Ledgers, banking architecture and pipes

For reasons that are genuinely too boring to recount, I was flicking through New Scientist magazine over the weekend. I read the magazine very throughly, so I’m a little behind on issues at the moment, which is why I have only got as far as 29th November 1956. This issue happens to have a very interesting article on the digitisation of banking, a subject of great current interest. It also has a very useful diagram for those of us who wonder how exactly it is that banks manage customers’ accounts using computers and such like.

I think this is pretty much what it looks like round the back at NatWest, although I think Fidor may have opted for a different architecture. Anyway, the article explains the basics of digitisation, which it turns out are all to do with something called “ledger management”.

If now, when a bank clerk first accepts a cheque, he prints on it with something like a typewriter a note of the amount in magnetic ink, all subsequent operations—sorting, listing and entering in ledgers—can be done without human assistance.

Reading further on, I discovered that you can have different kinds of ledgers that work in different ways.

This only one way of ledgering automatically. The choice of a system depends on how far was is prepared to go: whether automatic book-keeping is to be done only at head office, whether in this case the accounting for all the branches, or whether branches will have their own equipment or to be grouped around sub-centres.

The article goes on by noting that banks do not seem to be making as much of new technology as they might and that “what may prove to be more serious is the determination to cling to time-honoured procedures”. Well, yes indeed. This is just what Anthony Jenkins meant when he said that banks had yet to be disrupted by new technology (shortly before he was fired as Barclays CEO). The 1956 New Scientist article was written by Nigel Calder, who concluded:

Unprejudiced scientists who have questioned fundamental assumptions have achieved seemingly impossible improvements in operations.

Interesting. I think Nigel might be suggesting that disruptive innovation comes from applying some different thinking to a problem and so we shouldn’t be at all surprised that banks didn’t invent P2P lending. Fast forward 60 years from 1956 to 2016 and we find, indeed, that bankers didn’t invent the shared ledger technology (SLT) that does indeed question fundamental assumptions about banking (and about regulation), but there is at least the possibility that SLT will indeed achieve impossible improvements in banking operations. However, it is another question entirely about whether those operations will be inside banks or not. There is a counter-argument that the new technology means that market participants can do without intermediaries, of which banks are but one example. And it is certainly a possibility that banks could be left to be nothing more than heavily-regulated, capital-intensive pipes while all the value-added stuff goes elsewhere. This isn’t the view of techno-centric hype-merchants (e.g., me). It is Citi who think this is a possibility.

[Citi] presents three arguments as to why, two of which hold up and one that seems a little suspect.

From Citi: Blockchain technology could turn banks to ‘dumb pipes’ – Business Insider

Actually, having read through Citi’s arguments, I have to say that I completely disagree with them on this analysis. On the contrary, I think the first two arguments are suspect and it’s the third one that has the key to survival hidden within it. Let’s look at the first two to begin with.

First, Citi says “banks have a very valuable asset in the form of their large identifiable customer-base.” That’s true. It’s much harder to win new customers than it is to keep them and the banks will work very hard to keep their customers.

From Citi: Blockchain technology could turn banks to ‘dumb pipes’ – Business Insider

Well, as many people have observed, so what. Zopa isn’t stealing my current account, or for that matter my savings account. It is however, stealing my savings away from under the bank’s nose, meaning that they are now spending money to support a virtually empty account. The Fintechs are not tempting away customers, they are tempting away the profit pools. It is certainly true that banks ought to be able to use their vast customer base and unparalleled knowledge of the customers to build new businesses, but it’s not easy for them to do so.

Secondly, banks have “unmatched experience when it comes to handling burdensome financial regulation.” Again, that’s certainly true. Many fintech companies benefit from the fact that they are currently unregulated or too small to face any meaningful regulatory burden. But if the sector is to thrive and grow it will have to come to terms with regulation — something banks have been doing for years.

From Citi: Blockchain technology could turn banks to ‘dumb pipes’ – Business Insider

In Europe, the new 2nd Payment Services Directive (PSD2) will have precisely the opposite impact. The Fintechs will create lightly-regulated Account Information Service Providers (AISPs) and Payment Initiation Services Providers (PISPs) and leave the banks with the heavily-regulated infrastructure and onerous “basic banking” obligations. I have thought for some time that banks ought to have created their own Payment Institution (PI) subsidiaries to take advantage of the lightened regulatory burden and to create a space for innovation.

But Citi’s third argument is that “banks benefit from a relatively strong track record of safekeeping assets, and therefore have earned a certain amount of trust and credibility.” Given that banks are still fessing up to billion pound fines almost weekly, the words trust and credibility are probably not the first you’d associate with large banks these days.

From Citi: Blockchain technology could turn banks to ‘dumb pipes’ – Business Insider

Whatever you think about bank incompetence and the astonishing events of the great financial crisis, most people still trust banks to look after their assets (partly because of stringent regulation, partly because of deposit insurance, partly because of reputation). But if my money is in Zopa, exactly what asset of mine is it that Barclays can protect, tend, nurture and add value to?

You already know what the answer is.

If banks don’t want to be dumb pipes, then they must exploit an asset that generates value for others in the new economy. As I suggested some time ago, reshaping our view of banks so that we see them as enablers of the new economy might help them to develop constructive strategies that are based around more than transaction fees and interest foregone. In a new world of blockchain-enabled transparency, the role of banks as providers of identity, privacy, reputation could be essential in forming a platform for new businesses to build on. More on this soon.