Some things don’t change. But much does…

Around this time, many banks, usually family run, emerged including the Medici Bank and the Banca Monte dei Paschi di Siena, founded in the late 15^th century and still going today (despite a few near death experiences).

"Increasingly however the costs of complexity in bigger organisations have begun to outweigh the benefits of scale.”

These modern banks did what we would recognise as banking: they took in deposits, made loans, facilitated trade, managed payment systems. They helped communities and businesses thrive by amalgamating the assets of those with surplus and lending to those with an idea or a business but not the finance.

But will this kind of bank survive another half a millennium? One once-core attribute of a bank, a physical presence, is no longer necessary. Over the centuries, banks emphasised the “edifice” affect: they built big, solid, dominant buildings to advertise a sense of stability and security. Networks of these edifices were necessary to gather the deposits which sustained the business.

Today we have many successful banks which are digital-only. Not just so-called neobanks and fintechs but digital versions of existing bricks and mortar brands. (Meanwhile more than a few banks have failed after over-investing in edifice buildings.)

New lending models

These digital banks have, with varying levels of success, been able to gather deposits with the necessary condition in most advanced economies of obtaining the equivalent of an “approved deposit taking institution” licence from a regulator.

Regulators have tended to show more lenience to money lenders because if such a lender fails it’s the shareholders who cop it. If a deposit taker fails it is ordinary savers and ultimately taxpayers who bear the costs – stakeholders of far more political currency.

Nevertheless, new models of lending have emerged, notably peer-to-peer (P2P). The rationale behind this model, which typically sees a platform operator gather funding from one group of individuals and lend it to another, is that banks have historically charged a wider profit margin for doing the same thing.

The challenge for P2P lenders however has been in consistently raising sufficient funds to satisfy borrower appetite. That in turn has led to many turning to professional investors to raise funding – which is what banks do.

Pricing risk

Banks too have historically had a competitive advantage in credit analysis. Because of their branch networks and deep experience of lending to businesses, they have been better – although not always good – at pricing risk.

That’s not necessarily an enduring advantage – or “moat” in the business school jargon – however as newer companies, for example Google or Alipay, have extremely deep and detailed pictures of individual businesses from the data they gather from billions of transactions.

Payments is another field traditional banks have dominated because they have been able to manage the risk that arises in the period between a purchase being made and the transaction being settled.

Again, insight into credit risk and the business environment has been an advantage while the bank model allowed the accumulation of sufficient capital to manage failed transactions. But new technologies, such as distributed ledgers like blockchain, can almost eliminate the credit risk of the transaction.

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Lacking scale

Payments too is an extremely capital intensive business with increasingly enormous scale being necessary to stay ahead of consumer and merchant demand, price competition, fraud and other credit risks.

Even the biggest banks lack that scale – and have recognised that issue for decades. The global payment schemes Visa and MasterCard started as credit products offered by banks which then formed associations of other banks to increase the reach and security of the payment network and the integrity of payment authorisation.

What then does the future of banking hold? In many cases, banks became bigger to manage costs and credit risk as well as seeking new businesses – amplified by globalisation.

The history of the corporation followed similar economic logic: bigger companies could manage the fixed costs of bookkeeping and personnel more efficiently.

Increasingly however the costs of complexity in bigger organisations have begun to outweigh the benefits of scale. Particularly as new technologies have reduced the need for large corporate centres and specialist firms have emerged to offer superior products and management in businesses the organisation historically performed itself.

Better served

Meanwhile – and this is hardly recent – waves of non-bank competition have emerged with banking services offered by the likes of supermarkets, tech giants, industrial conglomerates, social networks – and, usually catastrophically – governments.

Banks then are becoming less complex and more willing to partner with non-bank organisations, aiming to better serve more select groups of customers, rather than trying to simply get bigger and offer all products to all customers.

Google is one tech giant with an eye on massive disruption in financial services. A hint of how it thinks can be seen the blurb for an upcoming conference by Google Cloud:

“Google Cloud’s view is that financial services have the most to gain by merging and leveraging the unique data and assets they already possess,” says Google Cloud (which obviously offers these kinds of services).

“By re-imagining themselves as ‘data companies with a banking licence’, banks will have access to previously unavailable innovation; for example, a one-hour home loan, frictionless onboarding and ultra-flexible, customer-centric products. These capabilities will make banking platforms stickier and allow them to provide highly relevant products and services for customers.”

This is a cogent view and it also recognises banks do not have some ontological right to be the only organisations which offer banking services. Just because a myriad of supermarkets, non-bank rivals, governments and fintechs have failed to take over financial services doesn’t mean it can’t be done. Many traditional banks too have failed or been engulfed because they have been unable to evolve.

But the key to the future of banking – which may or may not involve actual banks – is in the final line: successful organisations will need capabilities to make banking platforms stickier and allow them to provide highly relevant products and services for customers.

Take McKinsey & Co’s analysis of one of the more successful start-up banks: “Setting a bold vision, adapting the business to respond to market feedback, and putting customer satisfaction first has enabled digital-banking start-up N26 to grow rapidly into a global bank valued at $US3.5 billion.”

A key insight: “A strong brand and great user experience will be effective differentiators in every market—but local expertise is still required.”

Customers care about what they want the banking process to do for them, not the process itself nor the institution. Shareholders care about investing in the companies which do this the best. But these customers are human, even if they are running huge companies, and they value local - even individual - knowledge.

Andrew Cornell is Managing Editor of bluenotes