Fixing Finance: Incubating New Banks 12 comments
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The debate du jour around the world’s capitals and financial centers is of course “How do we save the banking system?” Good banks. Bad banks. Private banks. State banks. Capital injections. Credit insurance. Etcetera. But in this Dr. Seuss world of solutions, and despite thousands upon thousands of articles, blog posts and editorials, I have been very surprised to see that two crucial elements seems to be missing from all the solutions being discussed: innovation and entrepreneurialism.
Governments should invest (at least) a small amount of the billions and billions they are ploughing into the financial system into new banks. That’s right - start-ups. But not carbon copies of the banks we have today; 21st century banks. Banks that aren’t built on foundations of obsolete business models and technologies. Banks that are “digital natives”. Banks that by design answer the question: “If you had a blank sheet of paper, how would you build a platform and and organization to provide banking services in today’s (and tomorrow’s) world?” Banks that not only understand the importance of Moore’s (and Kryder’s) and Metcalfe’s and Linus’ and Amara’s laws but also their ramifications for a business that is intrinsically and structurally about managing digital information flows in a connected society and economy. Banks without (literally and psychologically) the corrosive burden of legacy costs and structures. Banks who apply Coase’s theories in the context of transacting in a networked world. Banks who embrace the lessons of Dunbar and Kahneman and Thaler (and Sunstein) when designing their management and compensation policies. Banks that strive to live up to Einstein’s suggestion that “things should be made as simple as possible, but not any simpler” and have an instinctive bias against complexity and a copy of Maeda’s The Laws of Simplicity
(adapted from Wikipedia) A bank is a financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money. It is an institution for receiving, keeping, and lending [and investing] money.
Obviously in order to build such a bank you need a team of leaders who not only understand banking and finance but understand intuitively the social and technological landscape of the 21st century: Bankers who refuse to trivialize novel tools and modes of communication and interaction simply because they are unfamiliar. Bankers who are as comfortable on Facebook or Twitter as they are on a trading floor or in a branch. Bankers who collect and collate their daily information via RSS readers and wikis and blogs and not just from the FT or CNBC or Bloomberg. Bankers who have accepted that the value they can create no longer comes from arbitraging information scarcity and building black boxes that hide complexity, but from embracing abundance and building tools to help people navigate this complexity as partners. Bankers who would be equally comfortable discussing the future of finance with the founders of Google (GOOG) as they would be with the governor of a Central Bank. Bankers who are passionate yet sober. Bankers who are focused on the future and on providing a service that doesn’t rely on coercion or inertia or lack of alternatives to keep their customers satisfied. Bankers who realize what a tremendous opportunity exists to start afresh and be part of creating a new paradigm in financial services.
These individuals exist. Many are readers of this blog. I am one of them. So is Amy. We are connected to many more via our networks. I suspect that many of them would jump at the chance to participate in a venture (or ventures) like this. And not just because the financial opportunity cost of doing so has plummeted (although that clearly helps, everyone has bills to pay…) but because it’s exciting. Because it would be challenging. Because it’s the right thing to do.
So why not just do it? Why the government? Why a billion dollars? Because building a bank by bootstrapping from nothing is exceedingly difficult, perhaps impossible. There are many reasons, importantly:
- The fundamental nature of the business - selling trust-based products and services in a highly regulated environment - means that the minimum level of operating costs and capital required to be credible is substantial.
- Perceptions are important, especially in these turbulent economic times; no matter how abusive the relationship (with their existing bankers), people and companies are going to be initially very cautious about giving their custom to a new bank, especially one that is obviously not too big to fail (indeed the implicit endorsement of the government in this context is probably even more important than the capital itself.)
- Much can be achieved within the existing legal and regulatory framework, but many of the most interesting opportunities rely on this “institutional framework” evolving to “catch up” to the technological and economic reality; having the government as a partner would facilitate the dialog and help to counter the inevitable resistance from incumbents who have a vested interest in maintaining the (old) environment to which they have adapted.
- Because as a taxpayer if I am forced to invest in the old (to mitigate catastrophic systemic risk), I want to also invest at least a part of my money in the future (to help build and profit from the reinvention of banking): remove the cancer yes, but start working on the cure.
- As for the billion dollars, this was just a nice round back-of-the-envelope (somewhat informed) guess; this would be sufficient equity to build an operation with credibility and critical mass, and would support a sufficiently large but conservatively leveraged asset base to produce enough operating income to sustain growth and profitability (and pay back the government in full over a 5-15 year horizon without jeopardizing the business.) The right (minimum) amount needed could well be less, is unlikely to be more, and would not need to come 100% from government coffers - indeed, private co-investment would be desirable - and further, the bulk of the capital would likely be called over a period of 1-3 years as the balance sheet is built up.
I’m deadly serious, but to be frank, I’m not sure where to go with this. Although I have a pretty interesting and diverse network that includes a number of even better connected people, I don’t think I’d have much success cold-calling Mr. Brown or Mr. Darling and getting a chance to pitch this over a latte at the local Costa… Even less Mr. Obama or Mr. Geithner… But perhaps if nothing else, I can catalyze the conversation and bring this option - earmarking at least a small portion of the various trillions of rescue funds to seeding a new generation of 21st century banks - to the attention of the politicians and the public.
I know there is a risk that this proposal sounds like just one more in a never ending line of petitioners going to the government for a handout. I hope that (at least, especially regular) readers will not doubt my integrity when I assure you that this is not my intent, and I genuinely believe that this is an idea worthy of serious consideration. And most importantly that - in this context - the government’s money is actually more valuable than anyone else’s. To get started. Essentially I’m suggesting the government(s) have a unique competitive advantage that makes them the ideal incubators for a new generation of banks (and that they would realize excess financial returns by exercising this advantage.)
Disclosure: none
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This article has 12 comments:
Perhaps you have some truly innovative ideas for the banking industry, or perhaps you don't... but if one were to base their opinion on this article, its unclear you understand the business at the most basic of levels. (You know, borrowing, lending, transaction processing... that sort of thing)
And its too bad, because, you do seem to have a solid grasp... it just doesn't show here. As you said so well in past articles... actually coming up with new and better ways to serve customers is hard.
The upside to doing this is every dollar put into such new banks can be aid in adding velocity to the money supply rather than being tied up in reserves supporting a welter of bad loans.
There is one catch and one why banks don't support this. As money moves to new sound banks money drains from the old unsound banks leaving them high and dry (as if they weren't already). This makes it 100% obvious someone has to pay the piper sooner rather than later and that hopes of their recovery are essentially nonexistent. Another-words, they are dinosaurs and extinction has come to claim them.
First off, we have to save what we have from utter destruction. It takes decades if not centuries to build banks the size and scope of Citigroup and Bank of America. You don't destroy what you have in a matter of 2 to 3 years what you painstakingly built over the few hundred years. Every available resources will be needed in order to improve the chances of saving a nations' lifeline.
New concept entrepreneural ventures are mostly born in adversity but will get financing during the economic upturn and not in the downturn.
As for the business of a bank - as you say "borrowing, lending, transaction processing, that sort of thing" - a point I implied, but didn't make clear, was that there is no competitive advantage in 'just' being able to do these things. They are commoditized. (Don't get me wrong I'm not suggesting they are trivial or even easy to do well, but that it is exceedingly hard to make a positive difference just by doing this. Like a telco: you can fail by messing up, but it is hard to succeed just by getting it right. It's expected.) And imho is a significant contributing factor in why it all when pear shaped: who cares about getting this stuff right when you can make 20x as much with 100x less blood, sweat and tears, just by punting the market and leveraging up to the max...When the going got tough, the not-so-tough got long. Very long.
So what I was really trying to suggest was that if you were to set out to build a business that lends, borrows, transacts payments, that sort of thing today, starting from a blank sheet of paper, you would not use the existing traditional bank business model, but would do it differently. Because you can. And because your customers' expectations have changed.
But you are right in saying this is not a blueprint. It's not even a napkin sketch, of what that kind of bank would look like. And even if I am talking rubbish, my main point was why funding new banks (just plain old new banks) wasn't part of any country's plan? If nothing else to give some competition to the old banks and to create more data points in terms of measuring policy effectiveness. I figure you could take 5-10% of the sums being thrown around and seed a material number of new institutions, without calling into question the need to shore up the incumbents.
Anyhow, thanks for keeping me honest.
On Feb 18 06:57 PM mathgeek wrote:
> This is dissapointing Technodrivel, and it reads like a pitch for
> Webvan circa 1997. (Those silly grocery stores, they just don't
> *get* technology!)
>
> Perhaps you have some truly innovative ideas for the banking industry,
> or perhaps you don't... but if one were to base their opinion on
> this article, its unclear you understand the business at the most
> basic of levels. (You know, borrowing, lending, transaction processing...
> that sort of thing)
>
> And its too bad, because, you do seem to have a solid grasp... it
> just doesn't show here. As you said so well in past articles...
> actually coming up with new and better ways to serve customers is
> hard.
>
>
>
>
>
On Feb 18 09:48 PM constructe wrote:
> You are right. Several of us in Seeking Alpha have mentioned this
> idea including myself. I fully support this idea. I'd be happy to
> put my deposits and my capital towards a Seeking Alpha bank. Maybe
> Alpha Bank sounds better. It sounds like a Fraternity credit union
> haha.
>
> The upside to doing this is every dollar put into such new banks
> can be aid in adding velocity to the money supply rather than being
> tied up in reserves supporting a welter of bad loans.
>
> There is one catch and one why banks don't support this. As money
> moves to new sound banks money drains from the old unsound banks
> leaving them high and dry (as if they weren't already). This makes
> it 100% obvious someone has to pay the piper sooner rather than later
> and that hopes of their recovery are essentially nonexistent. Another-words,
> they are dinosaurs and extinction has come to claim them.
On Feb 19 01:30 AM The hand wrote:
> i am with constructe and have written about and supported this concept.
> but the gods are against us. we would immediately have a sound banking
> system. but the bank lobbyists will make sure this does not happen.
It is evident by today’s frozen credit markets that the demand for loans is higher than it has been in years while the supply is almost nonexistent. In the current scenario, new banks will solve the supply problem by injecting fresh capital into the markets. Additionally, the increase in the consumer saving rates will continue to strengthen the depository base.
In today’s financial environment, it is difficult to raise private capital for new bank ventures. Investors have been harmed by the falling equity valuations and are constantly bombarded by bad news in the banking sector. These facts make it very difficult to raise the seed capital needed to fulfill regulatory requirements for a new bank charter. The TARP funds have not been utilized to help banking entrepreneurs.
I would love to see a government program that matches private funds raised by new banks. In such a scenario, a small government fund ($10-$20b) will inject the equivalent of $200-$400b in new liquidity in the marketplace. New banks will have to deploy this capital within the first three years of operations, as required by the regulators.
Additionally, the banking regulators, responsible for approving new bank applications are swamped by existing bank failures. This is delaying the approval of new bank applications. Additional resources at OCC, OTS and FDIC are necessary to accelerate the application process.
For some perspective, realize that in 2007, 196 new bank charters were created, while 320 banks were involved in mergers. This was a net loss of 124 banks. I expect 2008 numbers to show an even larger decline in the number of overall institutions.
The bank starter