Death By A Thousand Cuts: How Innovation Can Bring the Banks Into Line
“A necessary evil”. The term could have been coined about the banks rather than government. Post downturn, the ire formerly reserved for traffic wardens and lawyers has been largely directed at bankers. Yet despite their behaviour in the capital markets we all rely on the banks’ retail arms to enable us to make and accept payments, securely store our money and move it around.
Will this always be the case?
There are often calls for competition in the banking sector to break up the dominance of Barclays, HSBC, RBS and LloydsTSB. But increasingly I see competition coming from outside the sector, rather than from other, smaller banks and building societies.
It started in the first wave of the internet. Companies sprang up to process card payments from e-commerce websites. Some of them, like CyberSource, were started by an e-commerce company in frustration at the lack of options available from the traditional finance industry. These companies grew with the e-commerce sector, providing services that the banks did not: initially payment processing but also fraud management and integration support. But ultimately they still relied on the banks’ infrastructure to move money around.
A few years later the next wave of start-ups arrived, offering an alternative to card payments. PayPal is the great survivor of this wave, acquired by eBay in 2002. People assume — not unfairly — that most PayPal transactions are about eBay purchases, but that’s not the case. Less than half the company’s transactions (by volume) take place outside the auction site. PayPal credit became a way to transfer money between people and make purchases without routing through the banking system. But at one end or the other people generally still need to add credit or transfer it back to their accounts.
The most recent wave of start-ups have been focused on taking card payments face to face. This is a lucrative industry for the banks with merchant services and card terminal products commanding high fees and percentages on every transaction. Now companies like iZettle, Judo, Square and PayPal are coming into this space and dramatically cutting the barriers to entry to card acceptance for small businesses using low cost devices paired with smartphones. Their models offer rapid sign-up, near-zero up front costs, and often low monthly fees in return for marginally higher percentages on each transaction. This is something that small businesses seem willing to swallow to make sales that for the lack of a card machine may otherwise not have happened.
Now iZettle has announced that it is cutting transaction fees as low as 1.5% for businesses taking more than £13,000 per month through its platform. This makes the new, smartphone and internet-based payment platform potentially significantly cheaper than the traditional bank alternatives. And certainly quicker and easier to get started with.
New World Currency
This may start to shave lucrative slices off the big banks. And I think there will be other, similar niches where third parties can innovate aggressively to steal markets away from the banks. But ultimately our cash still needs to flow into and through them in order to be useful. For now.
Because one other big innovation has happened in the last few years: bitcoin.
In case your only experience of bitcoin has been rabid headlines about drug dealers shifting their illicit cash, here’s a quick explanation: bitcoin is an entirely virtual currency that sits outside the banking system, albeit it can be exchanged for other currencies. It operates entirely via the internet. That means no bank charges, no routing through global payment gateways. Money flows from you to whoever you want to send it to and vice versa. Lots of businesses already accept bitcoins as payment.
It has its issues: breadth of support, stability of valuation, high volume of illicit traffic. But despite those problems it — or perhaps its next-generation descendants — represent the potential for the biggest revolution in banking for a hundred years.
Imagine hooking up all of the peripheral services above — the ability to take and process payments, store value, and transfer it — to a new virtual currency that bypasses the traditional retail banks. That level of disintermediation could have a dramatic impact on the freedom to move capital, on the cost of doing business, and the control of wealth as a whole.
It’s a way off. Building trust in a stateless currency will take time. But in the intervening period I think we will continue to see innovative businesses slicing profitable niches off the big banks. Some might end up back in the hands of the establishment — as CyberSource did following its acquisition by Visa. But others, like PayPal/eBay will achieve a level of scale and independence that allows them to remain competitive.
This is where the competition will come from that forces the banks to change and innovate at a greater pace.