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The technology enabling the universal delivery of financial services

Wed 24 Apr 2019 | Michael Mudd

The FSI sector; banks, insurance companies and securities market makers are being profoundly affected by what is now seamless machine to machine communication. Michael Mudd, managing partner at Asia Policy Partners LLC examines how the financial services sector may become more robust and how regulators may approach these fundamental changes today, tomorrow and in the future

No I am not going to talk about bitcoin or any of the hundreds of cryptocurrencies out there. In fact they are not money by any definition – neither a stable store of value nor easily interchangeable, they have more in common with casino chips and penny stocks i.e. captive/highly speculative tokens. But I digress.

That we live in an ever more digitized world is immediately apparent if you are a citizen of Western Europe, North America or East Asia/Australasia. Accessing social media, communications and retail shopping – increasingly on a smartphone – are commonplace today.

But what is less obvious to consumers is the underlying technology that powers this ubiquitous, always-on world of discourse, commerce and communication that is being adopted virtually everywhere. McKinsey estimated in 2016 that 543 terabits of data (about 45 times bigger then the US Library of congress), are flowing across borders every second; this is almost certainly significantly higher today. Technology is rapidly changing not just how we do just about everything, but decreasing the time it takes at an ever faster rate.

Fourth industrial revolution

Klaus Schwab at the World Economic Forum (WEF) first spoke two years ago of a ‘Fourth Industrial Revolution’, one based on what he described as ‘cyber-physical systems’[1]. While the majority of his predictions are still to scale up, one that has already arrived is underlying the core of the digital economy: technology that is powering ecommerce and online payments and changing how the financial services industry (FSI) interacts with their customers.

At its most basic banking historically was an intermediary for the exchange of cash for goods or services. This remained essentially unchanged from Renaissance Italy where modern banking emerged to the end of the 20th century.

The tools bankers used progressed through double entry bookkeeping to essentially the same electronic ledger process that was hosted on mainframe computers. Over the centuries controls also remained unchanged: with few exceptions; government issued the currency and the banks managed its distribution.

“Cloud computing will enable both fintech companies and FSI’s to drive down costs even lower”

Cash is now on the decline in many economies; large denomination banknotes are being removed from circulation as being a societal risk in that they enable fraudsters and tax evaders to easily hide their crimes. Direct electronic payments can now replace most transactions from paying for a taxi fare in Kenya with a simple SMS phone service via M-Pesa, to e-wallets that are replacing plastic credit cards.

Depending on the country, the amount of cash in circulation as a percentage of total money averages about 8% and has been steadily declining. In Sweden the use of cash is now so low (1.5%) that the Riksbank is seriously studying its complete replacement with emoney.

The commonality behind both the fourth industrial revolution and the revolution in currency and payments is the widespread adoption of new technology that is both agile and that can affordably scale: this is hyper-scale cloud computing: services that scale using thousands of commoditised servers that can provide additional layers of security in addition to agility and economy.

The FSI sector; banks, insurance companies and securities market makers are being profoundly affected by what is now seamless machine to machine communication. This enables automation of secure double entry bookkeeping, reducing costs for all parties in the transaction.

In addition this is now being enhanced by the use of distributed ledger technology – the blockchain, which is far more than just the basic building blocks of Bitcoin and its clones. This article examines how the FSI sector may become more robust and how regulators may approach these fundamental changes today, tomorrow and in the future.

The financial industry today

The move away from cash is not driven by the incumbent banks or financial institutions as much as it is being pushed forward by software engineers, start-ups and entrepreneurs, including the established technology giants. It is also being abetted by governments that are keen to close loopholes for money laundering, corruption and terrorist finance.

The removal of the €500 note in 2016 (nicknamed the ‘Bin Laden’) is a direct consequence of this policy as is the replacement of high value notes in India and Venezuela in late 2016.

Only Switzerland and Singapore have high value notes today. The former US Secretary of the Treasury, Larry Summers, has even called for the US$100 bill to be eliminated.

“As the French economist Thomas Piketty observed, protectionism does not produce wealth”

Moreover with interest rates still at near historic lows, many banks now charge for large cash deposits to reflect the real cost of handling cash (as well as asking where it came from). Cash is no longer King for banks, but a liability. This has fueled the move to mobile money from Beijing to Johannesburg, where it has effectively brought banking to over 15 million South Africans for the first time.

The World Bank reports that while just 1 percent of adults globally use only a mobile money account, in Sub-Saharan Africa, this rises to 12 percent or 64 million adults, with 45 percent of them having only a mobile money account. In Nigeria, the new national identity card has electronic payments functionality built into the EMV chip. Thus technology is driving financial inclusion around the world through lowering the barriers to gain access to low cost payment services, a key issue in addressing inequality and development. This is also recognised by APEC as a driver of the digital economy.

Take your pick

Start-ups, banks and telecom companies are all competing in an increasingly crowded market for online and mobile financial services, so how is a potential customer to choose? When banks first started their journey to empower customers, it was not altruistic: cost containment was the driving issue. Although having been introduced as long as 50 years ago, the ATM remains central to the banking industry and adoption is still growing in many countries, with a projection for over 3.5 million units installed worldwide by 2020.

Depending on the bank’s location, the cost of ATM vs a counter service transaction is approximately 90% lower. ATM’s remain central to a cash economy, but the installed base is decreasing in Europe in line with the decrease in cash as the prime means of transaction and the rapid uptake in Europe of online banking for other services.

The next round of automation was phone banking followed in the late 1990’s by the first recognisable online banking service enabled by the internet. The first true internet banking (videotext in the 1980’s never really took off) was not embraced until the widespread availability of the World Wide Web (www) and the internet browser.

The first service was launched in 1995 by Wells Fargo bank in the US which enabled customers to interact with their accounts for information via its website. By the end of 1999 penetration was still less than 0.4% of households in the U.S. but by 2004, some 33 million U.S. households (31%) were using some form of online banking

Rajesh Kumar, Professor at the Institute of Management Technology Dubai, UAE, referenced a report that a typical branch teller transaction in the US costs the bank US$4.25, dropping to $2.40 through a phone call centre and then plunging to only US$0.20 for the same transaction online.

He has further postulated that a mobile transaction will be less than half that again at US$0.08. This is a decrease in cost almost comparable to Moore’s Law for computing. This is an important observation as it is access today to new technology, in particular the collection of services under cloud computing, that will enable both fintech companies and FSI’s to drive down costs even lower.

Paradoxically it is both a faster internet in more developed economies and weaker broadband infrastructure in lesser ones which has led to mobile becoming a far more practical option to carry out tasks and duties in developing economies. This in turn leads to what will be one of the key differentiators in a crowded bank/fintech market in the near future: lowering the cost of transactions to as close to zero as possible.

The financial industry of tomorrow

If we take the closing sentence above as the starting point, and if we further take tomorrow as January 1 2018, we have to ask is this practical and what does it mean for the FSI sector? For a traditional bank account to be economical, the customer must have an annual income of roughly US$10,000.

That falls to as little as US$2,000 for a digital-only service like Santander Banks ‘Superdigital’, which has, at its core, software from Temenos, a Swiss company that is also a major supplier of core banking systems worldwide. John Schlesinger, Chief Enterprise Architect at Temenos, stated “The advantages of cloud computing in terms of cost and customer experience look more compelling than ever.”

In a recent paper written by David Arnott, CEO Temenos, customers were asked questions regarding benefits and barriers in adopting cloud services.

The major benefits cited were lower overall IT costs (58 percent); ability to shift to new technology (50 percent) and to add new business functionality more quickly (34 percent).

“It is clear then that for banks to be competitive tomorrow they need to transform today”

Before we get into details, as banking has at its core the provision of services for both citizens and the financing of the exchange of goods and services, in other words trade, let’s look at that first. A U.S. study showed that cross-border data flows and the business trends that they enable generate enormous value globally.

Firstly, more globally connected economies increase their gross domestic product (GDP) growth by up to 40 percent more than less connected economies.

Second, ICT usage enables growth, particularly in emerging economies, by giving new and small businesses ready access to global service delivery platforms.

Finally, removing trade barriers faced by digitally intensive firms would markedly increase GDP, wages, sales and employment. Embracing cross-border data flows reduces physical trade barriers and reduces the impact of geographical isolation from major export markets.

As the French economist Thomas Piketty observed, protectionism does not produce wealth, and free trade and economic openness are ultimately in everyone’s interest. This message however is not accepted by all politicians, even in 2018.

Anyone who has used an Over the Top (OTT) service, so called as they layer on an internet connection, is already experiencing close to zero cost for their voice phone calls and SMS. Software and hardware companies are increasingly morphing into technology service companies and are making the world’s best technology available to consumers at close to zero marginal cost; many supported by advertising.

Free voice messaging apps like Skype, WhatsApp or Allo enables people to communicate and collaborate in ways – and at price points – never possible before. Online search saves the average consumer many hours each year to find products and services. GPS enabled mapping saves even more in time: congestion, fuel and pollution are all reduced in guiding people to where they need to go. Online marketplace platforms like Alibaba.com, Global Sources, Amazon and eBay mean micro enterprises and individuals can access global markets instantly.

Cloud and clear

An increasing majority of these instances host their data and it is processed in a cloud infrastructure, where the owner of the service has outsourced the hardware and often the software and storage for their service. A cloud-enabled infrastructure uses managed data centres that may scale on demand and therefore reduce the cost per transaction.

Distance is no longer a barrier nor is the cost of communication which has dropped virtually to zero due to packet switched technology, the same technology that powers the cloud. DTCC, the main US securities clearing house, last year said cloud computing had reached “a pivotal point” because they were now more secure, cheaper and sophisticated than in-house IT systems.

But not all cloud offerings are delivered equally. Although the basic attributes may be created and hosted on smaller data centres, the cloud efficiencies really come to the fore in hyperscale deployments: literally thousands of servers in a single geographic cluster, largely belonging to tech giants and public cloud providers. This is well suited to the financial industry which needs such scale to drive down transaction costs.

The only limitation to this is really regulation: regulators that do not open to the ‘hyper-cloud’ will create a disadvantage to their national banks in being unable to scale to increase their agility to modernize ageing legacy infrastructure and to embrace change and reduce costs. This disadvantage will, over time, both limit the services available to customers in the country and competitiveness.

There will certainly be some classes of data that regulators want stored locally (although over time I believe this will be minimal), so hybrid options are okay for now. Current policy focus needs to be on data classification and management rather than on large scale data localisation if the cost and scale benefits of the cloud are truly to be realised.

It is clear then that for banks to be competitive tomorrow they need to transform today. The technology for this is available now, in particular as the blockchain provides an immutable ledger of transactions. As proven with the widespread adoption of packet switch technology, costs have dropped dramatically and by logical extension, this may extend to ultra-low payments transaction costs; what next?

  • This is the first of a two-part special focus on the technologies that are disrupting financial services. Part two will be published next week.

Experts featured:

Michael Mudd

Managing Partner APP LLC
Asia Policy Partners LLC


Blockchain Cloud economics finance hyperscale
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