“There’s always the chance that a client will ask an unscripted question, and well-trained employees will be needed to handle such questions,” Meekings told me. “For example, a robot can tell you that in order to open a shared bank account with another person, you’ll have to go to the nearest branch and sign some forms. But what if you can’t make it to the bank branch because you just got sick and you’re bedridden? If you ask the bank to make an exception and open your new account via email, considering that the bank already has your signature on file, that sort of thing might not be in the robot’s script. The robot may not know how to answer you. That’s why robots will always need someone to assist them.”
ALGORITHMS HAVE FEWER CONFLICTS OF INTEREST
Betterment.com, one of the best-known virtual banks in America, began operating in 2010. Its founder, Jon Stein, was only thirty years old at the time. He had a bachelor’s degree in economics from Harvard and a master’s in business administration from Columbia. Stein says he always wanted to do something important, like launching his own company. He was passionate about the idea of offering automated financial services right from the start because he saw the banking industry as a whole to be totally outdated and thought that banks were often charging clients too much for their services.
“I got into this business because I was frustrated personally.” Stein was quoted as saying by Techonomy.com. He also believed that there were too many conflicts of interest in the financial services world. “You know, your broker might have a bad day, might have an interest in some stock that they’re promoting, might have a financial interest in selling you one thing over another.” By comparison, when you trust software to make these decisions, there are fewer conflicts of interest, and the system is more efficient and reliable, he argued.
Unlike Kensho’s founder, Nadler, Stein is optimistic that financial algorithms won’t produce massive layoffs in the banking industry. Financial advisers will be able to serve more customers than ever, he said. “Ultimately, this technology is going to be used by everyone, whether you’re investing on your own directly or you have an adviser, because it’s just that much better than not using technology,” he added.
Just eight years after starting up, Betterment.com already had served more than 270,000 customers and managed more than $10 billion in assets, according to the company’s website. It has made a bigger bang than most new companies that are shaking up Wall Street. Others, like Robinhood.com, another virtual bank founded by young people sporting jeans and flip-flops, are making even bolder moves, like offering automated financial investments without charging commission. Much like Internet music platforms that offer free music and charge for optional extra channels, Robinhood.com charges only those customers who want premium services.
ANOTHER THREAT TO BANKS: PEER-TO-PEER LENDING
Another form of virtual banking that is undercutting the industry’s foundations are interpersonal loans, also known as peer-to-peer lending. As Uber does with people who need a lift, peer-to-peer lending platforms directly connect people who need a loan with those who can offer it, bypassing banks altogether. This allows both parties to save the commissions banks charge for their operating costs. Peer-to-peer lending platforms like LendingClub.com or Prosper.com accounted for $65 billion in global transactions in 2015 and are projected to skyrocket to $1 trillion by 2025. And in China, where traditional banks are more bureaucratic than in most other countries, the switch to peer-to-peer lending platforms like Ant Financial and Lufax has been massive: by 2016, these and other similar platforms had already surpassed traditional banks as the country’s largest source of personal loans.
The first major online platform for interpersonal loans was Zopa, which was created in the United Kingdom in 2005. It was followed a year later by LendingClub.com and Prosper.com in San Francisco. These companies typically offer loans in the range of $1,000 to $40,000 to cover credit card debts, to pay for medical expenses, or to help small businesses grow. Many people carrying large amounts of credit card debt—and thus paying high monthly interest rates—would rather borrow from a peer-to-peer lending platform, cancel out their debt, and pay back the loan at a much lower interest rate than banks would charge. In 2016, LendingClub.com, which claims to be the largest virtual lending company in the United States, boasted on its website that it had given out over $21 billion in loans since its inception in 2006.
But what protection do online lenders have? How do they know that debtors will pay them back? Companies like LendingClub.com run a credit check, just as any traditional bank would do, and in some cases ask for guarantees or collateral. And often the ones making the loans aren’t just individuals but are pension funds and other institutional investors looking for better profit margins than what they could get from buying stocks or bonds on the open market. These investors don’t typically lend money to just one person at a time, but to many at once. For example, LendingClub.com allows investors to buy “notes” at $50 apiece, so instead of investing $5,000 in a loan to a single person, they can diversify their investment and lend that same amount to a hundred people. If one of them doesn’t repay the debt, the investor has lost only $50.
LendingClub.com handles collections every month, takes its commission, and sends the rest back to investors. According to the company, its rate of return for investors has averaged 6.2 percent, which is higher than most other investments. But the company was shaken by a financial scandal in 2016 when it was reported that its founder and CEO, Renaud Laplanche, had been fired by the board for alleged wrongdoing, and the company was being investigated by the Department of Justice. The news sent shockwaves through the industry, and many investors were scared off. A short while thereafter, Prosper.com announced that it was laying off over a quarter of its workforce. During the ensuing months, criticism began to grow amid concerns that online lending platforms weren’t being properly regulated. Opinions were divided between those who said that LendingClub.com and Prosper.com would end up being bought out by the big banks, eager to take advantage of their technological know-how, and those who saw this as simply a stumbling block, and believed that the online platforms would eventually demolish the brick-and-mortar banks.
THE CROWDFUNDING PHENOMENON
Another source of nonbank lending that is expanding rapidly is crowdfunding, or the process whereby many individual people lend money for a particular project. Just as Uber is a platform that connects people who need a ride with those who are willing to use their cars as private taxis, crowdfunding platforms like Kickstarter.com, Indiegogo.com, or CircleUp.com connect people who want to raise money for a creative project with others who are willing to invest in their venture. It’s an increasingly popular fund-raising mechanism among people who need loans to produce movies or other artistic and cultural projects, but it is also being used by business start-ups that either couldn’t get traditional bank loans or didn’t want to pay the high interest rates associated with them.
In my book Innovate or Die! I cited the case of Rafael Atijas, a New York University student and music lover who invented a three-stringed guitar to teach children how to play the instrument without going through the pains of having to learn it with a six-stringed instrument. Atijas built his first guitar in Uruguay and promoted it on Kickstarter.com in 2011, telling potential buyers in his sales pitch that he needed to raise $15,000 in one month to produce his guitars. That way, parents interested in buying his guitar for their children could use their credit card with the understanding that if Atijas didn’t reach his goal and the project didn’t take off, their purchase would be canceled and their money returned. Atijas raised $65,000—four times what he was hoping for—from roughly four hundred investors, so he built six hundred guitars in China and started selling them on his website, loogguitars.com, for $150 each. Soon enough, he was selling thousands of children’s guitars in thirty different nations, all without borrowing a penny from any bank.
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sp; Since Atijas started his guitar project on Kickstarter.com back in 2011, more than three hundred crowdfunding websites have popped up in the United States alone. These platforms are being used not only to raise funds for books, film projects, and other artistic works, but also to sponsor investigative journalism, geographical explorations, and a wide variety of altruistic causes. Globally, crowdfunding sites have increased from a dozen or so in 2009 to over 1,200 in 2015, according to a study by the Massolution consulting firm. And while it will be a long time before the total amount of crowdfunding loans equals that of traditional banks, their market share is growing.
BLOCKCHAIN WILL CHANGE THE BANKING INDUSTRY
In the medium term, starting a decade from now, blockchain is likely to be the most disruptive factor in the banking industry. It even has the potential to end banks as we know them. Blockchain is a digital record of encrypted financial transactions made outside the traditional banking system that works with virtual currencies like Bitcoin. When you make a transaction like buying a cup of coffee in blockchain, you enter a personal code known as a key, and the information is broadcast over the Internet to all the computers, or nodes, in the system. If the system validates the operation, the transaction is completed and registered in what is known as a block. So unlike with banks, the blockchain database is not stored in any single location, and the records are easily accessible and verifiable.
So what are blockchain’s advantages? When it comes to legitimate transactions, the platform cuts out intermediaries—the banks. In doing so, according to supporters, it makes for a much safer and cheaper transaction. While a hacker can penetrate a bank, the blockchain is a decentralized system, which means that a hacker would have to penetrate thousands or even millions of nodes in order to break into the system. And as Alec Ross writes in his book The Industries of the Future, “The blockchain could provide a much lower-cost solution for transactions that require a third-party intermediary as a guarantor, such as legal documents, brokerage fees, and ticket purchases.”
Many economists, including a number of Nobel Prize winners, believe that digital currencies like Bitcoin are a bubble that is being used primarily by criminals—because transactions can be handled with pseudonyms—and that it will end up hurting many innocent people. Nobel Prize–winning economist and New York Times columnist Paul Krugman, for example, has equated this crypto-currency with barbarism. His fellow Nobel laureate Joseph Stiglitz has described Bitcoin as a currency that has become popular only as a means of skirting government regulations, and that therefore it should be banned. And famed New York University economist Nouriel Roubini, who predicted the 2008 financial crisis, has gone so far as to reject the idea that Bitcoin is a currency. He tweeted that Bitcoin is “a Ponzi game and a conduit for criminal/illegal activities.”
But others passionately defend Bitcoin. Salim Ismail, one of the founders of Singularity University, told me that Bitcoin and the blockchain “will undoubtedly be the most important innovation in the banking industry. They will completely change the way we deal with money, and I wouldn’t be surprised if Bitcoin becomes not the world’s backup currency, but its primary one.” Ismail offered bank transfers as an example. Today we make these transfers through banks, which charge us a percentage for authentication services and protection from hackers. But with the blockchain, there’s no need for a bank’s authentication, because there are countless encrypted copies of each transaction. And it allows for a completely transparent record of all activity without the possibility of fraud, loss of data, or cyber piracy, he assured me.
“Consumer banking as we know it will disappear in a decade or so,” he added. “Banks are going through the same thing that the recording industry did. A few years ago there were eight big music labels, but thanks to digital platforms like Pandora and Spotify, people started getting music for free, and the record companies went bankrupt!”
What would you recommend that today’s young bankers do? I asked Ismail. He said, “First, I would recommend them to understand how blockchain and Bitcoin work. And then I would recommend them to try to convince their bosses to start moving toward blockchain and—if that doesn’t work—to look for a job at a company that is already doing that.”
After the rush on Bitcoin—whose value skyrocketed from $900 to nearly $20,000 per unit in 2017, only to drop to around $6,000 by early 2018—many other leading economists joined Krugman, Stiglitz, and Roubini in concluding that Bitcoin is a bubble. But even they were much more optimistic about blockchain: they saw it as a promising technology for virtual currency platforms other than Bitcoin, as well as for medical records or any other sort of data.
BANKERS OF THE FUTURE WILL BE DATA ANALYSTS
Ismail’s forecast about the end of banks may be a bit out there, but the fact is that traditional banks are rapidly losing their monopoly on taking deposits, offering loans, and making payments. Their future lies not in conducting transactions, but in doing data analysis and offering personalized economic advice to the super-rich. Banks will have to focus more on customers and less on products. Current bank departments—such as their credit card, loans, and mortgage divisions—will become rapidly outdated, since intelligent machines will be doing most of that. The main job of human bankers will be to find customers wherever they are. They will be mostly data analysts whose job will be to explore people’s social media and online shopping habits to identify potential clients and offer them their algorithms’ specialized services. The banks’ data analysts will notice, for instance, when somebody writes on her Facebook page that she recently got a promotion, and then reach out to her to offer a new line of credit. Or they’ll see on Twitter that a company is getting harsh reviews from its customers for one of its leading products, and anticipate declining sales long before the next quarterly report is available, allowing the banks to freeze their line of credit or propose a new business model.
Banks will be using data analysis “to understand a customer’s need and be present at the time of the need with a relevant offer. For example, spotting that a current bank customer is walking into a car showroom, and sending a message that the customer has been pre-authorized for financing (based upon analysis of existing accounts and spending behaviors),” says the PwC consulting firm. Not surprisingly, when PwC surveyed 560 bank executives across seventeen countries on what will be the “areas of significant effort” in the industry in 2020, two of the most common responses were “enhancing customer data collection” and “allowing for increased customer choice in configuring product features, including pricing.”
TECHNOLOGY WILL GROW THE CLIENT BASE
As the number of virtual banks grows, along with the number of traditional banks that are becoming increasingly automated, more and more engineers and programmers will be needed to maintain and improve the performance of the robots, as well as to make them more intelligent. According to EY’s Meekings, “The technological areas of the banking industry will undoubtedly be the ones with the highest growth in terms of jobs. This will become more and more important.”
The good news for bankers, especially those in developing countries, is that technology will allow them to vastly increase their client base. It has been estimated that by 2040, as many as 1.8 billion people will be moving from rural areas into cities worldwide and that over half of those people currently do not have bank accounts. According to PwC, “Banking the unbanked (urban and rural) will become a primary policy objective in both developed and emerging markets.”
The banks’ clientele will also grow because the global middle class is expected to expand by 180 percent over the next two decades, creating new needs that will require new services. For example, the gradual aging of the population in most countries means that more people will be planning for their retirement and looking for more long-term investment opportunities. As PwC’s Garvey told me, thanks to technology, “we will see a democratization of investment advisory services. Nowaday
s, rich people get better advice on their investments. You need to have a sizable enough balance for the large investment firms to take you on as a client. But with the automation of many financial services, it will be much easier for more people like teachers, for example, to get solid advice on how to invest their long-term savings for retirement.”
BANKERS ON BIKES
In the short term, many bankers will survive by reinventing themselves and finding underserved niches where they can offer their services. One of the most interesting examples of innovation in the world of traditional banking that I came across while doing research for this book was Tucán, a subsidiary of Banco de Costa Rica, which started attracting new clients in rural areas by using local grocers as de facto bank branches and by sending bankers out on motorcycles to reach the more remote locations in the countryside. Tucán teamed up with small grocery stores, convenience stores, and hardware stores in rural areas and in effect turned them into bank branches. Why build a new branch when a local shopkeeper already has a storefront and can offer the same banking services in exchange for a commission? By 2017, Tucán had more than 620 of these branches in markets, bodegas, restaurants, and general stores across the country.
The bank also offers “express services,” where bankers on motorcycles ride out into the countryside to meet with farmers, usually at dawn, before the workday begins, to offer them financial services. Instead of waiting for customers to come to the bank, the bank is going to the customers. Why aren’t these kinds of innovations seen more often in other countries? One reason is that banks have long prided themselves on being “traditional” and have shied away from sharing their services with nonbank actors. But another reason is that big banks have often been overprotected by regulations that prevent other industries from providing banking services. With no need to compete with other industries, banks could just rest on their laurels. But the technological onslaught will force them to change, to be more creative, and to look for new ways to bring in clients.
The Robots Are Coming! Page 16