Tag Archives: technology

What fintech revolution?

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You may have missed World Fintech Day this year. It was 1st August, a date chosen by (amongst others) my good friend Brett King. It was a day to take some time to congratulate an industry that has achieved… well, what exactly? What is there to celebrate when the truth is that we haven’t yet had a fintech revolution or anything like one. The “challenger banks” are just banks, they haven’t brought new business models or changed market dynamics.

If you think I’m being harsh, take at look at this survey of almost 800 companies that has just ranked financial services as one of the least innovative sectors of the economy! We all expect the pharmaceutical companies, to pick an obvious example, to be more innovative than banks. And according to this survey, they are. But even the textile industry is more innovative than banking, where business models and the cost of intermediation (which I would see as being a key measure of productivity) haven’t changed for generations. Yes, fintech has brought financial services to hundreds of millions of people in developing markets, but it has yet to transform developed markets.

Even the textile industry is more innovative than banking, where business models and the cost of intermediation haven’t changed for generations Click To Tweet

Why has nothing happened?

Well, there’s a story that I tell at seminars now and then about a guy who was retiring from a bank after spending almost his entire working life there (I heard the story a couple of times from a couple of different people but as far as I know its earliest written form is in Martin Mayer’s excellent book “The Bankers“).

The guy in question had risen to a fairly senior position, so he got a fancy retirement party as I believe is the custom in such institutions. When he stepped up on stage to accept his retirement gift, the chairman of the bank conducted a short interview with him to review his lifetime of service.

He asked the retiree “you’ve been here for such a long time and you’ve seen so many changes, so much new technology in your time here, tell us which new technology made the biggest difference to your job?”

The guy thought for a few seconds and then said  “air conditioning”.

It’s a funny story, but it’s an important story because it includes a profound truth. Robert Gordon’s magisterial investigation of productivity in the US economy “The Rise and Fall of American Growth”, shows very clearly that the introduction of air conditioning did indeed lead to a measurable jump in productivity, clearly visible in the productivity statistics. Of course, other technologies led to improvements in the productivity of banks and the wider financial services sector. Computers, for example. But it took a while for them to transform anything (we all remember Robert Solow’s 1987 “productivity paradox” that computers were everywhere except for the productivity statistics) and the figures seem to show that those improvements slowed to a standstill a couple of decades ago.

Pinkcard

with kind permission of TheOfficeMuse (CC-BY-ND 4.0)

In the last decade, the smart phone revolution does not seem to have been accompanied by any increase in productivity at all and it’s not just because half the workforce are playing Candy Crush and the other half are messing around on Instagram instead of doing any useful work. It is, as Gordon notes, because the technologies are being used to support existing products, processes, regulation and institutional structures rather than to create new and better ways of delivering financial services functionality into the economy. So while there are individual fintechs that have been incredibly successful (look at Paypal, the granddaddy of fin techs that is going gangbusters and just has its first five billion dollar quarter), fintech has yet to fulfil its promise of making the financial sector radically more efficient, more innovative and more useful to more people.

I can illustrate this point quite simply. While I was writing the piece, I happened to be out shopping and I went to get a coffee. I wanted a latte, my wife wanted a flat white. While I was walking toward the coffee shop, I used their app to order the drink. The app asked which shop I wanted to pick up the drinks from, defaulting using location services to the one that was about 50 yards away from me. Everything went smoothly until it came to payment. The app asked me for the CVV of my selected payment card, which I did not know so I had to open my password manager to find it. After I entered the CVV, I then saw a message about authentication. What a member of the general public would have made of this I’m not sure, but I knew that they message related to the Second Payment Services Directive (PSD2) requirement for Strong Customer Authentication (SCA) that was demanding a One Time Password (OTP) which was going to sent via the wholly insecure Short Message Service (SMS). Shortly afterwards, a text arrived with a number in it and I had to type the number in to the app. The internet, the mobile phone and the app had completely reinvented the retail experience whereas the payment experience was authentication chromewash on top of a three digit band-aid on top of a card-not-present hack on top of a 16-digit identifier on a card product that was launched in a time before the IBM 360 was even thought of.

Thomas Phillipon of the Stern School at NYU carried out a very detailed analysis of the US financial sector back in 2014 and found that the unit cost of financial intermediation was around 1.87% on average (which is a lot of money). This adds up to a significant chunk of GDP. Indeed, calculations seem to indicate that the finance sector consumes about 2% excess GDP. What’s more, these costs do not seem to have decreased significantly in recent years, despite advances in information technology and despite changes in the organization of the finance industry.  Earlier World Bank work looking at the impact of bank regulations, market structure, and national institutions on bank net interest margins and overhead costs using data from 1,400 banks across 72 countries tells us why: tighter regulations on bank entry and bank activities increase the cost of intermediation.

To put it crudely, Moore’s Law and Metcalfe’s Law are overcome by the actual law and the costs of KYC, AML, CTF, PEP, Basle II, MiFID, Durbin and so and forth climb far faster than costs of transistors fall. This observation in fact shows us the way forward. As technology has driven down the costs of computing and communications, the costs of shifting bits around has collapsed. But financial services is — as it should be — heavily regulated and the costs of that regulation have rocketed. The net result is that fintech has not brought about a revolution. If there is going to be such a revolution, if new technology is allowed to create new business models and new market structures, and if those new structures are to reduce the costs of intermediation, then we need the regulators to create the space for innovation. And perhaps, just perhaps, they have: open banking is the first step on an open data road that may ultimately not only revolutionise payments, banking and credit but… everything.

Banking Bubbles no attribution

@dgwbirch The Glass Bank (2020).

We all understand that the future competitive landscape is about data, so the regulators can make an more innovative platform for enterprise by opening up access to it and then providing new kinds of institutions to curate it (such as the Payment Institution in the European Union and the Payment Bank in India). This kind of regulatory innovation may allow fintech to deliver what it promised and lay the groundwork for some actual challengers. So, this World Fintech Day, let’s celebrate fintech for what it is going to bring as we move forward into the open banking era, not for what it has achieved so far.

[An edited version of this piece first appeared in Forbes, 1st August 2020.]

Horizon scanning in good company

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My favourite think tank, the Centre for the Study of Financial Innovation (CSFI) in London, where I am honoured to be the Technology Fellow, was asked by the law firm Dentons to put together a series of “horizon scanning” events, each looking at the major factors that will determine the shape of the financial services sector over the next 10-15 years. As part of this series they held a fintech breakfast to look at the world of tech-based challenger banks, P2P lenders, crowd-funding, new payments methodologies, AI, crypto-currencies, blockchain and so forth. I was flattered to be invited to take part, along with Clara Durodié (founder and managing partner of AI outfit Cognitive Finance Group) and Nick Ogden (the founder of ClearBank and, some years ago, the founder of WorldPay).

(In my opinion, Nick is at the heart of the current fintech revolution, the UK-centric whirlwind around open banking and the “platformisation” of financial services, whereas Clara is at the heart of the current regtech revolution, using AI to change the markets themselves. We may be a long way from Terminators and HAL 9000, but the massive AI investments pouring into financial services around the world mean that the technology is going to change the sector soon.)

For what it’s worth, my three main horizon-scanning observations were that:

  1. Open Banking starts in January and I remain convinced it will be far more disruptive than many people think. It is not far-fetched, as Wired magazine observed, that banks might go under because of this. At the risk of sounding like a broken record, this about identity, trust and reputation not money. Obviously, I left it to Nick to talk turkey on this one. He set up Clear Bank to provide building societies, credit unions, other banks and fintech companies with access to all the major payment and card schemes, including Faster Payments and is obviously pretty convinced that open banking is going to provide space for innovation.

  2. AI is an event horizon. In that 10-15 year timescale it is clearly the most important technological trend of the generation and it is impossible to see what is the other side of it. Obviously, I left it to Clara to run a few things up the flagpole here. What I will note is that analysts at Forrester have predicted that quarter of financial sector jobs will be “impacted” by AI before 2020 and John Cryan, the Deutsche Bank CEO, was quoted in the Financial Times in September saying that the bank is going to shift from employing people to act like robots to employing robots to act like people. The impact on employment is obvious, but we cannot hold back the tide so we must take advantage of the changes and begin to explore for new opportunities that can be built around a more productive financial services sector

  3. I wanted to bring something from left field to the discussion, so in addition to these two obvious key trends I spoke about the token and Initial Coin Offering (ICO) marketplace. I think that a regulated and organised token marketplace will be one of the big financial services business moves in 2018 and I’m pretty sure that it will be successful (for a variety of reasons to do with liquidity and the elimination of clearing and settlement).

Nick, Clara and I put forward our thoughts about the longer term. During the discussion that followed, there were a number of questions and comments about the impact of AI on the financial services sector. I think this is in many ways quite unpredictable not only because of the “event horizon” but because of the impending interaction. People tend to think in terms of robo-advisers and chat interfaces, focusing on the use of AI by financial institutions to either cut costs or deliver new services (some of which, of course, we can’t imagine). But, to paraphrase Fred Schwed’s 1940s financial services classic… where are the customers’ bots?

If you think about it, however, the customers will have access to AI as well. The customers smartphones will connect them, permanently, to an intelligence far greater than their own. Thus, if a bank is trying to sell me a mortgage or a credit card or whatever, it’s wasting its time showing me incomprehensible advertisements involving astronauts riding horses through fields of purple daffodils and people singing.

My AI is going to negotiate with the AI of the regulated financial institutions in order to obtain the best product for me. Since I’m not smart enough to choose the right credit card, pension or car loan then clearly I’m going to want my own giant killer robot to take care of things. But which robot? Should I choose the Saga robots or the Virgin Money robots or the best performing robot over the past 12 months or the Google self-taught super intelligent robot that is also the world Go champion?

How the banks’ robots will interact with the customers’ robots is at the same time fascinating and frightening. I’m not sure I really want to be in the loop when the discussion of a pension plan or insurance project is taking place, but I do want some sort of confidence that there’s a regulator in the loop and that should push come to shove, my robot will be out to explain why it made the decisions it did. All in all, what I can see on the horizon is giving my AI access to my account through open banking and then letting it decide which ICO is to invest in.

The best thing since… oh, that’s not on the list

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The Atlantic magazine published one of those articles based on the latest that I really should ignore and not take too seriously but can’t help reading — Fallows, J., “The 50 Greatest Breakthroughs Since The Wheel” in “The Atlantic” p.56(9) (Nov. 2013). This time it was the 50 greatest breakthroughs since the wheel. They asked various scientists, historians and technologists to rank a list of innovations for the article, and then put them together into a nice feature.

I’ll spoil the ending for you by telling you that number one on this list was the printing press! I was surprised that the telegraph only made it as far as position 26 because as an acolyte of the Economist writer Tom Standage (“The Victorian Internet”), I do think that the step change between being unable to communicate faster than physical matter could be propelled and being able to communicate at the speed of light represented some fundamental cusp in human history rather than any kind of marginal improvement, so think I would have pushed it further up the list. Damn. There I am getting caught up in thinking about the list again.

Oh and one more thing. The most amazing fact that I think I saw in the article concerns the sequencing of human DNA. The article notes that in the past 12 years the cost of sequencing human DNA has fallen to a millionth of its previous level. That’s an astonishing six orders of magnitude cost reduction in a decade. Now I can’t decide whether DNA sequencing or 3-D printing will feature in some future list as the most important technological breakthrough of our current era.

In the future, everyone will be famous for fifteen megabytes

None shall password

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[Dave Birch] Technology does throw up some damned difficult issues sometimes, particularly when it has an impact on law enforcement. In the old days, when your door was kicked in by size 12s, all of your documents could be read and used in evidence. But it’s not so easy now.

Brazilian police seized five hard drives when they raided the Rio apartment of banker Daniel Dantas as part of Operation Satyagraha in July 2008. But subsequent efforts to decrypt files held on the hardware using a variety of dictionary-based attacks failed even after the South Americans called in the assistance of the FBI. The files were encrypted using Truecrypt and an unnamed algorithm, reportedly based on the 256-bit AES standard. In the UK, Dantas would be compelled to reveal his passphrase under threat of imprisonment, but no such law exists in Brazil.

[From Brazilian banker’s crypto baffles FBI • The Register]

I suppose you could always say that you were mentally ill and couldn’t remember the password, or something similar, but in the UK that wouldn’t keep you out of chokey.

The first person jailed under draconian UK police powers that Ministers said were vital to battle terrorism and serious crime has been identified by The Register as a schizophrenic science hobbyist with no previous criminal record. His crime was a persistent refusal to give counter-terrorism police the keys to decrypt his computer files. The 33-year-old man, originally from London, is currently held at a secure mental health unit after being sectioned while serving his sentence at Winchester Prison.

[From UK jails schizophrenic for refusal to decrypt files • The Register]

This is a really difficult issue. In the UK it’s illegal to not give the police your password to (I think) anything. Certainly, if you have encrypted email, files, disks etc and you won’t hand over the password (or decryption key) to the forces of law and order then you will go to jail. Someone else just has, in fact.

A teenager has been jailed for 16 weeks after he refused to give police the password to his computer. Oliver Drage, 19, of Liverpool, was arrested in May 2009 by police tackling child sexual exploitation. Police seized his computer but could not access material on it as it had a 50-character encryption password. Drage was convicted of failing to disclose an encryption key in September. He was sentenced at Preston Crown Court on Monday.

[From BBC News – Man jailed over computer password refusal]

He got 16 weeks in chokey for this. I can see three possibilities here: he is guilty of some child porn offence and his encrypted files would prove it, he is guilty of something else or he is not guilty but just doesn’t want the police looking through his files. Take the worst case (from society’s point of view, not his) and let’s say he is guilty of a serious child porn offence (I’m not saying he is, or isn’t, and I fully recognise that he wasn’t convicted of any such thing). I’m a parent. If he did such a thing, I want him locked up for a long time and I don’t want him back on the streets without treatment. 16 weeks is a joke. 

In the future, everyone will be famous for fifteen megabytes