Its Just Money: The security of a comfortable past that in fact never existed. / by Adam Howard

Interesting clip, huh?  Before I start this week I want to remind everyone about the nature and origins of money.  Firstly, it is an abstract concept, meaning it has no concrete existence or form on it's own and exists as a measurement of wealth in our minds only.

Secondly, money is a promise to pay.  It is an electronic promise, that replaced a paper promise, that replaced a precious metal promise that replaced things of actual use and worth, like food, clothing or services.

Finally, the reason we have chosen fiat currency, now mostly represented by numbers on a screen, as a means of transferring and measuring wealth and value is it has the following characteristics;  it is transferrable, transportable and universal.

And banks have risen to prominence, even dominance, and are now the owners of great wealth because they control the system that transports, transfers and interprets the universality of money.

But, what would happen if their control of that system was loosened, or even stolen?

Whoa.  That got a bit deep.  Let's keep it a bit lighter.

Lately I have had some very kind friends sending me reports/information about new technology, or disruptive technology, and what it might mean for the banking sector.  These reports have been prepared by heavyweights in the professional services consulting sector such as PwC, Deloitte, McKinsey, Accenture and KPMG.

These reports are detailed, but are hardly ahead of the curve.  Big accounting firms aren't the most innovative of organisations, nor are they particularly forward looking, so if they are writing reports about something, you can be pretty confident that phenomenon has been around for a while.

But they are interesting.  Not only for what they contain, but for the fact all the above firms are releasing reports on a similar topic at the same time.  The timing alone tells me that our old mistress change, she is a comin' for the commercial banks.

I don't want to get all global on everyone, so I will limit this Update to the Australian banking sector.  

So, first of all the performance of the Big Four.  Their profits have been nothing short of stellar (or obscene, depending on your perspective) since 2009.  Those of you who have discussed this with me face-to-face will know I regard the 5 year patch from 2009 to 2014 as the "Golden Age" of Australian banking.

And here is a pretty graph, prepared by others and shamelessly plagiarised by me, to illustrate this:

Now, this isn't all the fault of the big banks, as we have been the ones asking for more credit, and that feeds into their results.  There were a few reasons for the sharp uplift in results from 2009 onwards, which included:

- recovery by the banks from a low base created by the GFC;

- being able to foreclose on a bit of riskier business debt via defaults, re-stock the coffers with that cash, and then lend out that extra capital as lower risk home loans; and

- declining costs of capital.

But the bank's have struggled with two things:

- lagging in developing or introducing any extra technology to help with back office and front line staff productivity; and

- stagnant credit growth.

Here is a graph that shows what has happened with credit growth in Australia over the past few years.

150502 Credit Growth.PNG

And while the bank's haven't spent a lot on productivity and efficiency enhancing tools, they DO have a very productive workforce, both in absolute terms and compared to banking sectors around the world.

By absolute terms, I mean comparing wage costs as a percentage of revenue in the banking sector with other industries that have high wage costs, such as hospitality where wage costs average about 30% of revenue.

All the major banks have been able to keep their wage costs below 30%, and beat almost all other global commercial banks.  Here are a couple of pretty pictures that illustrates these two facts:

150502 Banks Staff Costs.PNG

Summary?  Our banks have done very well on the basis of lower input costs; both capital and labour.  They have done so in an environment of sluggish credit growth by basically exchanging less profitable business debt for more profitable consumer debt. 

"So, what's the problem?" you ask.  Well, our banks aren't the most innovative organisations and technology is  You can see their lack of innovation by comparing their spend on innovation with other industries.

Here is a graph that shows, globally, the percentage of sales spent on innovation/Research and Development by sector.

150502 R and D by industry.PNG

Banking and finance isn't even on the graph...that says a lot.

But let's attempt to be fair and balanced.  As I said, I have read a few reports on the future of banking and the two best were by Price Waterhouse Coopers (PwC) and Deloitte.  I want to briefly look at the PwC report first as it provides some interesting data.  Firstly, here is the link:

PwC Banking Report

In 2013 total revenue for our Big Four was just shy of $81 Billion, and the total spent on innovation/productivity/efficiency programs was $2.2 Billion.

(2.2 / 81) x 100 = 2.7%.

So, 2.7% of total sales was spent on innovation, productivity AND efficiency measures, compared with a global average spend on innovation alone of 4.2%.

Even if we are being fair and balanced that's not very good, is it?  I mean, I don't want to be the only one saying this, but that's just not a lot of money being spent on the introduction of new, improved ways of doing business.

But if the Big Four are making $29 Billion in net profit between them, have a combined market capitalisation of $475 Billion and make up over 30% of the total value of the Australian share market, why should we be worried?

Particularly as their oligopoly is "protected" by the  Federal Government via the Four Pillars Policy.  Here is a brief explanation of that policy:

Four Pillars Policy

Well, isn't that level of concentration, that almost total lack of diversity exactly why we should be worried about these leviathans and their ability to keep pace with changing technology?

Here is a nice clip of the way bankers see themselves.  Unfortunately it is also frightening in how close to the mark it hits:

So, what do the banks need to do?  Well, respond to the demands of an increasingly digitized customer base for starters.  These customers expect, demand the following:

- seamless, free online banking and transactional capabilities;

- a purely transactional relationship with their bank;

- transparency around the banking process; and 

- to be educated regarding their finances, rather than handing responsibility to a financial advisor.

And this is where the bulk of innovation spending goes, particularly to the first two points.  Introducing new, slick, smooth transactional points of contact for customers.  There's no question that's important stuff, but what about the systems that support these capabilities?

Well, that's really where the innovation stops.  The banks themselves are never going to provide transparency around their processes.  

We need to be clear about the basis for the current processes, and the central problems/risks are:

- very old technology forming the basis of bank processes;

- paper records still forming the basis of record keeping and communication.

One of the great inflection points in the growth of the banking sector was the introduction of computers.  A move away from purely paper based forms of funds transfer and record keeping, and calculating the return on a capital base.

I hope everyone remembers what the old Disk Operating System (DOS) computer interfaces looked like?  Black screen, green text?  Special code to log in and abbreviated alpha-numeric instructions for any action?


Well, all the Big Four still use a DOS based system as the core system for customer details, account and loan balances, transfers...everything.

That's right.  50 year old technology is the bedrock of banking systems.

3 of the Big Four still use a paper based system to record interactions with customers.  So, a customer calls and discusses something credit related and a banker needs to record the details.  A word document is created, printed off, co-signed and then filed.

Customer databases of 3 of the Big Four are maintained using licensed Oracle or similar programs, where the base technology behind these systems is 35 years old.

The trend in this area is for customer relationship tools (CRTs) or customer relationship management (CRM) tools to be enterprise specific, not generic, bolt on tools, as these provide greater flexibility and are user (staff) friendly.

Problem is they are expensive to build, take a long time to build and require changes to most work practices.

I can say from first hand experience that the Bankwest CRM, which was the exception to the above rule, was great.  Enterprise specific and built from scratch and rolled out over 3 years with changes to almost every behind the scenes work process resulting in an all in one paperless system.

Cost a bit too though.  The internal word was about $500 million end to end.  And when CommBank bought Bankwest and found out about this, they were not happy.  Think about it.  If a bank's capital adequacy ratio is meant to be about 10%, then $500 million could turn into $5 Billion in lending.

Another issue is a lot of bank processes are based on rules, and rules can be computerised and automated pretty easily, but that isn't happening any time soon.

The Big Four are only just now embracing off-shoring where a lot of their support teams are now based in India, South East Asia or other low labour cost locations.

Now, there is a school of thought that off-shoring is just an overnight stay on the road to automation, but I will wait to be convinced when it comes to banking.  

So, the challenges are clear for the Big Four, and other global commercial banks.  Don't just make the shop front look shiny and smart.  Make sure the systems that support the shop front are digitised, automated and effective.

Now, just to ensure this isn't interpreted as a rant, here is a link to the Deloitte report that talks about this:

Deloitte Report

At present, it's a little like a giant robot, which looks impressive walking down the street, until you realise its thousands of little mice working like heel to make the robot walk in a straight line.

So, in summary, the banks are strong, but are faced with same innovators dilemma mentioned last week.  Do they change themselves and risk killing the golden goose, or just rest on their laurels.

Here is a video of a brief talk given by the author of a very good and slightly prophetic book making the rounds lately called The Second Machine Age.  Interesting reading.

Now, finally, please recall the three characteristics of money that have provided the banks with their power: transportability, transferability and universality.  The one thing that is missing is actual utility.  Money on it's own has no use, except to exchange for something that actually does have use.

What would happen if our mode of exchange became something easily transferrable, transportable and universal, but had use in it's own right?

Not bitcoin.  Same as money, really.

What about online access?  Phone credits?

Food for thought...