Edited excerpts from valedictory speech delivered by R. Gandhi, Deputy Governor, Reserve Bank of India, at the FIBAC 2016 “New Horizons in Indian Banking” on 17 August 2016 at Mumbai.
“Banking is necessary, but banks are not”, I am quoting here Bill Gates, what he said as Chairman, Microsoft, way back in 1994. Today, after twenty two years, has his prediction or forewarning come true?
In the PWC Report in July 2014 on “The future shape of banking – Time for reformation of banking and banks?” they mentioned the most influential of the trends to be “the demographic and social change, creating new customer demands and stakeholder expectations; and technological breakthroughs changing everything from customer relationships to business models”.
A Willis’ research report published in Resilience in April 2015 said that the financial institutions industry is currently faced with a paradigm shift caused by trends such as the regulatory capital requirements, digitalisation and technological advances, new market participants, demographic and behavioural changes in the new generation of customers.
Technology, Consumers and Regulation
Banks today are forced to make rapid and irreversible changes due to the developments in technology, customer behaviour and regulation. Let us explore a bit more on these developments.
Technological developments are changing the way the banks and their customers interact. The plethora of technological products and services have helped emergence of FinTech companies that offer low-cost alternatives to traditional services, such as e-payments and online trading. Social media companies such as Facebook, Twitter and Google are also entering into the financial sector, bringing new sources of competition.
The new generation of young people (known as millennials) have different expectations and their ways of interacting with banks are also different. They prefer not to come to banks for banking services. Rather they would prefer to avail the services online. They are using social media not just to connect and communicate among themselves, but also connect and communicate with banks. While Millenials behave this way, the Mature customers and Older / Retirees are demanding improved returns from investments and demand greater transparency.
Since the financial crisis, regulatory emphasis has been more on capital. This has led many banks to divest themselves of ‘risky’ or capital-intensive assets, businesses and even markets. This has also brought a sea change in bankers’ attitude towards risk and clearly marked the boundary between retail and wholesale banking. Banks have also been investing and recruiting heavily in compliance to meet new regulatory requirements.
Another offshoot of the stricter enforcement of regulations, is the increasing business and growth of non-banking financial institutions, the shadow banks that are not subjected to the same degree of intense regulation. They are offering competing services to bank clients, establishing specific funds or offering private equity.
These three trends have clearly redefined banking and banks.
Banking and Banks – Redefinition
These emerging trends are endangering banks’ existence. Am I echoing Bill Gates?
From the time the concept of money was understood, the concepts of lending and borrowing came into existence. But the concept of banking wasn’t there. However, the organized way of lending and borrowing happened when the prototypes of modern banks were established some 700 years ago. Banks undertook another service i.e. the remittance service. Thus, what the banks did viz., borrowing, lending and remittances, came to be known as banking.
The mega trends that we discussed have redefined banking and banks. Banking is no longer what a bank does. Now, non-banking entities also do banking.
Payment service providers, P2P (peer-to-peer) services, P2B (people-to-busines) services, SME financing, consumer retail financing, crowd funding, invoice financing, bill collectors, credit referrals, account aggregators, investment bankers, housing finance companies (HFCs) and credit rating agencies are some of the entities who chipped away chunk after chunk of banking. Is there an element of banking that remains the exclusive privilege of banks? Sadly, no. That’s why Bill Gates said what he said — “Banking is necessary, but banks are not”.
How this happened? Admittedly, it is the technology and the customer expectations which chunked away or which enabled chunking away the different elements of banking.
Will Banks Really Cease to Exist?
The chunking away of banking from the banks have given enormous business and growth for these non-banks. With their specialization and focused service rendering, they are able to offer that chosen service at greatest efficiency, speed and at very affordable cost to the consumers. This has stumbled the growth of banks today and has every potential to lead to de-growth and ultimately the decimation of banks in future.
The West no longer officially designate anybody as a bank. They have only a depository institution or a credit institution. In India, the Indian Financial Code recommended by the Financial Sector Legislative Reforms Commission (FSLRC) also reflects similar thinking.
The clear prognosis is that either the banks will be dead or at least the banks of the future are not going to be the banks of yesterdays and todays.
What to Do?
I have to paint such a dismal future for existence of banks. We have to recognize the realities of the day, the compulsions of the new driving forces that demand a new paradigm in banking and reflect on future course of action.
There are hopes. First, take full advantage of the technological developments and enmesh in them to meet the customer expectations. The new consumer is addicted to connectivity, convenience and freedom.
SME financing is one big area that banks vacated and/or let others to occupy due to lackluster attitude. It is there for banks to reclaim, if only banks make concerted and conscious effort. Small and medium sized enterprises (SMEs) reportedly account for more than half of the world’s gross domestic product (GDP) and employ almost two-thirds of the global work force. As reported by the International Financial Corporation (IFC), a “funding gap” of more than $2 trillion exists for small businesses in emerging markets alone.
In recent years, the FinTech companies and the marketplace lending have entered into this vacuum and have become immensely and instantly successful. If only the banks can change their current reluctant attitude towards SME financing, they can be a good antidote for these risks and therefore will display their socially relevant role, which in turn can justify their existence for the future.
If banks make themselves socially relevant, not just relevant in economic sense alone, they can have hopes to exist.