for their backers. Neither is natively adapted to transition to the business models that will emerge as Information Age leaders. Their economics are fundamentally flawed; being more efficient/better managed will give them an advantage over the incumbents, perhaps sufficient for some short term (2-5 year) wins. But in the longer term, they are just as exposed to disruptive new models as today’s incumbents (perhaps moreso given their lack of TBTF inertia.) (On the other hand, if they are able to take advantage of their challenger status, access to capital and more nimble management to partner with or acquire some of the new Banking 3.0 leaders, perhaps they can emerge as winners in the longer term…)

The economics of truly new entrants like Fidor Bank, Simple, Moven and dozens of others are not just marginally better, but in some cases an order of magnitude (or more) better. Clearly as new entrants they face many (often different) risks in gaining adoption and scaling. And while the success of any individual company amongst these “digitally native” new entrants is not assured, I would suggest that the big winners of 21st century banking will almost certainly be found amongst these types of businesses (and not from the ranks of traditional, branch-centric models.) As such I find it ironic that much more investment capital (seemingly an order of magnitude or more) is chasing these old models.

Having worked in capital markets and the investment world for a couple decades now, I actually do understand the dynamic at work – people (especially those working for large institutions) typically feel more comfortable investing in “more of the same”: better, faster, smarter versions, sure but… Of course it is easier to make linear projections of the past into the future. Investing in new models requires people to acknowledge discontinuities and exponentials, which is admittedly hard. The thing is, if you are in the middle of an epochal change in economic and societal frameworks (which I believe to be the case), this is the only rational choice.

For anyone thinking of investing in the future of banking, I’d invite them to compare the metrics (customers, assets, volumes, unit economics, etc.) of these digital newcomers with companies like Metro or Rainbow per dollar or pound of invested capital. Now think of what any of these companies could do with £100mn, let alone a £1bn… The puck may be in the corner for now, but I’d rather be in front of the net.

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Welcome to the stack: the end of mainframe banking

Many years ago, enterprise software was written to run on mainframe computers. This was the best (only?) solution at that time that had the requisite memory and processing power to run these applications and so – despite their cost, inflexibility and operational complexity – mainframes represented the optimal computing model for enterprise applications. Until a new computing model emerged. Based on powerful, plentiful and inexpensive blade servers and a number of new, standard software components, this “technology stack” became the new optimal computing model for running more and more of the enterprise. LAMP was the new 700/7000.

Not only was this new model less expensive, more robust and more resilient, it was much more adaptable. Further, the open standards encouraged a tremendous amount of innovation and experimentation which in turn fostered the development of a vast array of specialist but compatible variations. This enabled bespoke solutions for different applications and environments to be easily developed without the need to build a new platform each time. And as each component in the stack had a very specific role or purpose, its design could be optimised without compromise.

The traditional banking business model mirrors the mainframe: a vertically integrated, all-in-one solution with all the resources and tools needed to deliver banking products and services in one big (black) box. In the context of the 20th century competitive and technological landscape this worked fine. It was the optimal solution. But like the mainframe of the computing world, the all-in-one “big iron” approach to banking is no longer the optimal business model with which to efficiently and profitably serve the banking customers of today. A new approach, predicated on assembling specialist providers of the component elements required to deliver end products and services will prove to be the new optimal business model for banking. Welcome to the (banking) stack.

Take for example the process of making a loan. This actually breaks down into a “process stack” that at a high level looks something like this:

  • origination
  • underwriting
  • processing
  • funding
  • payments
  • servicing

Each layer of this stack requires different skills and resources. The value drivers for each activity are different. Each requires a different mix of technology, design and talent and the application of fundamentally different business models and capital resources. As such, trying to house them all in the same organisation means that some or indeed each of these activities are operated in a sub-optimal fashion. Indeed, the stronger the culture, the better managed the bank is (in the context of traditional, hierarchical models), the more acute is this problem.

That said, so long as margins remained high and competition muted, with competitors operating more or less efficient and skillfully executed versions of the same business model, sticking with the “mainframe” model was just about tenable. However this is no longer the case. New entrants – unburdened by legacy technologies and mindsets – are emerging across the stack with business models that are natively adapted not only to leverage the technologies of today but that also address the changing expectations of customers in terms of pricing, design and user experience. In many parts of the stack, incumbent institutions will find it hard to compete as the best of these new entrants gain traction.

The best managed of today’s leading institutions will adapt to this changing landscape. How? By letting go of their traditional business models, opening up their value chain and making an honest assessment of where in the stack they have a sustainable competitive advantage and where indeed they do not. This is not a trivial change for most traditional banks and aside from the adjustments in technology and business model it will entail, perhaps the most challenging aspect in this transition will be to change the culture and mindset of these institutions for whom open architectures and collaboration is often anathema.

But for those institutions that are able to make these changes, the rewards will be significant. By focusing their resources and talents on the areas of the stack where they have a true competitive advantage, exiting other areas where they are structurally uncompetitive and collaborating with (and investing in) companies with disruptive new and powerful value propositions in these areas, they will successfully navigate the transition to becoming an information age bank.

Taking the example above, already it is becoming clear that the traditional models for originating, underwriting and processing loans are no longer competitive. New models from companies like FundingOptions, Zopa, OnDeck Capital, Kabbage and many others are proving to be much more effective and economical. Traditional banks should be lining up to partner with companies like these and in particular become lenders and provide core transaction banking services, areas where they do have a real competitive advantage. They should also be leveraging their strong distribution channels to drive customers to these platforms in exchange for lead generation fees. Of course for the managers and employees responsible for these functions within traditional banks, the transition will be painful, ultimately their jobs will disappear. However, in any case, this outcome is inevitable as their value proposition and competitive position becomes ever more compromised.

By embracing change and working within the grain of this new paradigm, incumbent banks can do much to ensure their future success and survival and will find it much easier to rebuild trust – with customers, regulators and their communities – mitigating the short term pain and setting themselves on a path to sustainable profitability. The alternative is to keep doing the same thing and slowly but surely rust away. The best banking executives of tomorrow will need to be as familiar with APIs and SDKs as they are with APRs and RAROC.

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A Damascene Conversion?

Though your towers were tall
and your powers were grand
you could not understand
how you fell from great heights
and you burrowed with speed
a kingdom you did lead
from heaven to hell
- A Fistful of Swoon, Vandaveer

Excuse me if I seem a bit sarcastic but I can’t help but smile. Slowly but surely the masters of the universe seem to finally be waking up to the inevitability of the eventual obsolescence of the archetypal business model of 20th century banking. I’ve been talking about this for a decade and the fact that it only took, let’s see…a gigantic global financial crisis and several years of messy aftershocks for these great and good to even start thinking about switching horses? Well, you just have to laugh because the alternative is simply too depressing.

I happened to be traveling a fair bit this past week, which for me means I actually have a few minutes of downtime to read the Financial Times (thanks to British Airways and the rules forcing everyone to turn off all electronic devices upon take-off and landing…) and stumbled upon three articles that caught my attention. First up on Tuesday was Hugo Banzinger – Deutsche Bank’s Chief Risk Officer – highlighting the fact that “Banks must regain investors’ trust” on the op-ed pages. Really?? You think?

Banks have also remained remarkably silent on how they plan to adjust their business models. Lenders will have to demonstrate that their future business models are beneficial to society, that they can be run safely and that they are able to restore profitability to make them attractive investments again.

He continues:

Many investors shy from investing in bank equity. Business models and future profitability are too uncertain. Restoring bank profitability is of utmost importance, requiring drastic actions. The standardisation of products and automation of process has to replace the tailor-made approach of many trading desks. IT investment costing billions will be necessary. The number of people on trading floors will have to drop to levels seen at exchanges. Salaries will have to normalise to levels comparable to other services industries. Capital intensive inventory for securitisation will have to return to its originators. Market making will have to be networked and back offices will have to adopt lean production methods as seen in modern manufacturing.

These changes will eventually lead to a process revolution of the kind we experienced in retail banking in the early 1990s.

All good stuff. I concur. Indeed in April 2002 I wrote1:

The industrial revolution in investment banking is all about creating a new paradigm for the execution of capital markets business. It is about reinventing the organisational mindset, replacing the traditional front, mid- dle and back office with a highly flexible and efficient product factory attached to a profes- sional cadre of relationship managers and solution providers who work with customers and clients to tailor products and solutions to be produced and executed by the factory. It is about viewing the services we provide as two distinct value propositions, one resting on the creativity and knowledge base of the bank and its bankers, and the other resting on the efficiency and accuracy of production and execution.

And followed up in June 2003 with2:

Much is promised by banks in terms of ‘putting the customer first’ and ‘delivering solutions not products’ however the reality is that, even if this is the good faith intent, the current structure of the banks is still aligned to the delivery of financial products as a holistic package with all the ancillary bits (settlement, research, payments, etc.) thrown in to a greater or lesser extent. An essentially analogue model for an emerging digital world. The ‘digital’ model breaks down all aspects of the business into dis- crete component parts and allows for each to be optimised (either in-house or out- sourced) and then packaged and delivered to the client according to their needs.

Through this industrialization of the process, the skills and functions of the bankers must equally realign, with expert designers, engineers and manufacturers on the production side, and state of the art customer service representatives on the other.

I guess I just must have been saying’ it wrong…

Next, a bit later in the week, the infamous Sallie Krawcheck – yes the former Citigroup CFO & Head of Strategy, former CEO Citigroup Wealth Management, former President of the Bank of America Global Wealth & Investment Management division – was also given a slot by the Financial Times editors to explain to us that “JPMorgan shows fighting complexity is futile”. Gee, is this complexity stuff a recent development??

But despite coming a bit late to the game, she nails it:

It is complexity that in good part defines Wall Street and forms some of finance’s highest barriers to entry…In the main, the response from regulators to the perceived causes of the downturn has been to fight complexity with complexity.

Of course I agree. Too much complexity (June 2008):

I’m not suggesting that no economies of scale make sense in banking or financial services more generally, only that they are subsumed by complexity within these ‘integrated’ financial behemoths. I even have some sympathy for the seductive logic underlying integrated business models, however in my view the theoretical benefits of an integrated model – while possibly intellectually robust on paper – are impossible to exploit in reality. It ignores what I describe as corporate entropy: ie in any corporate process there exists an inherent tendency towards the dissipation of useful energy.

Indeed – sticking with the chemical analogy and without writing a book about it – it would be fair to say that giant bank mergers are at best an (intrinsically unstable) intermediate product in the reaction coordinate and to make any sense need to be followed by a subsequent division into multiple new end products (which individually release the benefits of economies of scale and synergy without the instability engendered by excessive complexity.) So Citigroup (or UBS or HSBC or RBS/ABN Amro, etc…) should naturally “decay” to form multiple specialist firms that are more focused and efficient than the multiple firms that had been combined first to form these giants.

And too little competition (in the form of disruptive new entrants in particular):

Of course more regulations hurt the large financial institutions, but they hurt new entrants more. And competition is a whole lot scarier than regulation to incumbents. If you want to get a sense of this, you could do worse than reading Aaron Greenspan’s take on US payment regulations http://www.moneyscience.com/pg/bookmarks/Admin/read/77403/held-hostage-how-the-banking-sector-has-distorted-financial-regulation-and-destroyed-technological-progress-pdf. And similar examples exist across the spectrum of financial services and across the globe.

The irony is that most financial regulations are born through the desire to protect the little guy from losses, and to some extent they achieve this on one (direct) level but following the law of unintended consequences, the result to often is to create an environment where far larger risks (and losses) are incurred at a systemic level. And who pays for that? Well as we all know now, increasingly it’s all of us (including of course, the little guy.) Via government subsidies, interventions, increasing costs to maintain ever larger and more complex regulatory regimes, all of which need to be paid for with higher taxes and more importantly slower economic growth. Here the bankers are right, all these new regulations make our current system less able to produce growth which of course hits the 99% hardest. But then the bankers stop before asking for a level regulatory playing field that would pour fuel on the smouldering fire of new, innovative, disruptive entrants. Please Lord deregulate me, but not just yet.

But of course if you are reading this, you already know we’re working hard and investing big to help change this. And despite my slight snarkiness above, I am actually excited to see views I’ve held dearly for many years starting to be adopted by (some of) the leaders and personalities of the financial services establishment. (Indeed, Sallie if you’re reading this, I’d love to have the opportunity to tell you about Anthemis and compare notes on the future of finance. And good to see you on twitter. Welcome to the (financial) reformation!)

The third article was about Senator Sherrod Brown trying to revive new legislation is the US which would mandate a break-up of the megabanks. He states:

“I am confident that we will see the government over time requiring some divesting of assets because if [big banks] keep getting an advantage in the marketplace, and they keep growing and having a higher percentage of assets, it’s basically a government-endowed advantage. Thank you, US taxpayers.”

I wonder if we might eventually see something along the lines of the break-up of AT&T, a process that was initiated in 1974 but took ten years and lots of litigation before taking effect in 1984. However ultimately, the problem with banking is not just about size. In this respect, I have some sympathy for the banking lobby: creating 5 or 10 mini-JPMorgans or BoAs is not really the solution (although it could be an intermediate step.) Sheila Bair has also been making the case for smaller, less complex banks:

Yet instead of waiting for the government or shareholders to act, the leadership of these megabanks should take the lead in downsizing. The best way for Dimon to provide a better return to his investors is to recognize that his bank is worth more in smaller, easier-to-manage pieces. Let’s face it, making a competitive return on equity is going to become even harder for megabanks as their capital requirements go up, their trading and derivatives activities are reined in, and their cost of borrowing rises as bond investors recognize that too-big-too-fail is over. If, by downsizing, Dimon can achieve valuations comparable to the regional banks’, he will potentially release tens of billions of value to his shareholders.

More importantly, I think we will inextricably move towards a fundamental reconfiguration of the industry: away from vertically-integrated monoliths and towards an ecosystem or “stack” of firms focused on different components of the industry. The stack metaphor I think is particularly apt, not only because it is a useful conceit to describe the financial system but also because finance is essentially an information technology business and much useful inspiration can be taken from observing the evolution of the ICT industry as it moved from the mainframe to the internet to the cloud era. And it’s not entirely coincidental that I first presented these ideas at a telecommunications conference in 2009.

In such a world, it would not be inconsistent to have several megabanks with enormous balance sheets, but these would likely be very simple constructs – highly regulated and limited utilities, providing a basic deposit taking and liquidity providing function to the system. As I suggested in my AmazonBay video in 2005, the ultimate destiny of (the core) of the global megabanks might to simply become “giant regulated pools of capital.” Such banks would have relatively few employees, extremely robust but relatively limited infrastructure, and would make consistent but modest returns on their capital. They would sit towards the bottom of the financial stack, the financial equivalent of the massive (but usually faceless) data centers that run the internet…

As you might suspect, we have a number of ideas of how this reconfiguration might play out, and this thesis deeply informs our investment process and some aspects of it are already reflected in our portfolio, other aspects not yet but soon we hope. I was thinking of writing an article that would map out how we see banking services being organized in say 2022 but rather than give too many of our secrets away here and now, I think I’ll keep some of these in reserve for the moment. Especially since the industry seems finally to be starting to pay attention and I don’t want to lose our 10 year head-start on designing the future of finance as it makes my job so much easier! As William Gibson said, “the future is already here, it’s just unevenly distributed”.


1 Industrial Revolution (2002)

2 Minority Report (2003)

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More competition beats more regulation

As the “Occupy[anywhere bankers work]” movement gains momentum, renewed calls and support for more regulation of banks and other financial institutions grow. And yet.

Financial institutions are already highly regulated and one could argue that at best, this has not achieved the desired outcomes and at worst has actually contributed to some of the most egregious behaviors as the clever folks in financial institutions lost sight of the end game (ie the products and services and customers that lie at the heart of their raison d’etre) and focused increasing amount of energy and talent to working the system.

And not unlike Br’er Rabbit fighting with the Tar Baby, getting stuck and then pleading with Mr. Fox not to be thrown into the Briar Patch, the large incumbent banks pleading with the regulators not to write more rules may just be a brilliant case of misdirection.

but do please, Brer Fox, don’t fling me in dat brier-patch

Of course more regulations hurt the large financial institutions, but they hurt new entrants more. And competition is a whole lot scarier than regulation to incumbents. If you want to get a sense of this, you could do worse than reading Aaron Greenspan’s take on US payment regulations. And similar examples exist across the spectrum of financial services and across the globe.

The irony is that most financial regulations are born through the desire to protect the little guy from losses, and to some extent they achieve this on one (direct) level but following the law of unintended consequences, the result to often is to create an environment where far larger risks (and losses) are incurred at a systemic level. And who pays for that? Well as we all know now, increasingly it’s all of us (including of course, the little guy.) Via government subsidies, interventions, increasing costs to maintain ever larger and more complex regulatory regimes, all of which need to be paid for with higher taxes and more importantly slower economic growth. Here the bankers are right, all these new regulations make our current system less able to produce growth which of course hits the 99% hardest. But then the bankers stop before asking for a level regulatory playing field that would pour fuel on the smouldering fire of new, innovative, disruptive entrants. Please Lord deregulate me, but not just yet.

I’d like to coin a new phrase, “regulatory theater” inspired of course by Bruce Schneier‘s “security theater“:

Security theater is a term that describes security countermeasures intended to provide the feeling of improved security while doing little or nothing to actually improve security…Security theater gains importance both by satisfying and exploiting the gap between perceived risk and actual risk.

Regulators (and politicians) sensing the need to be seen to be doing something about the risk, fall into a trap of creating more and more regulations hoping to protect all of us from ourselves, only to create new (almost always) more dangerous and costly risks higher up in the system. Rinse and repeat. Until these risks reach the top of the pyramid and can no longer be shuffled and redistributed. At which time, they come tumbling down on all. This regulatory theater can be comforting in the short term but actually takes us further and further away from a sustainable solution to managing financial risks in our economies.

These risks exist and cannot be regulated away. Call it the 1st law of Financial Dynamics: the of conservation of risk. And I would postulate that pushed down to the base of our economic system, these risks would be easier and less costly to manage. With a more competitive and open system, with continuous renewal through many new entrants, the end users of financial services would get better (higher quality, lower cost) products and services with much lower risk of catastrophic systemic failures. Certainly – statistically – some of these new entrants would be managed incompently. Some would be frauds. People, customers would lose money. But the costs of dealing with these failures would pale in comparison to the multi-trillion dollar, economy-crushing losses that the existing system has allowed, nay encouraged to build up.

I’ll finish with an example, take UK retail banking. Concentrated, uncompetitive, legacy. No new entrants, no competition. Metro Bank, NBNK, Virgin/Northern Rock in my opinion are just shuffling deck chairs; better than nothing I would grant but essentially no real innovation, run in the same way with (mostly) the same assets, same people and same business models that previously existed. A token nod for the industry and the government to be able to say their is new competition (much as a dictator allows a hapless opponent to run in an election…) – window dressing. And even here, look at the hoops Metro Bank (who claim to be the “first new UK bank in 100 years”, QED…) had to go through to get a new banking license… If I were Cameron/Osbourne/Cable, the first thing I would do to start fixing the problem would be to create a new “entry” banking charter. Light touch. Basically just vet the founders and investors for fitness. Perhaps make them put up a certain minimum amount of the equity and/or guarantees as a percentage of their net worth. 90 days from application to charter. Nothing more. But restrict these new banks to say £50mn of assets until they have a 2 year track record (at which point they could apply for an increase in permissible assets and/or a full license.) Then oblige the large banks to open up their core banking infrastructure via APIs – analogous to obliging BT to make available their core telecom network to other operators.

I wouldn’t be surprised if within a year or two you had 30 or 40 new banks competing in various different ways, with many different (and differentiated) value propositions. And some would go bust. And some would be frauds. But even making the (ridiculous in my opinion) assumption that they all lost all of their customer’s money, and all of this money was insured by the government, we are talking about £2bn. Compare that to the direct losses of c. £23bn on RBS and Lloyd’s alone, not even considering the contingent losses and indirect costs born by the UK economy as a result of their predicament. Of course, I believe that many of these new banks would succeed and grow and any losses would be substantially smaller than £2bn. But none of these new banks would be too big to fail for a very long time (hopefully never) and although failure of even just one of them would attract headlines and aggrieved customers giving interviews on BBC1, especially if the cause of failure were to be fraud – it would behove us to put this into perspective. To not forget the difference between perceived and actual risk. To remember that huge failure even if diffuse and “no one individual could credibly be blamed” even if more psychologically comfortable, is actually much much more damaging than smaller point failures where cause and effect are more brutally obvious.

The world’s incumbent financial institutions are deeply mired in Christensen’s Innovator’s Dilemma, protected by regulatory barriers to entry that while not fundamentally altering the long-term calculus, have pushed back the day of reckoning only to make that day seem ever scarier. It might seem counter-intuitive, but I think we should be calling not for more regulation but for de-regulation of financial services (the real, robust, playing-field-leveling type and not the let-us-do-what-we-want-but-keep-out-any-competitors type). Competition is a far more robust route to salvation than regulation. Let a thousand flowers bloom.

One day…

…we might see GigaOm write this:

Amazon JP Morgan, displaying a sense of urgency that is perhaps driven by the pending launch of Apple’s tablet-style computeranti-trust legislation which will end the US banking oligopoly, is turning its Kindle device banking and payments infrastructure into a platform. The Seattle New York-based company has announced that it will allow software developers to “build and upload active content applications” and distribute it through the Kindle Chase Store “later this year.” Amazon JP Morgan will be giving out a Kindle Chase Development Kit that will give “developers access to programming interfaces, tools and documentation to build active content innovative financial services and products for Kindle. Chase” The company will launch a limited beta effort next month. From the press release:

“We’ve heard from lots of developers over the past two years who are excited to build on top of Kindle Chase,” said Ian Freed, Vice President, Amazon Kindle Bo Nusmore, EVP, JP Morgan Chase. “The Kindle Chase Development Kit opens many possibilities–we look forward to being surprised by what developers invent.”

Vertically integrated black box? Or open platform? Which type of bank makes for a more robust system? Which type of a bank is more evolutionarily fit to compete on a level playing field? I know that their is an enormous moat protecting large financial institutions from competition but I would hope they would be using the super-profits that this affords them to prepare for the day the moat is breached. And perhaps behind the parapets they are. Because I pretty sure there are an increasing number of very clever, ambitious (and even angry) folks starting to congregate on the edge of that moat and while it might take some time and a dash of luck, it would seem certain that eventually they will be inside the castle. And then, it just might be too late.

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What would Teddy (Roosevelt) do?

I have long been concerned by the rise and rise of the global mega-bank, first due to my conviction of the impossibility of managing such complex behemoths (with the dangers as we all now know having repercussions far beyond any individual bank’s shareholders or creditors) and also due to the increasing rents such a de facto oligopoly could (and so logically does) extract from the rest of the global economy. I’ve started and then stopped writing this post at least half a dozen times in the past year; partly due to a sense of ‘what’s the point’, partly due to the problem being covered by many with much (much) more influence than I, and partly (I’m somewhat ashamed to admit) due to a small underlying element of self-censorship. As some of you know, we have ambitions to raise capital to allow us to catalyze the re-invention of financial services by investing in companies with disruptive new business models in this sector, and well the big banks are not only potential sources of capital in their own right, but also have significant influence with many of the people and institutions who are potential sources of capital for us. As regular readers know, I try always to tell it like I see it but if I’m objective, I probably have had a tendency to pull my punches a bit when discussing the banking industry. But as the debate on reforming global banking takes centre stage, and at the risk of annoying some of our potential future investors with a dissident opinion, I thought it would be worthwhile to lay out my key thoughts on the subject.

Commenting on an interview with Christine Lagarde (French Finance Minister), the FT editorial page identified the issue clearly:

Weak competition is obvious to customers: financial companies demand high fees that are often calculated according to illogical tariffs. Fund managers’ charges, for example, are usually large and are often not linked to the quality, or the real costs of their services.

The lack of competition shows up to economists in the sector’s staggering profitability. In the second quarter of 2009, 29 per cent of US domestic profits came from finance. The profit-generating power of financial companies across the developed world has stubbornly remained higher than that of other companies.

There is, in addition, good reason to suppose that competitive pressures will weaken further. The recent wave of bank failures and mergers, born of the crisis, have left the sector more concentrated. With fewer players on the field – many enjoying implicit state guarantees – competition will be further enfeebled.

The followed on from a great column earlier this month by one of my favorite economists, John Kay:

But in more advanced economies, rent-seeking takes more sophisticated forms. Instead of 10 per cent on arms sales, we have 7 per cent on new issues. Rents are often extracted indirectly from consumers rather than directly from government: as in protection from competition from foreign goods and new entrants, and the clamour for the extension of intellectual property rights. Rents can also be secured through overpaid employment in overmanned government activities.

Rent-seeking is found whenever economic power is concentrated – in the state, in large private business, in groups of co-operating and colluding firms. Private concentrations of economic power tend to be self-reinforcing. This problem was widely recognised in America’s gilded age. The well-founded fear was that the new mega-rich – the Rockefellers, Carnegies, Vanderbilts – would use their wealth to enhance their political influence and grow their economic power, subverting both the market and democracy. Today it is Russia that exemplifies this problem.

But America has a new generation of rent-seekers. The modern equivalents of castles on the Rhine are first-class lounges and corporate jets. Their occupants are investment bankers and corporate executives.

So much of the conversation seems to revolve around this question of how do we deal with financial institutions which are “too big to fail”, with the turkeys running the world’s mega-banks almost unanimously (and somewhat breathlessly) insisting that breaking banks up would achieve nothing except to hurt customers.

Back in June, I set down my thoughts on what the key issues were in terms of (fixing) banking regulation, highlighting that size (of assets or business) was not the only variable to consider when assessing systemic risk, but that ‘connectedness’ was probably even more important. Certainly the combination of both is something that should ring alarm bells.

Wouldn’t it make much more sense to build a set of rules that explicitly addresses the vulnerabilities of a scale free network and as such focuses disproportion attention and resources on protecting the hubs from attack or failure. The beauty is that the digital global financial system of the 21st century and advances in the science of networks actually now allows us to do this: we can empirically and quantitatively observe, measure and manage the ‘connectedness’ of institutions. Forget the rating agencies, companies like Bonabeau’s IcoSystems and others could help the regulators create, maintain and monitor network ‘maps’ and score each market participant in terms of their connectivity. This should be the defining core metric of financial regulation and mirroring the power law distribution of the underlying network, financial regulation should focus its attention and resources in geometrically increasing fashion.

However it’s pretty frustrating to continue to read much of the ‘financial establishment’ – people who have the luxury and the privilege of being able to speak from the pages of the FT – continue to miss the point entirely and cling to a (slighty) new and improved version of the regulatory status quo. I have enormous respect for Jamie Dimon, and while I agree with him that the system must be re-engineered so as to allow any bank of any size to fail without jeopardizing the system, I disagree that breaking up the biggest banks would be damaging and serve no purpose. The rules need to be reset (to build-in automatic and steeply increasing impediments to growth in size and connectedness), but at the same time the biggest global and domestic mega-banks need to be pruned back to a size that is commensurate with this new paradigm.

The parallels between the rise and rise of Standard Oil in the late 19th and early 20th centuries, and its subsequent government mandated break-up and the rise and rise of giant global banks in the late 20th and early 21st centuries are real. John D. Rockefeller sounded every bit as sincere and paternalistic in calling for an ever bigger, ever more dominant Standard Oil – a company that would bring ‘order’ and ‘stability’ to the market making customers’ lives and choices ‘easier.’ Well of course we know that the market for oil products didn’t suffer as a result of the break-up of Standard Oil, nor did anarchy descend on the US telecommunications markets following the break-up of AT&T. I think you’ll actually find that there is a decent case to be made that things got better in both cases, with more robust and innovative markets and better value for customers. (I highly recommend that legislators everywhere take a moment to read Chernow’s great Titan: The Life of John D. Rockefeller, Sr. before reaching their conclusions as to the merits (or not) of breaking up the biggest banks.)

But the most important long-term reason to consider government intervention in the size and power of the world’s largest financial institutions is that failing to do so will inevitably starve one of the key sectors of the economy of innovation and progress with increasingly damaging results. Indeed, in the conclusion to his column Mr. Kay hits the nail on the head:

Because innovation is dependent on new entry it is essential to resist concentration of economic power. A stance which is pro-business must be distinguished from a stance which is pro-market. In the two decades since the fall of the Berlin Wall, that distinction has not been appreciated well enough.

It’s time for a change. It’s time to shake things up a bit. No?

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Platforms, Markets and Bytes

This morning I gave my presentation – “platforms, markets and bytes” at eComm 09 in Amsterdam. I’m not sure if it makes sense as a standalone but if Lee posts the video, I’ll link to it here later.

Using the tried and tested TED 20min format, it was a great opportunity for me to collect my thoughts into (what I hope was) a coherent overview of how I think technological and economic forces will shape the optimally adapted ‘industrial stack’ for the sixth paradigm. It’s a great summary of the prism through which we look at potential investment opportunities and I hope will help us articulate this more powerfully to entrepreneurs and prospective investors.

I’d love to hear any feedback (good, bad and ugly) from any of the eComm delegates who saw my presentation and hope to continue the conversation with you and others here. You can also follow me on twitter @nauiokaspark.

Thanks to Paul and Lee for inviting me and especially to those of you who took the time to respond to my call for input – it was tremendously valuable in helping me to shape and refine my thinking and in building the presentation; just a few years ago, assembling this kind of distributed brainpower would have been impossible, and I hope I never lose my ‘childlike sense of wonder’ at the boundless possibilities that technology enables.)

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Seeing the future of finance.

I first wrote here about Ken Banks and FrontlineSMS a little over a year ago, after having seen him speak at Supernova in San Francisco where he made a tremendous impression. I remember immediately being excited by the obvious possibility of leveraging the Frontline:SMS platform to provide financial services, not only in developing countries but also in more mature markets. I put ‘try to set up meeting with Ken to discuss’ on my to do list, but it never quite made it to the top as the myriad challenges of setting up our business (and moving house) in the midst of generalized global financial calamity conspired to keep it from becoming an urgent priority. Of course (and thank goodness) the world does not wait for me and an enterprising young man, Ben Lyons, spotted the same opportunity and (much) more importantly has moved to action, teaming up with Ken and FrontlineSMS to create FrontlineSMS:credit:

FrontlineSMS:Credit aims to make every formal financial service available to the entrepreneurial poor in 160 characters or less. By meshing the functionality of FrontlineSMS with local mobile payment systems, implementing institutions will be able to provide a full range of customizable services, from savings and credit to insurance and payroll.

FrontlineSMS:credit

Launching FrontlineSMS:credit a few weeks ago, Ben wrote:

Our mission is simple: leverage the mobile space to extend access to affordable financial services to rural, disconnected and impoverished communities. To achieve this end, we are constructing a series of free and open source financial modules that will allow FrontlineSMS to communicate with mobile payment systems in real time, turning FrontlineSMS in to a microfinance management information system, a payroll center for small & medium enterprises (SMEs), a collection and distribution center for micro-insurance premiums and payouts, and a detailed center for individual credit histories and scores.

Now if this isn’t a massive opportunity, well I don’t know what is. At the risk of sounding churlish, it’s an order of magnitude more substantial and important (socially, financially, economically…) than half the me-too start-ups chasing funding and customers amongst the western digerati. Take another look at Ben’s mission statement:

… leverage the mobile space to extend access to affordable financial services to rural, disconnected and impoverished communities.

I suspect the first time you read that you thought “in Africa”, or perhaps India, or developing countries more generally. But these same under-served communities (alas) exist in every country in the world, and one could even make a case for saying that for those living in a developed economy, the relative disadvantage of not having access to basic financial services is even more damaging. It seems inevitable that the approach taken by FrontlineSMS:credit will become the primary channel through which universal access to basic financial services is delivered in any country or economy. Which leaves the politicians of many European states very little time to figure out what the hell to do with all the postal employees currently cashing cheques and taking payments for utility bills, who will soon need to find more productive work. And I’m not sure how complacent I would be as a shareholder in an incumbent retail banking operation (the top executives I doubt will lose much sleep as the timeline for this kind of transition is probably 10-15 years or so, much longer than their expected tenure…) as this bottom up, platform approach to delivering financial services has the very real potential of blowing a giant hole right in the middle of their business and revenue model.

To further whet your appetite here is an excellent 10 minute introduction to FrontlineSMS:credit by Ben at Africa Gathering in London a couple weeks ago:

Ben Lyon from Africa Gathering on Vimeo.

And on my list to “meet Ken Banks”, I’ve now added “meet Ben Lyons” and hopefully this time I’ll actually make it happen…

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Bittersweet mint.

A couple years ago, I had just decided to try to build what would become Nauiokas Park.  I wasn’t entirely sure exactly how I was going to go about it but I had a vision of what it might look like and I knew the market opportunity – to develop technology-enabled disruptive business models in financial services and markets – was vast.  Also, Saul and Reshma’s inaugural seedcamp had given me an excuse (or a push) to stop ‘mulling it over’ and ‘get started’ even if I didn’t exactly know what ‘it’ was yet.

One of the first things I did was to start building a database of startups and private growth companies that I thought fell into my embryonic firm’s new investment universe,  and one of the first companies I added (on August 29th, 2007 to be exact) was Mint.com.  I had first heard of them early that year when they were raising a Series A round and the concept had always appealed to me (and I had always wondered why banks had been so oblivious to it.)  I had definitely hoped to be able to take a closer look once I had raised outside investment capital (they were already past the seed stage where I could have contemplated trying to play as an angel) and so it was one of the first companies on our internal ‘radar screen’.  Well as they say in the start-up game, it always takes longer than you expect and here we are – one giant financial crisis later – in the fall of 2009 and Mint will now be coming off our radar screen (into our archives) having gone and gotten itself acquired by Intuit for $170mn.

Mint.
Image via Wikipedia

On the one hand, it is exciting to see innovation in the space we are calling our own, succeed and be rewarded. And although I’ve never had the pleasure of meeting Aaron, I would like to congratulate him and wish him continued success with Mint and Intuit. Who knows, perhaps I’ll get to meet him in the future. Maybe when he’s contemplating his next venture? On the other hand, I can’t help but wonder if they sold too soon. I have to insert a disclaimer here – I have absolutely no idea what Mint’s financials looked like – so my view is entirely speculative, but I can’t shake the suspicion that if they had enough traction to get $170mn from Intuit, they had already hit and passed the inflection point and could have aimed at becoming (at least) a billion dollar company and owned the space.

Bittersweet? Well partly for not having invested as an angel but that’s just back-trading, so not really. Mainly it’s because – if the company was for sale – I would have really liked to have been in a position to run our slide-rule over it and, if it made sense, put in a bid, either alone or as part of a club deal with one or two private equity peers. If they have attained critical mass – which it looks like they may well have – it doesn’t take too much imagination (if you live in the sixth paradigm) to see them developing into a multi-billion dollar business over the next 5 years or so. Don’t get me wrong, I understand why management, the angels and the VCs, might find this exit attractive, especially given events of the past 24 months, but I can’t help thinking they’d done the hardest part and instead of letting a winner run, took their profits too soon.


PS If anyone knows where I can find Mint’s financials and projections, I’d love to have a look.
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