What would a disruptive bank look like?

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A while back, I got into a to-and-fro on Twitter with Marc Andreessen and Chris Dixon about banking, which garnered a fair amount of interest and commentary1234, after Marc declared that he is “dying to fund a disruptive bank“.

So far, finance startups have shied away getting their own banking licence, opting to use an existing bank instead. Movenbank and BankSimple talked up their plans to shake up banking but, in the end, both dropped “bank” from their name and partnered with CBW Bank and Bancorp respectively (Simple was subsequently acquired by BBVA). In effect, they built a presentation layer on top of an existing bank. I don’t think that’s the path to the future of banking. Even if you ignore the downsides of building a business on someone else’s platform, I believe that you can’t be truly disruptive unless you build the full stack.

A bank can be broken down into two distinct businesses. The first is the infrastructure required to offer banking services: the banking licence or charter, branches and call centres (increasingly optional), IT systems, ATMs, AML and KYC procedures, connections to domestic inter-bank networks and SWIFT, the ability to issue credit and debit cards, etc. Some of these are revenue-generating (e.g. fees on SWIFT transfers, payment card interchange fees) but, traditionally, retail banks have offered “free” banking to attract customers so that the second business can offer them financial products like credit, overdrafts, loans, savings, investments, pensions, foreign exchange and insurance. This second business has attracted plenty of competition (including startups like Wonga, FundingCircle and TransferWise), but there appears to be little appetite for investing in the infrastructure required to become an actual bank.

The last company to do so in the UK was Metro Bank, which launched in 2010 (the first new high street bank to do so in 150 years) but has failed to make a make a significant impact on the incumbents’ market share (the top four UK banking groups have 70% of the market for personal current accounts5) and is yet to achieve profitability, having racked up over £150m in cumulative losses. With hindsight, part of the reason for Metro’s slow progress is the fact that, rather than trying to disrupt the market, it challenged the incumbents on their own turf by opening high street branches (26 so far, at a cost of over £2m each) and sought to compete on customer service (e.g. Sunday opening and welcoming customers’ pets into branches). Notably, it did not attempt to differentiate itself through technology, opting instead to outsource its IT to Swiss banking systems provider Temenos.

I believe that the technology platform can provide a strategic competitive advantage. As I’ve written before, the lack of competition in the UK market bred complacency and resulted in a failure to innovate and invest in technology (banks are notoriously reluctant to invest in something that doesn’t generate revenue unless it’s mandated by the regulators). As a result, the incumbents’ core banking systems are monolithic, clunky and ill-suited for supporting the kind of services that are made possible by modern consumer technology and connectivity. 

The ability to offer those kind of services would be a key differentiating factor but would require that the new bank build its own platform. I imagine it will look something like this:

Click to enlarge

A core banking engine, with integrated CRM functionality, wrapped in an API/service layer supporting online banking, and both in-house and 3rd party apps (e.g. personal finance managers, business accounting packages). Building a new engine from scratch, rather than using an off-the-shelf product, will allow the new bank to incorporate new features and functionality, like allowing customers to control which apps have access to their account (in a manner similar to the way Twitter lets you control which apps have access to your Twitter account) and set up IFTTT-style triggers. A modern platform will also make it easy to integrate with new financial networks.

Certain traditional banking services are prerequisites, such as payment cards, access to withdraw cash from ATMs and the ability to send and receive bank transfers both domestically and internationally. However, note the absence of any mention of branches, cheques or accepting cash deposits - all services that are expensive to provide and whose usage is declining precipitously.

Commoditised products like foreign exchange, credit and deposits are a competitive market and it’s easy for customers to access competitors’ product offerings, so it would make sense to create a marketplace where customers can get direct access to 3rd party products as well as those offered by the in-house Treasury product teams. In fact, providing a banking platform-as-a-service and white label services to other financial startups could generate significant revenues.

Efforts by UK regulators to foster competition in the banking market by encouraging more new entrants mean that now is probably the perfect time to launch a bank like this in the UK. In fact, last week brought the news that one of the co-founders of Metro Bank has teamed up with the former chief executive of First Direct (HSBC’s online and phone banking brand) to launch the UK’s first truly digital bank“, although they appear to be following in Metro Bank’s footsteps by outsourcing the technology platform to Fiserv, a US financial technology provider.

The UK is arguably the best location for a disruptive bank to launch, with a financial technology talent pool that is probably the best in the world, and a sizeable addressable market that’s ripe for disruption. Once established in the UK market, a new bank will be well-positioned to take advantage of the single European market for financial services to expand throughout the EU and, with a tried and tested technology platform, it should be easy to attract the investment required to launch in the US.

The potential rewards are huge but so is the investment needed. Building a new technology platform and putting in place the support structures required is a major undertaking, not to mention the marketing spend that would be required to go mass market. VCs have become used to backing small teams of young technologists who build and launch a business over the course of a three month accelerator programme, or providing growth capital to companies that are scaling a proven business model. Whether they have the risk appetite for a disruptive bank remains to be seen.

 


 

  1. VCs Start Pining to Own a Bank at bankinnovation.net
  2. To disrupt banking, do you need to own the bank? at qz.com
  3. Financial interaction: the next generation by Roger Ehrenberg
  4. If you think ‘rip out and replace our systems’ is naive … think again at thefinanser.co.uk
  5. Calculated from the 75% quoted by the OFT in their January 2013 Review of the personal current account market less TSB’s 4.3% share after being spun out of Lloyds

 

Written by jackgavigan

April 14, 2014 at 1:23 pm

Posted in Fin.Tech

Bitcoin Part 2 – The Legacy

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tl;dr – Bitcoin will not survive long-term. The value of Bitcoins will ultimately go to ~0. However, the underlying technology and protocols are a testbed/prototype for future implementations of distributed, decentralised financial technologies.

“The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.” — F. Scott Fitgerald

I previously wrote about Bitcoin’s flaws. However, despite the fact that I doubt Bitcoin will succeed as a currency, I expect that it will leave a positive legacy. For all its flaws, Bitcoin has garnered far more usage and media attention than any previous cryptocurrency. That will have long-term ramifications, for a number of reasons.

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Written by jackgavigan

March 21, 2014 at 11:37 am

Posted in Bubble 2.0, Fin.Tech

Bitcoin Part 1 – The Flaws

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tl;dr – Bitcoin will not survive long-term. The value of Bitcoins will ultimately go to ~0. However, the underlying technology and protocols are a testbed/prototype for future implementations of distributed, decentralised financial technologies.

Currency

When I return home from an overseas trip, I toss my left-over notes and coins into a drawer. Euros and US dollars obviously get used (as long as I remember to take them with me!) but the dirham, rubles, rupees, yuan, francs, and dollars from Hong Kong and New Zealand just sit there gathering dust – pieces of paper and metal that are effectively worthless here in London.

However, for all its faults, physical notes and coins remain the only way in which you can transfer currency in a decentralised fashion. Electronic money – the ones and zeroes in our bank accounts, the records of credit card transactions and inter-bank transfers – ultimately rely on central banks and mechanisms like CLS, which keep track of how much money each bank has.

Bitcoin is an effort to bring the advantages of physical currency – specifically the ability to transfer wealth with little-to-no cost and without needing to involve anyone else in the transaction – to the electronic medium.

(Many assume that Bitcoin transactions are anonymous. They’re not. All Bitcoin transactions are recorded publicly in the blockchain. At best, Bitcoin transactions are pseudonymous; at worst, network analysis – something that security and intelligence services are very good at – can provide major clues to participants’ identities.)

I first became aware of Bitcoin in 2010, when someone paid 10,000 bitcoins for a couple of pizzas. My instinctive gut reaction was that it was an interesting technology but, ultimately, would prove to be nothing more than a fad. Three years later, I have yet to be proven correct. Enough people have supported Bitcoin that an eco-system has built up around it. There are online exchanges where you can buy and sell bitcoins for dollars, euros or pounds; payment processors that allow merchants to accept bitcoins for goods or services; casinos where you can gamble your bitcoins; and online marketplaces where you can use bitcoins to buy drugs.

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Written by jackgavigan

April 11, 2013 at 12:54 pm

Regulators encourage competition in UK banking and payments sectors

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Hot on the heels of last week’s fin.tech-themed Digital Sizzle, two important (and welcome) pieces of news from the regulators regarding the UK financial services.

Firstly, the FSA and the Bank of England have released their review of the barriers to entry into the UK banking sector. The key changes being introduced as a result of that review are a relaxation of the capital and liquidity requirements for new banks, and a reduction in the timetable for achieving authorisation, to six months.

As I wrote last week, the lack of innovation in the UK banking sector is the result of a lack of competition. Making it easier for new entrants to achieve the authorisation they need to start offering banking services should lead to greater competition and, indirectly, to more innovation, as the new entrants create service offerings that have a better product/market fit than the incumbent banks. For example, there’s a clear opportunity here for the creation of a new “branch-less” bank targeting SMEs who don’t need to handle physical cash or cheques. Once you remove the physical component from a bank’s business model, the cost structure changes drastically.

Secondly, HM Treasury has launched a consultation on “Opening up UK payments“, soliciting feedback on the government’s proposals for a “new competition-focused, utility-style regulator for retail payment systems”.

The brass ring for payments would be the introduction of a regulatory regime that makes it significantly easier for new payments schemes to plug directly into the UK payments infrastructure (i.e. Bacs, Faster Payments, the LINK ATM network), in the same way that the regulations supporting liberalisation of the telecoms market in the 1990s required that BT interconnect with new telcos, thereby attracting a slew of new entrants and spurring both competition and the development of new business models (e.g. Freeserve’s dispensation of the tradition subscription-based model for dial-up Internet access in favour of a model based on interconnect revenue). Such a move would create opportunities for companies like Transferwise and Droplet to reduce the friction caused by the “air-gap” between their services and their customers’ bank accounts.

These are significant steps forward for the UK and should ignite even more interest in the fin.tech space.

Written by jackgavigan

March 26, 2013 at 3:08 pm

London’s Fin.Tech Opportunity

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This article first appeared on the 3 Beards’ blog ahead of Digital Sizzle 8.

We're gonna need a bigger boat...

Finance and technology have been inextricably linked – and entrepreneurs have been exploiting that link – since the introduction of the telegraph in the 19th century.  Until 1851, news was carried between England and the Continent by ships. That year, however, a telegraph cable was laid across the English channel. A German-born entrepreneur named Paul Reuter (who had previously used homing pigeons to bridge a hundred-mile gap in the telegraph links between Paris and Berlin) opened a “Submarine Telegraph” office in London and negotiated a deal with the London Stock Exchange to provide stock prices from European exchanges, in return for access to the London prices, which he then sold to stockbrokers in Paris. Over the next 150 years, London grew to become one of the world’s top financial centres and the company Reuter founded grew along with it. By the time it was acquired by Canada’s Thomson Group in 2008, the Reuters Group was worth $17.6bn.

For decades, the phrase “financial technology” referred to the institutional finance sector that deals with the capital markets – broker-dealing, sales and trading of shares, bonds and derivatives. Many large, established companies started out as fin.tech startups.

In 1981, Michael Bloomberg (now the mayor of New York) was made redundant from the investment bank Salomon Brothers. He used his severance package to found a company called Innovative Market Systems to provide market information to Treasury bond dealers. In 1986, it was renamed Bloomberg LLP and by 2008 it was worth over $20bn. Also in 1981, a company called Intercom Data Systems was founded in London. It later changed its name to Fidessa and by 2008, 70% of equity trades in London were being processed through trading systems built on Fidessa software. Today, Fidessa is listed on the London Stock Exchange, with a market capitalisation of over £700m.

By the late ’90s, investment banks were embracing Internet technologies and incubating startups. Tradeweb, an online platform for trading government bonds, was founded in 1996 by a group of dealer-brokers, led by Credit Suisse First Boston. It was acquired in 2004 by Thomson Financial (now Thomson Reuters) for $385m in cash, plus an earn-out of up to $150m. Three years later, a group of investment banks reinvested in a deal that valued the company at over $1bn. MarketAxess, a platform for trading corporate bonds, was incubated by JP Morgan and spun out as an independent company in 2000. It went public in 2004 and is worth $1.5bn today.

Both those companies are based in New York but over the past few years, London has emerged as a prime location for a new generation of financial technology startups like OpenGamma and Kurtosys.

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Written by jackgavigan

March 22, 2013 at 3:49 pm

Foursquare does a down round

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11th April 2013 Update – Foursquare have finally announced a $41m round of debt and/or convertible debt. Union Square Ventures’ Fred Wilson has blogged about the round

Keith Rabois appears to be enjoying his birthday. After a Twitter tête-à-tête with Foursquare founder/CEO Dennis Crowley (which was amusingly misreported by Business Insider as “Square-bashing”), Rabois referred to “another down round” (emphasis mine) at Foursquare, which intrigued me, so I asked the obvious question:

Rabois

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Written by jackgavigan

March 17, 2013 at 8:15 pm

Examining how Paypal makes money on cross-currency payments

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Making cross-currency payments can be expensive. The mark-up (or, more accurately, the spread to inter-bank FX rates) applied to transactions that involve a currency conversion can be as high as 4%. In the past, it could be argued that the cost of processing international payments and the FX risk that banks assumed when providing the cross-currency component justified such high mark-ups. However, advances in technology now mean that the processing of such transactions can be almost entirely automated, which drastically reduces the cost per transaction, and the FX exposure can be tracked and managed in real-time, which reduces the risk. Furthermore, growth in transaction volumes means that economies of scale can be harnessed to further reduce the costs and risk.

However, mark-ups have remained stubbornly high. An example is the  “Non-Sterling Transaction Fee” that most UK credit card issuers apply when a card is used to make a payment in a foreign currency (card issuers in other countries apply similar fees). This fee is typically in the 2.75-2.99% range and is supposed to cover the costs associated with the currency conversion. However, the fee charged to card issuers by Mastercard and Visa for processing such transactions is just 1%. I’ve never been able to find out the justification for that extra 1.75-1.99%. If anyone can enlighten me, let me know!

Those juicy fees present an opportunity for companies that process credit card payments to persuade customers to pay those fees to the credit card processor instead of their card issuers. Last August, I grabbed some screenshots to demonstrate how Paypal does this.

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Written by jackgavigan

March 12, 2013 at 11:42 pm

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