Banks Against
Disruptors —
The Final Act

of The Ballet

de la Merlaison

We see it happening. The banks are ultimately in a position to lose their grip on banking. Not towards fintech or neobanks though.

Banks have been prophesying the most unenviable future for more than 30 years. The gloomy prophecies say that new heroes will come and spoil the banking industry so that nothing remains of banks. That banks are not effective, they are hopelessly outdated and remained in the 20th century. As Bill Gates said at the end of that same 20th century: «Banking is necessary, banks are not». 20 years have passed, banks are still working, although it seems that their time is running out.

Now a story is happening before our eyes. Messengers, social networks, search engines and e-commerce finally gain the attention and trust of consumers. The combination of these functions within ecosystems strengthens their position even more.

This is how Apple develops both as a manufacturer of user devices and an owner of Internet services that cover the vast majority of the needs for entertainment, work and education. Other examples are WeChat as a messenger with built-in tools for shopping and payments, or Instagram as a social network with dynamically developing functions of purchases and communication.

There were no players with such a frequency of contact with a client, proximity to him and such a loyal clientele. Unless an old-fashioned pub in a small British town could claim such close contact with clients and customer loyalty. And at first glance, banks have no chance, banking ecosystems will not help.

Why would you go to Tinkoff Bank’s super app if you could send money to a colleague for lunch without leaving WhatsApp? And will the ecosystem of Sberbank have the same density of contact with customers if it is not based on a social network or messenger? And can you really compare customer loyalty to banks with the loyalty of Apple, WeChat or Facebook?

By the way, a couple of months ago, WhatsApp announced plans to launch PDL loans in India. Amazon has already launched POS loans there. We stock up on popcorn. It is not small players like Funding Circle and Lending Club, who got into lending, but companies with capitalization above the largest banking groups.

Let’s stop for a moment and study the history of the issue.

The first truly successful disrupter, PayPal, expectedly left E-Commerce (due to spinning off Ebay as a separate company) in the early 2000s, and its success can hardly be overestimated. Then, with the spread of mobile communications and the advent of smartphones, telecom operators who developed mobile payment systems entered the scene. The most famous stories are M-Pesa, processing amounts up to half of Kenya’s GDP and bKash, Bangladesh. But such platforms have spread only in countries where banking was not a developed industry. In no developed country did telecoms manage to squeeze banks.

As a result of the 2008 crisis, due to tightening regulation (Basel 3) and decreasing risk appetite of banks, credit funds, MFIs, non-banks began to grow exponentially and p2p sites appeared, which reporters immediately dubbed bank killers as an ineffective and expensive player in lending. However, p2p did not and will not become a replacement for banks in lending. So, Lending Club and SME loans OnDeck have lost in value more than 90% since entering the IPO. The growth of their portfolios has stopped and there is no significant demand either from investors or from borrowers. On both sides, these are exceptions that go beyond two sigma.

For example, the volume of the current portfolio at the largest European p2p platform Mintos (about half of the European p2p market) is $ 0.6 billion, while the portfolios of each of the largest European banking groups are about $ 2 trillion. And though loan funds are growing, according to Prequin estimates, their total volume is still about $ 800 billion. They remain babies compared to banks. They are more likely to complement, rather than displace, banks. Again, we are talking about transactions with increased risk, which do not fit into the modern banking logic. And in half the cases, investors in European credit funds are American banks, a classic arbitration history due to tighter regulation in Europe.

Then there was the boom of fintech startups, the «era of easy money, ” including neo-banks, whose task was to disrupt one of the functions of banks. For example, Revolut — conversion and currency transfers, RobinHood — investments. However, as such disruption in most cases did not occur, there was no strategic inflection point.

A reduction in the cost of services for consumers is usually achieved at the expense of investors of a startup. To engage in dumping at the expense of investor funds is not a great wisdom and certainly not a strategic long-term competitive advantage. Now we can say that for most startups of this wave, the business model as a result will not be working and many of them will become targets for M&A. Moreover, a significant part of them will be already gone in the near future. And others will switch entirely to brokerage / banking models and eventually become banks.

What else is going on in the market?

We see pretty successful stories of the symbiosis of fintechs and banks, when only its balance sheet and license were on the side of the bank, and all onboarding and even risk assessment was on the fintech side. So does Cross River, on the balance of which dozens of fintechs issue more than a billion dollars a month, the most famous one — Affirm. And vice versa, neobanks with ambitions in lending, who were supposed to fight evil, themselves joined it. And they went to get bank licenses. So for example did Klarna and Revolut.

A couple of years ago, there was a restart of the decentralized finance story, where any protocols can be implemented on smart contracts: payments, loans, investments, etc. So far, this story is very niche and has extremely vague prospects at the moment. At the same time, the decentralization technology itself assumes a significant degree of reliability, if desired — anonymity, flexibility, which not only does not let it be discounted, but also makes us expect to reveal great potential. For example, the story of DAI cryptocurrency, stablecoin secured by a pledge in the cryptocurrency, which underlies almost many lending protocols.

As for payments, a little less than a year ago, the PSD2 directive in Europe, which established common standards and protocols for payments by non-bank organizations, came into operation. The European regulator, as it were, tells the banks: „Engage in credit and investment activities, and leave the payments to other players who will do it faster and cheaper.“ Cheaper for yourself and for the customers.

And finally, around 2014, really serious players began to appear on the market. Players who added financial functions to their ecosystems. Marketplaces, such as Amazon, Alibaba, Uber, Grab, went to banking on the one hand, and social networks and instant messengers on the other. For example, the volume of payments through AliPay and WeChat exceeds the volume of payments through the national payment system of China — UnionPay, as well as Visa and MasterCard combined. About China 2020, one can even say with some exaggeration, „if something is not in Wechat, it does not exist.“ We believe that it is with them that the future of most financial services is.

The future is bright not for fintech, not for neobanks, but for large technology companies with direct access to the client.

Such a forecast primarily relates to retail lending and small business. In the corporate segment everything will remain as it is for a long time. Transaction business with large corporate clients and corporate lending are not very interesting for technology companies, as this is a low-margin and highly competitive segment. This business in terms of settlements has long been digitized by the banks themselves.

For example, many banks have for many years provided a service for organizing a single or centralized corporate treasury, which involves the automated management of a payment position and settlements on the accounts of each of the companies included in a single holding. In the corporate segment, each client needs a special approach, an individual manager and personalized services. Banks have great experience and reputation in this, so here we do not expect radical changes.

Another important factor that will have a huge impact on the development of disruptors and their place in the market is regulation.

We all remember the story with Libra and GRAM — the promising cryptocurrencies of Whatsapp and Telegram, whose stories ended in nothing. Simply because the regulator forbade them. Those who saw Zuckerberg’s speech in Congress will probably remember the main concerns of lawmakers, formulated as „danger to the nation“, „the threat of terrorist financing, etc.“ The problem is not that regulators see threats where they do not exist. The dangers can just be very real. The difficulty lies in the lack of understanding on the part of the authorities of the principles of operation of modern technologies and sometimes lack of the desire to immerse themselves in them in order to understand how they can be used.

With such regulatory approaches, it is difficult to expect breakthroughs. Regulators are conservative, cautious. On the other hand, it is difficult to expect from persons who are endowed with power and an obligation to ensure the stability of the financial system and the safety of people’s money that they will become advanced and technological right at the moment.

There is another place where regulatory influence is applied — the authorities are aware of the increasing role of technical corporations in the economy and are looking for ways to prevent their growing influence from progressing too quickly. Without artificial containment, organically, IT giants in a number of countries would have already captured the market, however, the efforts of the regulator hinder the desire of tech giants for a monopoly.

One of the great stories on this subject — and already in 2020 — WhatsApp, which launched payments in Brazil. It had a long discussion with the local regulator, but after the launch, the service worked for only a week. The Central Bank of Brazil banned it, explaining this by the desire to maintain competition. In India, WhatsApp has been discussing connecting payments since 2018. This raises doubts, first of all, not whether technical corporations will be able to make a cool financial product, but whether the regulator will let them launch such a product on the market. But even if regulators completely prohibit external players from expanding their business in the local market, this will not save banks from local technology players and companies from the Internet industry, which will inevitably try to occupy a vacant niche.

Further transition of banking functions to non-bank players largely depends on the reactionary nature of the authorities and on whether tech giants can negotiate with regulators. On the one hand, central banks fear a monopolization of the market, loss of control, especially in favor of foreign players, and, in general, all that’s new. On the other hand, such companies have previously impossible levels of the frequency of contacts with the client, and they also know much more about the client than the bank — practically everything that is critical for making credit decisions. Therefore, they also have something to offer in return.

It is very interesting and important for us to try to predict what will happen in the future with each area of ​​banking and what the fate of banks, in fact, is in it. We plan to publish several posts and articles where we will consider each of these areas. Looking a little ahead, we believe that with a high degree of probability banks will eventually cease to play a key role in making transfers and payments, managing investments and interacting with customers. At the same time, banks will most likely remain to play their key initial role — to save clients’ funds and, at the expense of them, to lend and invest. That’s probably it.

Special thanks to Sergey Khairullin who helped to write the Russian version of the Article published on Forbes Council on May 14th, 2020.