Size gives some Banks great power today and size looks like an obvious asset on a balance sheet. However, in the network and tech age, can their size actually be a liability?
Below are some insights into the threats that can disrupt banking as we know. Read on to find out more.
IT meltdowns and the liability of “technical debt”
Bankers often talk about the millions invested into IT as an asset. However, software degrades over time and at a certain point that “technical debt” becomes a liability and not an asset.
It is now cheaper to build the IT infrastructure for a startup bank, using open source and APIs, than it is to adapt Legacy IT for a modern world. The $ millions invested in IT now have a negative ROI.
The programming cost is not the issue, but the reason they might be crumbling is:
- The banks cannot change their business model fast enough. Bank CXO teams are perfectly away of the threat of disruptive technology and that they must change their business model at a fundamental level.
- Loss of consumer trust. Consumers might be enraged by bailouts, but they still assume that banks are at least reliable and the only game in town. Some consumers read about Cyprus where the government unilaterally took money from their bank; a series of IT meltdowns mean that consumers have days when they cannot get cash from an ATM or use their credit cards; banks are no longer “reliable”. Finally they hear from a friend who is raving about one these startup banks; the big old banks are no longer the only game in town.
Blockchain and the Coase’s post Corporate vision
Coase’s 1937 essay The Nature Of The Firm asked why hire employees instead of contracting tasks? His answer – a company exists because it is cheaper to do transactions within a company than outside. Blockchain has resurfaced this theory by dramatically reducing transaction costs.
The Internet seemed to be the realisation of Coase’s post Corporate vision. However, although Dot Com and Social Media changed our world, that change was limited to exchanging content online. The Internet was the perfect free copy copy machine. Blockchain enables us to exchange value online – where copying is not allowed (if I send you that asset I no longer have it).
Satoshi’s vision of 7 billion banks
Anybody can be their own bank. All you need is a wallet that can hold cryptocurrencies. You no longer need to trust a Central Bank and whoever guides their actions. You trust the math and the code, both of which you can verify.
Although most people won’t choose to be their own bank, it is the fact that it is possible that is such a wake-up call for big banks. This is the Napster moment. Napster proved that digital audio/video was possible. It was free and illegal. After that came cheap and legal in services such as iTunes and Spotify. Those services were only possible because the alternative of free illegal services such Napster and Kazaa brought disruptive competition.
This is why a network of small banks is the more imminent threat.
Regulators typically arrive late
When 2008 happened, the regulators in America threw a complex rule book called Dodd Frank at the banks. For 10 years, the lawyers and regulators have worked through the details and now some elements seem to be up for negotiation. It has become a political football, just when technology may be making it irrelevant.
This has happened before. Regulators typically arrive about the time that technology is doing the job for them. Look at what happened in two earlier waves of technological disruption:
- IBM was being regulated just when the world was moving from mainframes to PCs.
- Microsoft was being regulated just when the world was moving from PCs to Internet.
- Today Google and Facebook are being regulated just when the world was moving against all our data being used as a tool to control us. Note: this is happening right now, which makes it a bit harder to see than the two previous waves.
The problem is that in 2008, the technological disruption was still in the mind(s) of Satoshi Nakamoto. So the regulators resorted to the only thing they knew – a complex legal document.
When the next financial crisis hits, the discussion around bailouts and regulation will be quite different.
Why Bailouts will not be possible next time
- Populism has a political voice. The rise of extremism of both right and left is all over the globe will make it harder to bail out banks again.
- Governments are running out of firepower to pump in more liquidity. For every loan there has to be a lender and at some point lenders worry about inflation from money printing. Lack of funds will make it harder to bail out banks again.
- The disruptive alternative (Bitcoin) is now more mature and tested. People now have the tools to take control over their own financial resources, regardless of what politicians say.
Analog Scale vs. Network Scale
Analog Scale, what most Big Banks have, is all about vertical integration, management hierarchy, secrecy and control. In short, hierarchy.
Network Scale is all about networked partnerships through APIs, online networking, knowledge networks and verifiable transparency. In short, wirearchy.
Article originally published by Bernard Lunn on Daily Fintech, Crumbling Behemoths: why banking size is a liability not an asset in the Blockchain Economy.