Opportunities in banking…

I was flying on Friday and so got the chance to read the FT and thought Christopher Johnson’s editorial piece on the virtues of people and branches in retail banking a good read:

Much of the blame can be laid at the door of “customer services”, that amorphous tentacular monster that spawns in a global hyperspace disconnected from both banks and their customers. Banks claim to have cut costs by taking operations out of their branches into customer services, but the level of service has been cut even more. Banks are like hospitals. The more you cut nursing staff to save money, the less service you can give patients.

Banks have made it almost impossible to use branches. With great difficulty I discovered the name and telephone number of my branch manager, only to find that a letter I wrote to her had been intercepted by “customer services”, who passed it to her a couple of weeks after deciding that they could not deal with it – nor could she, incidentally.

Building societies once used branches more than banks. But one former building society asked me to deal with three different branches in the course of a year, after shutting the first, then the second, under pressure from its banking parent.

Banks still have about 10,000 branches in the UK. Many are threatened with closure because of mergers, but they will not be so easy to turn into bars in the present property market. Now is the time for our banking behemoths to go back to basics by revitalising their branch networks with real, identifiable people as managers who can offer advice as well as good service to customers.

Clearly there is an enormous opportunity to get this right, using a judicious and creative combination of technology, entertainment and design. And people are at the heart of that equation.

Regular readers might just now be falling off their chairs: “But isn’t the Park Paradigm all about a world of progressive and innovative application of technology?!? What’s this people-centric business model endorsement doing here…” I’m exaggerating of course but I thought this article was a great excuse to reiterate and clarify my strong ideas on the importance of people in many (most) areas of financial services and that my clarion call for an enlightened and progressive embrace of the wonderful opportunities opened to us by exponential advances in technology was almost always grounded in the thesis that it would allow smart, creative finance professionals to offer better, faster, cheaper, more relevant solutions and products to their customers.

Call it hubris – I’ve never worked in retail financial services before – but I am certain that with a blank canvas and by collaborating with various clever innovators in the space, I could build a new kind of retail financial services experience that would beat the pants off most of the mainstream high street banks. In fact, I would guess that the most difficult competitive factor to overcome would be to economically create a sufficiently dense/convenient network of stores, but even here there are a number of potentially creative / non-traditional approaches that may work. It might sound crazy given what has happened in the last 12 months or so, but I’m pretty sure there has never been a better time to start a new bank in the UK. Not top of the agenda for me at the moment, but something I’d love to get involved in before I hang up my spurs. I’m putting it on the list.

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I wish I had written this.

Normally this is the sort of thing I would post to my ‘tumble blog’ Everything you can imagine is real.  (This is where I now post links to articles and items I find interesting but don’t have the time or inclination or need to add any comment of value.)  But since many of you may not subscribe / read that blog, and because I think this is such a well written – concise, insightful, eloquent – essay, I wanted to post a link to John Kay’s latest editorial here.

How could banks have persuaded themselves, their shareholders and the public that they were making so much money when in reality they were losing it? The history of financial deception and self-deception is as old as humanity, but a few themes recur. A Ponzi scheme offers a high return using the funds of newcomers to make payments to earlier subscribers, and collapses when the supply of suckers runs out. The New Economy was the greatest of Ponzi schemes. It has been different this time. But not so different.

Read the whole thing. Brilliant.

Too few resisted.

We all know the old adage:

Power corrupts. Absolute power corrupts absolutely.

Put another way:

In this country, you gotta make the money first. Then when you get the money, you get the power. Then when you get the power, then you get the women. - T. Montana, 1983

Clearly this operates in all walks of life, including business. Including banking. But I agree with this excellent post from Overcoming Bias, that it is not inevitable. The corrupting nature of power can be resisted:

The moral of this story, and the reason for going into the evolutionary explanation, is that you shouldn’t reason as if people who are corrupted by power are evil mutants, whose mutations you do not share.

Evolution is not an infinitely powerful deceiving demon, and our ancestors evolved under conditions of not knowing about evolutionary psychology. The tendency to be corrupted by power can be beaten, I think. The “warp” doesn’t seem on the same level of deeply woven insidiousness as, say, confirmation bias.

In particular, given the many opportunities for making money and building businesses in banking, resisting should be that much easier: you can have your cake and eat it too. Perhaps just not the biggest cake in the world. And whether or not you choose to believe me (I’ll admit to the potential that I may be biased), many good people in the industry did resist. But hewing to the “Law of High School” (that life is a fractal of high school and a few immature jerks can and will ruin it for everyone), those that didn’t were over-represented at the top. And so it is not surprising that ultimately in ended in tears.

So be ambitious. Strive to succeed. But resist. You know you can.

Oversimplification? Maybe. But no less true.

As someone who worked in banks and capital markets for many years but is now on the outside looking in, many people I know have been asking for my take on the seeming collapse of the existing financial and banking system. With so many talking heads already contributing to the cacophony of fact, rumour, opinion and innuendo surrounding the financial markets, I have been loathe to add to the noise.

However, in particular I have been struck by the sheer volume of spurious information and the overwhelming complexity of many of the explanations emanating from a seemingly endless array of ‘experts’. At the risk of falling into the same trap I think we (in the financial community) are at great risk of creating even greater confusion and mistrust: by talking too much about the trees, we have lost sight of the forest.

The key to understanding the current fracas is this:

[(Leverage + Short Term Funding)*Opaqueness]^Hubris = Explosive Risk

Activate said risk with an exogenous shock leading to a decline in asset values, and….

tick, tick, tick…BOOM.

This is not really hard to understand. Most people could get this if explained to them. Indeed, I tried to do just that over a year ago when Northern Rock was (one of the) first to fall victim to this toxic cocktail.

So why did all those ostensibly clever people running banks and such not know about and/or understand the equation above? Well, the short answer I would posit is that they did, or at least most of them did, and they either:

• (a) thought they were clever / nimble enough to get out quickly when the tide would turn
• (b) rationally (and cynically) traded their implicit free-ish option; ie the NPV of a few years of bonuses on steroids would compensate for the bust
• (c) figured it was easier to “keep dancing” than to explain to staff, customers and shareholders why they were missing the party
• or..(d) all of the above.

And it didn’t start out as a problem. Much of what went wrong started out as intelligent and robust financial innovation and smart management, creating real value. But it worked too well. Made too much money. And somewhere along the way, critical thinking was left in the dust. The ability to question the business model, to continue to innovate, to remain open-minded was mostly crushed by the profits juggernaut that seemed unstoppable.

And this proved fatal. Because also along the way – as with all industrial revolutions – the juice was arbitraged away. But no one wanted to admit this. Inventing new and better, more profitable ways to serve your customers is hard. Something to be avoided. Delayed at least. “The next guys problem.” Better, there was a built-in mechanism allowing one to ignore it. Just add a bit more leverage. Stretch the funding gap a week. A month. A year. Obfuscate both with some structuring. Toss in the hubris that inevitably emerges when people make millions and millions commanding the heights of the economy… Lather. Rinse. Repeat. And so you have the proverbial frog that cooked in a pot slowly but inexorably brought to a boil.

The business model, the compensation paradigm, the culture, all were predicated on scarcity – of information, of competition, of resources – that drove high margins. This was once true. It ceased being so (at least) several years ago. This is what I was trying to get at when I wrote these essays in 2002 and 2003 (!)

So why is this important? How does it help us move forward? First, we need to understand that the old way of doing things – the historical business model of banking – is (and has been for a few years) obsolete. That out of this obsolescence will rise a new and different approach to providing financial services and that many of the extraordinary innovations in finance and technology can truly help create great wealth in our economies and are not the problem but are – applied intelligently – part of the solution. In these very trying circumstances, my fear is that as a society we retrench into some sort of financial dark age. Especially since I am convinced that we now have all the tools at our disposal to create an epochal change in the financial services landscape, in particular I see the potential for a radical democratization of finance. The importance and effect of such a shift over the next 30-40 years would be analogous in its impact on our society as to the impact of the Protestant Reformation: removing the monopoly heretofore enjoyed by the financial papacy would I think create a less risky financial substrate for the global economy.

I don’t want to minimize or trivialize the current crisis. But there is reason for optimism amongst all this gloom. The best catalyst for change, the best bromide against inertia is of course catastrophic failure. I think we can all agree on that.

Now what?

(…the President) insisting that the crisis came “solely from our extravagant and vicious system of paper currency and bank credits, exciting the people to wild speculations and gambling in stocks.

The period (of the past 10 years) was one in which it was easy to grow rich. There was a steady increase in the value of property and commodities, and an active market all the time. One had only to buy anything and wait, to sell at a profit; sometimes, as in real estate for instance, at a very large profit in a short time. (- a well-respected leading banker)

As you will have seen, I have not been posting much over the past several weeks. Indeed a few kind readers have gone so far as to contact me directly to ask why and in some cases to compare notes on the unfolding financial drama. There have been two main (entirely unrelated) reasons for my recent silence. The first is simply – I’ve been very very busy: as anyone who has ever started a business will know, there aren’t enough hours in the day or days in the week. I suppose the economic backdrop only contributes further to an already innate sense of urgency. The second is more practical: insofar as I can make an intelligent contribution to understanding current events and more to the point, what actions might be intelligent or appropriate and what opportunities and outcomes may now be possible or probable, it is almost certainly in taking a step (or several) back from the torrent of daily news-flow.

Not that blow-by-blow commentary is not valuable – I’ve been enormously impressed with the breadth and quality of (informed) opinion that the new information ecology has provided me in these incredible markets – just that there are many people who are already doing it, and in many cases exceptionally well – better than I ever could.

There are a number of observations I think are worth making (many though not all, would in fact dredge up ideas that have formed the foundations of the narrative here over the past three years.) And most of these I think would be more or less immune to the vagaries of the swirling markets (and so ‘waiting for it to play out’ / ‘waiting for the dust to settle’ is not really a relevant or accurate excuse.) What I have struggled with is how to articulate these observations – eloquently, concisely but yet accurately, with context – in the short form that is a blog post. At the risk of being delusional, I kept thinking to myself that this or that thesis was the basis for a chapter in a book…

There is one theme in particular – at the heart of the current crisis – that I am very keen to develop, as much as anything to organize my own thinking on the subject as so often is the case. Not the least because in addition to helping to explain the current situation, I think it will be an enormously fertile ground for generating business opportunities in the next financial services industry paradigm. (Can we now all agree that the prevailing paradigm is now well and truly dead or dying and that something new and different will emerge from the ashes of the current wreckage? Hey, if you like we can even call it the sixth paradigm, but I’m open to suggestions.

So watch this space: Part 1 later this week…