For traditional banks, the alternative innovation channels of financial services engender an equal mixture of fear and indifference. To the big, massive capital-intensive and capital-rich banks, tablet banking, for example, resembles something akin to an annoying house fly. That the old lady may or may not swallow.
Last night, in an auditorium in one of Citigroup’s many offices here in New York, a group of traditional bankers debated the future of banking as part of a lecture series sponsored by the Risk Management Association of New York. To call the discussion lively is to undersell it. This was a bunch of Wall Street and banking old timers talking shop — and they had plenty of stories to tell.
One of them, Brad Hintz, the former chief financial officer and managing director of Lehman Brothers Holdings, shared what it was like walking into Lehman Brothers for the first time in 1996 — and seeing massive quantities of liquidity risk on its books. The other grey hairs on the panel simply nodded their heads slowly as Hintz told the story.
Being that this was a panel about the future of banking, a discussion about innovation channels invariably surfaced, and it offered a rare glimpse into what old-time bankers think of mobile/tablet/online banking. David Hendler, head of US financial services research at CreditSights Inc., called alternative banking channels “disrupters,” and predicted that such banking would become a noteworthy channel.
“You have got to start thinking about these mega trends,” he said.
But Hendler was shunned. Another panelist (I am afraid I didn’t catch his name) argued that “Amazon or Google” are not going to make inroads into the banking sector. “Banks are too central to the economy to be overcome,” he said. This panelist declared that “Amazon is not going to make me a mortgage loan,” as a sort of line in the sand.
Whether Amazon, in particular, is going to make a mortgage loan is beside the point. The question of whether alternative financial services providers will displace traditional banks is. Just to frame this question, Bank of America Corp. has $1.08 trillion of deposits on its balance sheet today. To foresee, say, a tablet bank stealing that volume of deposits from BofA in the next five years is hard to fathom.
But alternative banking providers can make inroads, as Hendler maintained. With one caveat. Missing from the discussion last night — and from the innovation discussion broadly — is the risk management required to make sizable inroads. Amazon, which has around $8 billion of cash on its balance sheet, could make mortgages, as long as it had the risk management to maintain the credit portfolio. I went through Brett King’s new book, Bank 3.0, and while he makes wonderful points about a lot of important matters related to innovation, the risk management required for innovation channels is not one of them.
I would argue that any innovation channel has a degree of risk that is beyond what we understand today. Last night, the grey-hairs recounted the credit crisis, offering a diagnosis for the calamitous failure that boiled down to this: it was a bunch of little things. In other words, it was not one particular failure that resulted in the credit crisis, but a host of small ones, such as regulators not pushing hard enough, bankers being blinded by rosy financial models, and rating agencies becoming co-opted by their sources of revenue. (This is not a new theory.)
Similarly, “little” risks can — perhaps will — undo alternative banking channels, and until the risk management is there, no truly alternative banking provider will take meaningful share, and that includes Apple. As a point of reference, Amazon does not take on payment risk today, despite the fact that it sells a checkout system. I would suggest that PayPal (and, by extension, eBay) is the only truly alternative banking provider that has centered its innovation efforts not just on innovation or customer acquisition, but on the risk management required to be in an alternative channel. That was the whole reason why eBay bought PayPal in the first place back in 2002: because no other financial institutions would take the payment risk of eBay customers. Today, PayPal is upping its risk ante with its new international remittances business, which requires PayPal to float currency/capital risk for up to five business days. Not every financial institution would take on that risk.
What exactly do I mean by “any innovation channel has a degree of risk that is beyond what we understand today”? Well, how can an enterprise fully understand the entire gamut of risks of something that is entirely new? Has there ever been, say, a mobile-only bank before Moven? So how can Moven understand all the risks of a mobile-only bank? It can’t. I’ve raised this issue before, in particular about Moven’s Cred credit score system that incorporates social media influences and the degree to which a consumer works with Moven as part of an overall credit score.
Here’s what I wrote in October 2011:
Cred strikes me as a nice theory, but a bear to put into practice. By adding a whole slew of data points into its underwriting, Movenbank is potentially opening itself to risks it simply cannot know or understand, much as CDOs contained risks that were beyond the comprehension of even the brightest Ph.Ds at Goldman Sachs.
And that is still true today. There is a slew of risks that alternative banking providers are facing, and while some are minor, some could be catastrophic. I am not suggesting that these risks are insurmountable or should convince any bank CEO to, say, ditch her mobile banking aspirations. My point is simply that risk management is to banking as HTML is to Mark Zuckerberg (or at least before he was worth gazillions of dollars). I have never, ever heard a Finovate demo that touches on how the proposed whizbang startup will manage risk. To me, this is wrong, and I hope we don’t pay the price for missing the “little” risks some day.
Learn more at Bank Innovation 2013, March 18-19 in San Francisco. Get invited here.