The U.S. Banking System Is Behind The Times

by: John M. Mason


The United States banking system is being accused of a failure to modernize sufficiently, and is falling behind England, India, and Africa in its operational platform.

Changes are taking place in the private sector with respect to payments systems and peer-to-peer lending.

How this is going to work itself out - and be regulated - is anybody's guess right now, but the evolution of the system could include some developments that would result in safer banking.

John Gapper has written an article for the Financial Times titled "US banks will pay dearly for their failure to modernize."

Gapper basically concentrates on the money holding and money transfer side of the banking business, and concludes that "the US lags behind the rest of the world with no obvious way to solve its difficulties."

Although in the United States there are competing private payment networks like PayPal and Popmoney for consumers, there is very little oversight of these organizations, and there is very little being done within the regulatory system to bring the US payments system into the 21st century.

This places the United States, as Gapper observes, quite a bit behind England, India, and Africa. He writes: "It is strange that a country that often leads the rest of the world in consumer technology lags behind badly in the basic infrastructure of retail banking."

On the other side of the balance sheet is a lot of activity taking place, and these lenders are generally referred to as peer-to-peer lenders or the crowdfunders. These online lenders have received a lot of publicity in recent months, some of the more prominent ones being Lending Club, Prosper, and ZestFinance.

Then you have another growing group of lenders that are located more to the business side of the banking spectrum. I have written about the merchant funders, three of which you might want to check up upon are Merchant Cash and Capital, On Deck, and Fora Financial.

The independent lending business seems to be flourishing, and the funding of these loans is not coming from deposits.

The banking world is changing, whether you call the developments a part of the shadow banking world or the alternative finance world. And in this discussion, we haven't even touched asset management organizations, hedge funds, or private equity.

An interesting aspect of this financial innovation is that we are getting a separation of the asset side of a bank's balance sheet and the liability side. This seems to me to be one of the reasons why these developments are taking place outside of the existing regulatory system.

Realizing this, the question then becomes, will these advances continue to take place in the United States outside of existing banks and the existing banking system, or will the existing banks or the existing banking system get into the game and play a part in the evolution of the system? Or will the existing banks stay out of the process until the evolution reaches a certain advanced stage, and then acquire the more fully developed systems?

Furthermore, Gapper brings up an interesting comparative situation. "Europe's lead reminds me of the period a decade ago when it was ahead of the US in the use of mobile phones." If you remember, European countries, in general, tended to chose one specific system with one specific platform to build its future upon. The United States, however, let several firms compete for the market, and this allowed different platforms to be developed and, finally, when the market forces reduced the number of compatible systems, the mobile network in the US took off and came to dominate its European competitors.

Will that happen in the banking sector? Gapper is not convinced. The reason, "the US has a big gap to make up in payments."

At this stage, another thought crosses my mind. There has been a growing discussion over the past couple of years about possible fundamental changes in the banking system itself. The particular suggestion I am referring to is the proposal to change the deposit side of the banking system into a 100 percent reserve system.

This proposal is associated with something called "the Chicago Plan," a proposal put together by several economists at the University of Chicago in 1933. Obviously, the effort was a response to the events connected with the Great Depression. A recent write-up of this "plan" can be found in the June 7 issue of the Economist (This article also includes references to studies on the subject).

As presented by the Economist, the central idea of the Chicago Plan, called "narrow banking," suggests "any bank or bank-like entity, such as a money-market mutual fund, financing itself with short-term fixed-value liabilities could only invest in short-term debt issued by the Treasury or the Federal Reserve. Banks could still engage in other business, but they would be barred from using short-term debt to fund such activities." In essence, the deposits of the bank would be supported, essentially, by a 100 percent reserve backing.

A system set up like this would not be subject to bank runs.

There are operating difficulties associated with such an idea, but the concept is being floated around an alternative to what exists now.

Well, one could argue that the financial system is evolving in a way that maybe 100 percent banking could be an alternative system. Maybe, just maybe, alternative institutions could be constructed that would use the evolving payments mechanisms currently coming to the marketplace. These alternative institutions could even possibly be not-for-profit organizations that would allow a management team to focus on the social aspects of providing a deposit system to the public that was exempt from bank runs. This "banking" institution could even provide other services to the public, especially to a less wealthy public that did not have the many alternative asset sources that the more wealthy public might have.

An institution like this could even have a companion organization related to it that provided lending sources similar to those now being offered by peer-to-peer organizations or merchant funders. I am thinking of this as a horizontal organizational relationship.

Of course, the two (in this example) independent functions could be combined in something that was more vertical to achieve the same thing under one umbrella.

The crucial factor in this discussion is that developments are already under way to change the structure of the banking/financial industry. The information technology behind this movement will continue to improve at a faster and faster pace. Thinking will also evolve along these lines. What the result will be is unknown at the present time. But it is going to be an interesting trip, and there will be lots of investment opportunities that will become available along the way.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.