In any legal business, the ability to operate is at the discretion of the government. This is particularly true in banking, where a licence has traditionally been akin to a financial system sinecure.
Now, ultra-low and negative central bank interest rates in Europe have cut or removed the profit banks used to make from attracting deposits at low or zero rates just by placing them at the central bank.
At the same time, since the crisis, the state has imposed on banks all manner of new and more onerous requirements around capital and customer verification, while making it much harder to boost their profits through opaque loan and savings products.
Rates, regulation and fintech competition are already pushing big banks to become more efficient. More radical reform could be risky
Given these difficulties, the news that the Bank of England (BoE) could open up its balance sheet to non-bank financial technology companies, which would give them access to the central bank’s reserve accounts, looks like a fundamental removal of the privileges on which banking was built.
The UK, after all, has already allowed five non-bank payment service providers to use its payments architecture in the past couple of years, and a further 20 hope to do so in the future.
Huw van Steenis
Taken together, the measures could help big fintech companies overtake the big established banks in payments. But this is only the most eye-catching of a series of recommendations unveiled in June by Huw van Steenis, formerly a banks analyst at Morgan Stanley, now working as an advisor to BoE governor Mark Carney.
Underlying it all is a consideration that the UK’s financial system is, and can remain, more innovative than its peers and London can remain at the heart of the global financial industry.
At the same time, finance can better serve a new economy of entrepreneurs and gig workers. The proposals mention numerous times that the UK was the first G20 economy to allow non-bank payments firms access to its settlement accounts.
The most important aim is to make the financial life of smaller businesses easier, especially businesses with around 15 employees. These entities are stuck between, on the one hand, micro-enterprises and sole traders that are easier for banks to serve by using statistical models and, on the other, the bigger customers that bring banks greater revenues.
There is a sense that payments today (especially across borders) are not as cheap, instantaneous and fraud-free as they could be, especially for smaller firms. There is little to stop the general shift to electronic payments and the decline of cash, so the report mainly targets facilitating international transfers as a means to help smaller businesses to export.
Less bombastic – but related – recommendations steer the wider public sector towards further standardization in the ways in which banks can identify businesses. They also want to make it easier for potential borrowers to look at tax records as a reliable source of revenues and costs (it looks to India as a forerunner in this regard), so that they could have a kind of portable credit file.
The thinking goes that banks need to look beyond the traditional bases upon which they have granted SME credit.
So, what are the banks getting to help them manage this erosion of their privileges? For a start, the report recognizes their increased regulatory burden, so wants to make it easier for them to use technology such as artificial intelligence to lighten that burden – so-called regtech.
It also sees benefits in moving more systems onto the cloud – something that UK banks have not led in, and that the BoE could do more to encourage. The report also urges the UK to consider forcing telecoms companies and utilities to open access to their data, extending the spirit of the Open Banking framework in a way that might be more beneficial to the banks.
All this is laudable in its aims, if perhaps a little star-struck by technology. If properly managed, there could be benefits for consumers and businesses. Just how easy it will be for the big banks to adapt, if the full potential of the changes is realized, is another question. Rates, regulation and fintech competition are already pushing them to become more efficient. More radical reform could be risky.
Mark Carney now merely proposes to consult on most of these measures – and certainly in the case of cryptocurrencies like Libra to take a cautious approach – so the big banks may hang onto their privileges for a little longer yet.
But the elephant in the room, one Van Steenis has had to ignore for the most part, is Brexit. Tweaks to the payments infrastructure might be beneficial whatever happens, but it is hardly going to make much of a difference when the country is about to voluntarily sever ties to its largest trading partner.
Brexit, surely, will make it massively more complicated and costlier to export, especially for smaller businesses. In a no-deal scenario, the financial sector’s ability and willingness to lend to such risky borrowers, especially exporters, would evaporate – although that could then be the least of the financial system’s worries.