Writing in the 11th century, the Persian scholar Naser-e-Khosraw in his Safarnama or Book of Travels relates how one can shop without using cash: ‘The procedure at the bazaar is as follows: you turn over whatever you have to a moneychanger and get in return a draft; then you buy whatever you need, deducting the price from the moneychanger’s draft.’
If that procedure sounds familiar, it’s probably because it’s very much like a modern day debit card… without the instant electronic aspect. Accounts like Khosraw’s tell us that the services we associate with modern banking were very much in place in the ancient world. The Babylonian Talmud, an ancient Jewish text, for example, discusses at length the practices and law concerning money changers and money lenders. It reveals: ‘It was the custom for money-changers in those days to carry their tables with them, and hence they were called ‘the men of the tables’. That is interesting because the term bank is generally thought to have been derived from the old Italian word for table: banca. Babylon had fallen, long ago, in the 6th century BCE. But one thousand years later, the merchant bankers of the Renaissance were still setting up their tables.
The activities that constitute the core business of banks such as accepting deposits of cash for safekeeping and making loans, were very much a part of ancient society. And there were transfers of funds on deposit: the elements of a rudimentary payment system. Many scholars have sought to identify what it is that banks do. And to determine if, as some maintain, they are really special. Robert C. Merton, who won the Nobel Prize for Economic Sciences in 1997 for refining the Black-Scholes option valuation model, has identified a number of functions that financial systems perform.
The main one, perhaps, is the movement of funds across time and space. This movement of funds is made whenever a payment or an investment is made. The difference being that transactions are for immediate consumption while an investment is, typically, an act of saving. The latter is vitally important to the future health of the economy. Wealth is generated by business firms that rely on the capital provided by you and I when we save. You may find it strange that large multinational corporations use the funds that ordinary people are saving or that we even have enough money for these corporations to use. But while they are many such corporations, there are even more ordinary folk. Overall, households are lenders and corporations are borrowers.
And this is the second important function that a financial system provides: it pools the savings of many small savers so that the banks and the markets can provide billion-dollar loans to corporations. This pooling of funds also reduces risk. Risk reduction is the system’s third function. A good way of seeing how this works is by looking at banks. Bank make loans which are inherently risky. Yet they offer us deposit accounts that are as safe as cash. This is technically referred to asset transformation. Banks transform risky, long-term, illiquid loans (loans are assets to a bank) into virtually riskless, short-term (we can withdraw our money anytime), liquid (we use the balances in our accounts like cash) deposits (deposits are assets to us).
And all of this back-and-forth of funds is made on the basis of information about the borrowers and the lenders so that the system helps us weed out good credit risks from bad. This provision of information is the fourth vital function that the financial systems undertakes. We can see then that although banks may be privately-owned institutions, they perform very public functions. Allowing a bank to fail doesn’t only hurt its shareholders or customers. The wider economy suffers. There are social costs. Letting a bank fail amounts to cutting off the nose to spite the face.
We’ve used banks to buy stuff and make other payments. We’ve used ATMs. (The first ATM was one operated by Barclays in the U.K in 1967.) We’ve used debit cards and credit cards. We all depend on the Automated Clearing House (ACH) network. We got our student loans from banks. We’ve probably had to roll over our employer-sponsored Individual Retirement Arrangements to an account managed by a bank. It seems we can’t live without banks. But all that is changing. New information technologies are changing the financial landscape. The relationship between bank and customer is being ‘unbundled’ into a number of services that can be marketed separately. And new fintech companies are finding innovative ways to do just that.
At the time of writing there were 4,897 financial services startups listed on AngelList, a platform that links investors and entrepreneurs. According to The Economist in a Special Report published in May of this year, ‘Fintech newcomers are tapping into a deep reservoir of consumer mistrust towards incumbents.’ Millennials have grown up with the internet. For them, traversing the internet is as natural as walking the road. That’s where they get their news or a taxi or find dates; that’s where Facebook and Youtube and LinkedIn are. They’re comfortable with technology. In fact, they’re more likely to choose the solution, for anything, that’s new and cutting edge. They’re still young enough not to be affected as yet by the ‘good old days’ syndrome that eventually strikes us all down.
These fintech companies are nibbling away at the three businesses that provide the bulk of banking revenues. These are the loan business, the payment business, and the fees on a variety of other services such as foreign exchange, money transfers, overdrafts and brokerage. Now the savvy millennial can get a loan from a peer-to-peer lender. Peer-to-peer lending began with Zopa in the U.K. in 2004 and now it’s all over the world. According to Crowd Crux, the top five peer-to-peer lenders are, in reverse order, #5 Kiva, #4 Upstart, #3 Funding Circle, #2 Prosper Marketplace and #1 Lending Club.
Kiva allows you to lend, as little as $25, to an entrepreneur in a developing country. You choose who you lend to. Upstart is a platform for HENRYS (high-income, not rich yet). It’s meant for people who’ve studied finance or engineering or medicine at good schools and gotten good grades. Funding Circle facilitates loans to small and medium-sized businesses. And Prosper and Lending Club focus on personal loans. Social Finance (SoFi) is particularly active in the HENRYS market. It refinances student loans. The company, founded in 2011, has funded some $4 billion in student loans, mortgage loans and personal loans according to Business Insider earlier this month. CommonBond, another fintech which also started in 2011, actually makes student loans to graduates who want to further their studies. In addition, it has promised that for every loan it makes in the domestic market, it will fund an overseas student for one year.
In the world of online payment services, PayPal dominates. According to its Q4 2014 Fast Facts, it has 162 million active accounts. It allows payments in over one hundred currencies and allows account holders to hold balances in 26 different currencies. And Search Engine Journal (SEJ) in a recent article entitled The 10 Most Popular Online Payment Solutions, claims that Google Wallet has knocked PayPal off the top perch. Their line-up is as follows: #1 Google Wallet, #2 PayPal, #3 Amazon Payments, #4 Dwolla, #5 Authorize.Net, #6 WePay, #7 ACH Payments, #8 Stripe, #9 2CheckOut and #1 WooCommerce.
The great success story of fintech, though, has been crowd funding. Crowd funding is the pooling of many small contributions to finance a project, i.e. funding by a crowd of small investors. The Crowdsourcing.org has released a report cited by The Huffington Post showing that worldwide funding on crowdsourcing platforms increased to $16.3 Billion in 2014. And, says Forbes magazine in a piece published about a year ago, London is now the crowdfunding capital of the world.
You’ve heard of RoboCop so it will be no surprise to deal with a robo-advisor. Robo-advisors employ algorithms to manage portfolios. And whereas wealth management outfits charge, on average 2%, robo-advisors or automated wealth managers, such as Vanguard Personal Advisory Services, charge 0.30%, albeit for a minimum account of $100,000.00. According to The Street, Vanguard is the largest robo-advisor with over $4 billion AUM (assets under management) at the end of 2014. Betterment is No. 2. It has over $2.5 B AUM and charges as little as 0.15% for some accounts. And Wealthfront is No. 3 with $1.7 B AUM.
What will banks look like in the future? They might not even exist. As the confident millennial strides through the 21 century, he or she is looking ahead to the future… to the brave new world… to the next smart app or technology. Leave the dinosaurs behind. We’ll gather their skeletons in our museums.
This article was written by Anthony de Freitas, a writer for dusk magazine.