BackWould you much rather self disrupt or self destruct?
The single biggest disruptor, not to the banking industry, but to the structure of the industry, has been technology
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Yes. I am aware. Obituaries are being written on how banks are going to implode in the face of disruption. For instance, media reports are exploding with stories of how non-traditional entities can now be a part of the financial services business using wallets on electronic devices. As developments go, it is an interesting one. However, it is a little too early to write obituaries for all of us who have been around for as long as we have.
The real threat, not just to those in the financial services business like banks, but to any industry, is not a competitor that threatens to disrupt. It is the inability of established firms to play the game right. Most lack the foresight and risk appetite to embrace technology and shut newcomers out.
The way I see it, newcomers into the business are under constant pressure to deliver profits. Their honeymoon periods with investors wane. When the money they’ve burnt fails to deliver returns, things begin to get horribly uncomfortable. Established firms can force this to happen. But to do that, they must demonstrate the courage and wisdom to shed baggage from the past and create a war chest to make life difficult for cash burning, fresh off-the-block, so-called disruptors.
Leaders who hesitate, or worse still, continue to cling to old notions like fully manned bank branches, do not need these external disruptors to make life difficult for themselves. They will kill themselves.
To put this into perspective, some understanding of how banking evolved is pertinent.
When the barter system gave way to value denominated coins, what we now call the financial services business was born. The need for intermediation came alive. The earliest formal institution, which we now identify as a “bank", emerged out of Venice and was promoted by the Medici family. For 500 years now, their purpose has remained much the same.
•Move money from one person or entity to another, and from one place to another, safely and credibly.
•Stand as a guarantor in trade-related transactions between two or more parties.
•Aggregate idle money and make it productive.
•Deploy idle money to where there is a requirement, beyond the capital markets.
•Function as settlers for the capital markets.
•Function as capital raisers and distributors of capital market products.
•Broker consolidation through mergers and acquisitions, to make capital more efficient.
•Deploy money in the most efficient manner for wealth creation at all levels—whether it be for governments, enterprises or individuals.
But the structure and process by which the financial services industry has stayed true to this purpose, has periodically undergone changes. In fact, banks were the first formal structural entities that emerged to deliver financial services. Along with banks, many non-banking financial service delivering entities have competitively co-existed. Each time a non-banking industry identified a new need of the society and walked into the space to take charge of it, panicky pundits predicted the death of banks.
The single biggest disruptor, not to the industry, but to the structure of the industry, has been technology.
But the banking business has assimilated all of these threats into its fold.
When credit cards made their appearance, an epitaph was written for the banks. How many pure card companies have survived? On the contrary, every innovation has expanded the revenue and profit pool of banks.
The beauty of technology is that it gets commoditized within months. The question is, what share of the revenue and profit pool will current and potential cede? That depends on how much headway banks give disruptors. Let us take for example payment disruptors of the kind I had alluded to earlier. They are deploying mobile technologies to create virtual wallets and everybody is gung-ho about them. But let us look at the facts.
The total share of payments-driven, fee-based income is a fraction of the universe of revenue and profits for the financial services industry. Firms who are getting in now are focused mainly on the retail segment. But the share from the retail segment in payments is even smaller.
Bear in mind, banks and non-banking financial services entities make the major share of their revenue and profits through net interest income and income from investments. The largest share of income even in the payments segment comes from entities, private and government—and not retail. The payments industry has to make its revenue largely from the fee. To that extent, the float is likely to be wafer-thin and transient.
The banks may appear tardy now. But anyone counting them out will do so at their own peril. Sure, a share of the new expanding market will be taken away by the disruptors. But this will not be a share out of the current pool of banks. Banks will join in and grow this market, and take a healthy share for themselves.
The real risk lies in that banks are blind to the revenue and profits staring them in the face. Technology is making heavily manned bank branches redundant. Almost two-thirds of the cost of banks are locked in the operating expenses of the branches. Less than 10% of customers ever visit a bank branch.
The fully automated branches and the automatic cash acceptance machines are shrinking the space requirement of a branch and the number of people who need to be stationed inside a branch. The profit pool to be harvested from this is many times more than the profit pool that any payment disruptor can take away.
My argument is not that we need to ignore one for the other. Branch automation and cost rationalization, in my estimate, has a minimum 25% to offer to profit accretion of the banks’ retail segments. In less than 10 years, bank branches will be similar to landline phones—a supplementary channel and not the main channel.
So long as traditional firms don’t lose sight of facts like these and stay open to embracing disruptions, there is no need to lose sleep yet.
An unabridged version of this article is available at foundingfuel.com
K. Ramkumar is an executive director on the board of ICICI Bank Ltd and the president of ICICI Foundation.
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