08 March 2016

Financial Times: Good news — fintech could disrupt finance

Today, banks and insurance companies are the core financial institutions. Banks manage payments systems, create most of the economy’s money, are responsible for a large proportion of financial intermediation, are creators of financial instruments and act as market-makers and agents. Similarly, insurance companies play the central role in assessing and managing risks.

Why might one hope that new financial technology, or “Fintech” as it is known, will transform these businesses? The answer, especially for banking, is that they are currently not done very well. Banking seems inefficient, costly, riddled with conflicts of interest, prone to unethical behaviour, and, not least, able to generate huge crises.

In a recent speech on the possibilities for a financial revolution, Andrew Haldane of the Bank of England notes that, astonishingly, the unit cost of US financial intermediation seems to be unchanged over a century (see chart). Moreover, income from finance simply rises and falls with the value of assets. That suggests a huge amount of rent-
extraction. Additionally, 10m US households and 1.5m UK adults still have no bank accounts. Worldwide, banks generate a staggering $1.7tn in revenue, 40 per cent of the total, from the job of making payments. In the computer age, settlement can still take hours or days.

On behaviour, as John Kay has written, “parts of the financial sector today . . . demonstrate the lowest ethical standards of any legal industry”. The payment of vast fines seems to be viewed as just a cost of doing business. Finally, the post-2007 banking crises were as big as any in the past. That their economic impact was not still worse than earlier was due to the willingness of governments to bail banks out.

New technology might help change this in at least two ways. First, it might transform payments. One possibility is real-time settlement via distributed ledgers. The advantages of instantaneous settlement are evident. The advantage of distributed ledgers, an element in bitcoin’s “blockchain” technology, is an improvement in the robustness of record-keeping. Instead of centralised accounts, the database would be shared across a network of sites, all of which would hold an identical copy. Such technologies might revolutionise domestic and foreign payments. Many businesses are already pursuing this possibility.

A second transformation might be via peer-to-peer lending, in which new platforms disintermediate the traditional businesses in matching savers with investments. Such lending is growing rapidly (see chart). The theory here is that computerised information might allow savers to dispense with the (costly) services of bankers altogether.

Full article on Financial Times (subscription required)

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