What disruptive technology means for banking

People often ask me what my job in ‘global markets’ is all about.  We follow things like interest rates, currencies, and commodity prices. Threats in our world look like Trump and market bubbles.  We don’t think too much about robots and driverless cars as being a threat.

But financial services are not immune to the impacts of so-called ‘exponential technologies’. This really hit home for me at a recent fintech conference run by the Silicon Valley think tank Singularity University. 

Banks have always valued being at the front of a customer relationship through understanding customer’s needs via their transactional relationship.  With the rise of companies such as Amazon and Google as well as the changing regulatory landscape, the advantage a bank has had in customer relationships is at risk of eroding.

Between Amazon and Google they know plenty about you already - your propensity to buy and in Amazon's case, increasingly, what you buy.  Combine their sheer volume of data with developments in artificial intelligence and regulatory changes in Europe (called Payment Services Directive, or PSD2) that allow companies and small fintech startups the ability to perform payment services for banking customers and access their data, and the customer insight landscape is rich and deep.  

The technology companies will then be in a position to leapfrog banks in really knowing customer behaviours and buying patterns.  The risk for banks is relegation to a role of commoditised product manufacturers with the bulk of the regulatory burden, but without the upside potential in the more valuable parts of the customer value chain.  The risk is compounded through the uptake of personal assistants such as Amazon’s Alexa.  Banking services would be an embedded component of the customer experience, rather than at the face.

More broadly, developments in areas such as robotics will improve efficiency and productivity, but will likely disrupt workplace and employment operating models; while emerging disruptive innovations risk a bank’s position in the customer value chain. 

The development of blockchain technology will also have a significant impact on finance.  While there are few use-cases currently at scale (other than Bitcoin), the potential exists for substantial growth in areas with significant customer friction.  International payments and cross-border trade of goods and services are two examples where transaction flows can be slow, expensive and require a trusted third party (i.e. a bank) to intermediate parties to the transaction.  Blockchain potentially eliminates this friction, requiring banks to pivot their operating models in order to retain the customer.

The clear lesson for me is that work life for my children will be vastly different to what it has been for me, and that ‘Moore's Law’ is expanding to the wider economy.  In many cases, we are at the ‘knee’ of the exponential curve where adoption of new technology is on the verge of explosive growth rates.  The implications are far-reaching, from structural changes in the job market to where we live and how we work.

But on a positive note, challenges such as these bring opportunity.  Companies that embrace and understand the impacts of exponential technology are well placed to support and advise their clients on how to respond to the disruptive forces in their own industries, and by doing so, strengthening the customer relationships.

Exponential technology is also having broader macro-economic impacts, particularly in structurally altering the traditional drivers of inflation.  As technology costs fall, they drive down tradeable inflation.  Think of what happened when Skype achieved scale - it disrupted nearly $40bn from the telco industry, $2bn of which Skype captured.  The rest went back to consumers in the form of cheap or free calls- what economists call ’consumer surplus’.

Unless non-tradeable inflation increases to offset the decline, inflation will be structurally lower than would be expected, implying interest rates would also be lower than would otherwise be the case.  Arguably, this is good deflation as it is the result of productive innovation in the economy driving benefits to the end consumer.

Yet we have central banks who are fighting this trend through quantitative easing to generate inflation to revert to their target bands, which creates an interesting tension between exponential technologies creating an abundant, cheaper economy; and Central Banks attempting to engineer an inflation outcome based on assumed mean-reverting economic conditions.

Ironically, banking’s profitability is both a strength and a weakness in responding to the threat of exponential technology.  Strong profitability signals there is no burning platform to change with urgency.  Strong profitability also means shareholders expect stable future returns.  But disruptive competitors don’t think this way.  They are happy to sacrifice short-term profitability for longer-term growth that drives greater consumer surpluses.  The challenge for banks is striking the right balance to maintain and enhance their position in the customer value chain. 

As Salim Ismail, Global Ambassador at Singularity University warns, if you are not the disruptor in your industry, you are the disruptee.