Money, banking & insurance

A tidal wave of money

Thanks to booming foreign exports (worth US$969 billion in 2006) China is now in the enviable but difficult position of having US$1.4 trillion sitting on bank deposit.Until recently most of these funds were invested in domestic infrastructure projects or used to buy US debt (US Treasury bonds) but with the US dollar falling in value this may be changing. The China Development Bank (CDB) is currently involved with a consortium that’s bought a stake in Barclays, one of Europe’s largest banks and, in July, Beijing’s State Investment Company bought a stake in the private-equity group Blackstone. Have we seen this before? Yes. First CNOOC (the Chinese oil company) tried to buy Unocol (the US oil company) in 2005 but failed partly because US politicians and media became protectionist in the face of China attempting to buy what many of them considered to be a ‘strategic resource’. The other similar instance was in the late 1980s when Japanese companies went on a spending spree in the US and elsewhere. Will the Chinese fair any better than the Japanese? The answer is probably yes. First, the Chinese are buying small strategic stakes in companies, often working with non-Chinese joint venture partners, so the deals are less visible. Second they are not overpaying as the Japanese once did. Nevertheless this great wall of Chinese money is something to watch in terms of global capital markets and political responses.

The history of banking (as seen from the future)

Writing about the present from the perspective of someone living in the future is a good trick if you can pull it off. Someone that has is ‘Tessa Johnson’, who is an avatar on Fourth Life (# 2243564) and is writing a term paper on Banking and Finance at Google Virtual University in 2027. The paper explores some of the developments in banking between 2007-2027 and attempts to understand why banking effectively ‘disappeared’ as a distinct industry in the US.
The first reason for the collapse of retail banking was that the industry became ensnarled in various ‘legacy’ issues that resulted in slow decision-making (actions), poor risk-related decisions and consolidation during a time of massive fragmentation and change outside the industry. This all resulted in a squeeze on the bank’s role as an intermediary, but despite this the banks continued to roll out various products and practices that were not in the best interest of their customers. It was essentially as though the banks collectively withdrew the trust and goodwill that had been deposited with customers over more than a century. A good example of this type of activity was the US$17 billion charged to customers in the US way back in 2007 for overdraft checking fees. Credit cards with complex and ever-changing rates and penalty fees were other examples. Other reasons for the decline of retail banks in the US included the growth of ‘me too’ products (in turn created by poorly-differentiated strategies and business models), an inability to innovate (due to risk-averse corporate cultures), an unwillingness to partner with other organisations and a ‘hollowing out’ of staff skills and knowledge. For example, back in 2007 the financial services industry was moving from generalist to specialist. Despite this, many of the banks continued to target all segments, all products and all distribution channels. Add to this a general lack of research & development (little or no time and money and rarely an R&D department) and it is perhaps no surprise that peer-to-peer lending markets, virtual communities and advice bureaus expanded as fast as they did.

It’s a bank Jim, but not as we know it.

Would you like a coffee or a free chocolate with that? Once upon a time the bank was the cornerstone of the local community. However, once ATMs appeared (to be followed by telephone banking and now online banking) reasons to visit your local bank started to dry up. Moreover, the digitalisation of many products and services has lead to commoditisation, so competing on price alone is becoming a recipe for oblivion. This was dilemma facing Ray Davis, CEO of Umpqua Bank, 12 years ago when he was pondering how to get more people through the doors of his five local bank branches. His solution, if people were disappearing online and elsewhere, was to upgrade the physical experience and to give customers more things to do once they were inside. Hence you can now drink Umpqua coffee, buy books and music and surf the Internet for free in any of Umpqua’s branches – which now number 144 in the US. Other innovations include staff trained by Ritz-Carlton (the hotel chain) and a budget to spend on customer service (perhaps a bunch of flowers for someone that’s sick or an ice cream for some kids on a hot day). Umpqua is not the only bank that’s stretching the definition of what a bank is either.
Spain’s second largest bank (by assets), BBVA, uses its financial muscle to buy consumer products and sell them to its customers through its branch network (an idea similar to the one used by the German coffee chain Tchibo). BBVA also closes many of its branches in the afternoon only to re-open them as stores offering cheap international telephone calls, money transfers and legal advice for recently-arrived immigrants (the idea here being that these people will eventually ‘upgrade’ to full banking services). Another bank that’s pushing the envelope in terms of the ‘banking experience’ is Washington Mutual (WaMu) in the US. WaMu has replaced its tellers with ‘concierges’ that direct customers to appropriate sections of its ‘stores’ (which have been designed by the same company that designed Disney’s retail stores) and have even brought out a WaMu Action Teller doll.

Retail banking trends

What’s going on in retail banking around the world from an Indian perspective?The answer is that change is endemic, although the pace and direction of change varies from one country or region to another. What does seem to be consistent is that up to now scale economies (that is, economic efficiencies created by scale) have not really applied to retail banks, which, if anything, seem to get less efficient the bigger they become. However, this may change in the future, which could be a catalyst for industry restructuring. This appears to have been the case in analogous industries like power and telecommunications. Another driver of change in retail banking is technology and at first glance it would appear that technology would drive new competitive realities as banks lose their monopoly as centres for the transmission of money from one place to another. In other words, the number and type of distribution channels is likely to increase in the future and banks will have to compete with a variety of service providers from outside the banking industry. As a result, retail banking is likely to disaggregate into a series of linked activities. For example, the industry may spilt into product formulators, customer gateways and industry service suppliers. The first develop and sell products direct to customers or intermediaries; the second capitalise on knowledge and expertise to sell products to individual customers through a range of channels of the customers choosing; the third is essentially back-office services, which can either be outsourced or made into a profit centre to service other providers. Is anything missing from this analysis? I’d add the fact that retail banks will increasingly hire non-banking retail specialists to design and run retail operations, banks will offer in-store ‘technical support’ for complex products and transactions, products will start to be arranged around customer interests rather than demographic segments and mini-stores and kiosks will plug the gaps between ATMs and the flagship branches.

Death bonds

In the late 1980s and early 1990s, a market called ‘viatical settlements’ appeared. This was essentially terminally ill people (largely AIDs patients) selling their long-term life insurance policies to pay for short-term medical procedures and treatments. Fast-forward to 2005 and the ‘life settlement’ market (as it’s now called) has become a US $10 billion industry that is expected to be worth US$30 billion by the end of 2007. Projections are that the industry could eventually be worth US$160 billion and typically offer annual returns of 8%. The market works like this. Speculators buy the life insurance policies of healthy people in return for a cash payment and then wait until the person dies when they in turn receive a payout. And the earlier the death the larger the payout. Creepy? Yes. But not quite as creepy as companies that take out a policy on an individual’s behalf and then immediately buy the policy back off them. Even worse, some ethnic groups die earlier than others (African-Americans for instance) so this leads to thoughts about rich financial service companies stalking poor and disadvantaged groups. Is the trend going away? Short of a major collapse related to complex securitisation no. There is a large bubble of ageing baby boomers, many of whom will be keen to supplement their nest eggs in the future so the market will, if anything, grow in line with the demographic projections.