Banking and Financial Services Expert, Martin Berkeley, considers the impact of technology on banking, regulation and individuals.
‘‘The computer says no’- a comedy phrase that has entered common parlance, summarises the first thought people have when they think of computers and banks. Banks and other financial institutions are, in reality, computer companies that process financial data. They have huge IT spends and employ many people in related functions.
Banks were early investors in computing - largely to automate processes and manage the vast amounts of data they produce and communicate. These legacy systems are now a burden as the skills needed to maintain the systems are in short supply; the long-retired programmers having used an archaic computer language. In terms of IT spend, just maintaining their legacy system takes up 75% of Deutsche Bank’s IT budget, with the remaining funds being fought over for implementation of new regulations and innovation.
Effective use of IT can automate internal processes and save costs (typically 8%) and streamline payment systems (e.g. ‘BlockChain’ technology) or ‘robo-advice’. The rise of ‘Fintech’ (financial technology firms) presents both a threat and opportunity for banks and their ability to meet the preferences of the ‘Millennials’. IT system upgrades are also not without risks – get these wrong and not only may you end up wasting money, but also losing customers and suffering ‘brand damage’.
Fintech is essentially the application of technology to the finance sector, to create a disruptive business model. Other industries have seen this occur; for example the music industry with the growth in online music and digital downloads. The travel industry with online booking and dynamic pricing, and the taxi industry with the rise of Uber type services. These changes are characterised by new business models, innovation facilitated by technology and ultimately a better customer experience. The aim being customers receive the goods or service quicker, cheaper and efficiently than with existing providers. Additionally, the Fintech challengers do not have the baggage of legacy systems and perhaps out-dated corporate working methods. They are nimble, commercial, and able to exploit opportunities – in the finance world, they are a headache for banks.
The rise of Fintech has proved attractive for investors, with significant investments being made by venture capital firms (though Europe lags far behind the USA in this respect). Banks have started to invest in Fintech, but again levels of investment are comparatively modest.
There also remains the issue of implementation. Banks are naturally conservative and there may be cultural, regulatory and organisational barriers to accepting new working methods.
A good example of Fintech innovation is in the payments area. Traditionally banks have relied on bulk (batch) processing of payment messages. There may be hundreds of legacy systems, all of which may not work well together, and there is no single customer view. This leads to slow and expensive payment systems when customers want fast, low-cost and above all- easy to use (and of course secure) payments. Most bank transfers used to take at least 3 days, but this is now within two hours for Fastpay systems. However, Fintech challengers have entered the payments area and eroded the bank’s market share. Notably some of the new competitors are not banks at all, but technology companies – like Apple with ApplePay or Paypal and notably the virtual currency Bitcoin.
Bitcoin is based on a technology known as Blockchain. Essentially, this is a method of organising and sharing data in a dispersed manner, known as a mutually distributed ledger. The aim is to create a single version of the truth (i.e. all parties agree that the data is correct). Conventional ledgers are held by different parties and may differ- and the reconciliation process can be expensive. The aim of the Blockchain approach is to create incentives for honesty and transparency. The lack of central control has, however, led to concerns about its role in money laundering and potential effects on the stability of the financial system. Blockchain technology could also be used in other areas such as property transactions and have received significant attention and investment from some banks.
The entry of non-banks to the banking arena creates new dynamics in the industry. Banks traditionally lend money as their core business. Now, new lenders have appeared, peer-to-peer lending is an established alternative funding mechanism- offering alternative sources of finance. Behind these new players there is course technology, innovation and change of business model, though some essentials do not change. In lending, this is the key question – will I get the money I lent back? Banks have developed sophisticated credit systems to assess, manage and price this risk. The interest rate you pay on a loan is a function of the perceived credit risk. But, what if your social media usage were a better predictor of credit risk than the traditional methods?
Facebook is a huge gatherer of user data and already tailors advertisements based on your usage and preferences. What if Facebook used the data they held on you to approve or decline loans to you? In 2015 Facebook was granted a patent to do exactly this: ‘When an individual applies for a loan, the lender examines the credit ratings of members of the individual's social network who are connected to the individual through authorized nodes. If the average credit rating of these members is at least a minimum credit score, the lender continues to process the loan application. Otherwise, the loan application is rejected’.
In the UK, the car insurance company Admiral launched a product (www.firstcarquote.com) using social media posts to price car insurance. The concept was to use an algorithm, which measured and scored personality traits based on your Facebook behaviour. However, concerns about the use of personal data caused Admiral to delay the project launch and radically redesign the process using only a small and less personal Facebook data set. Naturally this raises a number of issues regarding privacy and personal data.
Personal data is a valuable commodity. We ‘leak’ it everywhere through social media interactions and companies we interact with and we give it away for free for companies to profit from. For banks it is, ‘more treasured than the bullion in its vaults are the data a bank has stored on its servers’. The selling of personal data is an important revenue stream and the analysis and manipulation of personal data is used to customise and provide new products and services. The London Stock Exchange derives 37% of its income from data products.
You agreed to this in the terms and conditions you signed up to. Or maybe you didn’t read them? Most people don’t, but perhaps they should. On 1st April 2010, the computer game provider Gamestation inserted a clause into its End User Licence Agreement (EULA). 7,500 customers agreed to the new terms, a handful spotted the amendment and they were given a voucher. The new clause stated: ‘By placing an order via this web site on the first day of the fourth month of the year 2010 Anno Domini, you agree to grant Us a non-transferable option to claim, for now and for ever more, your immortal soul’. Literally you were selling your soul. Gamestation did this as a prank, but also to make a wider point about the importance of terms and conditions. You may find that the many terms and conditions you have agreed to without reading have committed you to giving away personal data, not only for you but also your descendants. The DNA profiling service sold by Ancestry.com asks for perpetual rights to your DNA and hence your descendants.
Terms and conditions are of course part of a contract and they are bidirectional and binding on parties. Institutions, companies and organisations are also bound by the contracts and this can have unintended consequences. Dmity Agarkov amended the terms of a credit card he was sent by a Russian bank Tinkoff Credit systems. He removed all commissions and changed the interest rate from 45% to zero, unlimited credit line, as well as adding in large penalty clauses should the bank cancel or violate the agreement. He signed and returned the form to the bank, which then sent him a credit card. The bank ultimately cancelled the card but was served with a claim for $730,000 from Agarkov. The defence of not reading the contract – often used by customers did not help the bank and Agarkov won his case in court.
The question of contracts and the law is relevant when considering the impact of new technology. The Computer Misuse Act  is the major piece of law that attempts to regulate the use of computers. It does not define a computer, but rather describes the nature of prohibited activity. These are mostly of being unauthorised to do something, such as unauthorised access or acts. This creates considerable flexibility in the law as it may be applied to technologies not yet invented. However, it may also create conflicts. If you steal some information via a computer is this unauthorised access or a theft? The existing law may need to be flexible and reinterpreted in respect of data protection.
Innovation is not new in financial services, however the rise of new technologies has hastened the pace of change and enabled new business models to develop. These threaten the traditional banking business model, as well as our understanding of the value of data- and causes existing legislation to be stretched to cope with problems that didn’t previously exist. Inevitably regulation is slow to respond to rapid change, but perhaps taking a considered view is beneficial. Despite the rapid changes introduced by technology, some things don’t change in financial services: the need to move money, make investments, know what is being sold, manage the risks and of course, look after clients better. Computers can also help you say yes!