Samir’s Selection 03/09/2016 (a.m.)

  • Why might one hope that new financial technology, or “Fintech” as it is known, will transform these businesses? The answer, especially for banking, is that they are currently not done very well. Banking seems inefficient, costly, riddled with conflicts of interest, prone to unethical behaviour, and, not least, able to generate huge crises.

    In a recent speech on the possibilities for a financial revolution, Andrew Haldane of the Bank of England notes that, astonishingly, the unit cost of US financial intermediation seems to be unchanged over a century (see chart). Moreover, income from finance simply rises and falls with the value of assets. That suggests a huge amount of rent-
    extraction. Additionally, 10m US households and 1.5m UK adults still have no bank accounts. Worldwide, banks generate a staggering $1.7tn in revenue, 40 per cent of the total, from the job of making payments. In the computer age, settlement can still take hours or days.

    On behaviour, as John Kay has written, “parts of the financial sector today … demonstrate the lowest ethical standards of any legal industry”. The payment of vast fines seems to be viewed as just a cost of doing business. Finally, the post-2007 banking crises were as big as any in the past. That their economic impact was not still worse than earlier was due to the willingness of governments to bail banks out.

    New technology might help change this in at least two ways. First, it might transform payments. One possibility is real-time settlement via distributed ledgers. The advantages of instantaneous settlement are evident. The advantage of distributed ledgers, an element in bitcoin’s “blockchain” technology, is an improvement in the robustness of record-keeping. Instead of centralised accounts, the database would be shared across a network of sites, all of which would hold an identical copy.

    A second transformation might be via peer-to-peer lending, in which new platforms disintermediate the traditional businesses in matching savers with investments. Such lending is growing rapidly (see chart). The theory here is that computerised information might allow savers to dispense with the (costly) services of bankers altogether.

    Optimists imagine a future in which payments, the creation of money (unquestionably liquid and safe assets), and intermediation would be separated. In this case, the capacity of the banking sector to create havoc would be reduced and so would the perils created by the state’s backstop to private institutions. It is, however, far too early to be confident of such benefits. Indeed it is easy to see that new record-keeping and payments systems would create huge security issues. Similarly, opportunities for malfeasance also exist on peer-to-peer platforms. Indeed, these are inevitable with transactions that rest on promises against an inherently uncertain future.

    On balance, the opportunities afforded by the application of information technologies to our financial system seem large. The difficulty might rather be to ensure that the benefits accrue this time to the public rather than to a small number of incumbents or even to their more dynamic replacements. Finance, particularly banking, does need a revolution. But this is one area where policymakers cannot just assume things will work out well. It is because finance is so important that a revolution is needed. But for that very reason the revolution also requires careful watching.

    tags: fintech banking efficiency competition innovation MartinWolf

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