Rise of the mega bank-bots

Christopher Joye

In the AFR I assault the notion that the big banks are going to be threatened with irrelevance, nay disintermediated, by the various threats posed by fin-techs, blockchain, bitcoin, and/or the FANGs (click on that link to read for free or AFR subs can click here). Excerpt:

Magellan's Hamish Douglass recently argued that the banking business model might have a limited half-life given the spectre of digital disintermediation posed by fintechs and/or FANG companies.

The extreme version of this vision is a world of entirely digital, peer-to-peer lenders using bitcoin and blockchain that operate outside the traditional regulatory sphere. While this might attract media attention, it does not stand up to deep scrutiny...

My first offering is that while anarcho-libertarianslove to proselytize about an alternative technology-enabled utopia that allows us to live beyond the nation state and its laws, the hard empirical fact is that rather than fostering egalitarian outcomes, digitisation tends to favour dictactorships (or commercial monopolies).

How many search engines, social networks, photo-sharing apps or online shopping sites do you use? In most cases, just one: Google; Facebook; Instagram; and Amazon. These are monopolies controlled by a handful of (non-democratically-elected) 21st century oligarchs who have more power than any other non-state actors in history. Think Sergey Brin, Larry Page, Mark Zuckerberg, and Jeff Bezos, who measure their billions in multiples of ten.

What about the hardware and software that allows us to interface with the internet? For laptops, PCs and other devices, the world is dependent on an operating system duopoly: you either use Microsoft and Apple. In mobile phones the software is either Apple's iOS or Google's Android system. These two companies have captured an amazing 99.9 per cent of the smartphone market.

Yes, house prices are falling, as we forecast in April 2017, but they are doing so in exactly the same way they have done in previous cycles. Louie Douvis

This begs the question: why does the supposedly democratic internet encourage all-powerful monopolies rather than the libertarian ideal of a diffuse and perfectly competitive environment managed by the masses?

I would submit it's because one of the internet's most powerful impacts is the way it promotes positive feedback loops, or "network effects", that generate extraordinary economies of scale for winners. In the 1990s and 2000s we started with many social networks, search engines, file-sharing apps and operating systems. Yet the winner-takes-all network effect means that we are left with one or two companies dominating market share.

In most industries outside of financial services, it is true that digitisation has dislocated bricks and mortar. The difference with banking is found in "money" and its role in the economy.

Money represents our savings, or the fruits of our labour exertions. Our human capital is our single most important asset. We will do everything possible to protect the value of our money, which, rightly or wrongly, is a critical currency for progressing through life. Without money, it is very hard to get by. For many, it is a passport to freedom.

A necessary condition for money to serve as a medium of exchange is security, which is the inherent flaw in digital currencies. What is the safest asset you can own? Most reflex to government bonds. These are described as "risk-free" because their principal and interest is guaranteed by the sovereign (and its collective financial and military might).

This is also true of money: it is issued by the government and its face value vouchsafed by it. In contrast, what backs the value of your bitcoin? Nothing other than an encryption algorithm designed by some faceless programmer. Indeed, we still don't know who created bitcoin.

And every day we learn more and more about the vulnerabilities of digital currencies, which can be hacked. This problem is only likely to get worse when a quantum computer that can break bitcoin's security protocols finally arrives. As the world becomes more attuned to these risks, the balance of power will swing back to conventional currency backed by nation states. This insight is important for understanding the effects of technology on banks.

The essential role of banks is to serve as a safe store of wealth. This is why the Australian government guarantees bank deposits and bank bonds (it did the latter during the global financial crisis). It is why the Reserve Bank of Australia stands committed to lend unlimited amounts of money to banks during liquidity shocks to ensure they never fail. And it is why non-banks, just like digital currencies, will always have embedded at the heart of their business models a fatal flaw.

When savers get nervous during crises, they pull their cash out of non-banks and put them back into the government-guaranteed sector. This triggers an immediate mismatch between at-call liabilities and a non-banks' long-term assets, which is why scores of non-banks in Australia and overseas went under after 2007.

The highest probability scenario right now is that banks exploit technology for their own considerable benefit. Banks are already masters of scale – the four majors are among the 10 biggest banks in the world.

The advent of a real-time payments system, online application processing, electronic conveyancing and artificial intelligence will allow banks to eliminate most of their workforce and become almost entirely automated, much as factories have done. Branches are going to disappear. And the 60 per cent of the major banks' operating costs currently accounted for by people will drop like a stone. This will bequeath huge opportunities to improve returns on equity notwithstanding the unprecedented deleveraging they have had to endure since 2014.

Read full column for free here or for AFR subs here.


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