Online Lenders vs The Banks

The financial crisis of 2008 has spawned a number of innovations in the world of finance. Cryptocurrency and fintech startups are two of them, but these were preceded by a new wave of online lenders.

The truth is, and it remains so, that the Big Banks failed to respond to the financial crisis in a meaningful way for consumers. They caused the problem, but they remained in denial about the effects on the person in the street who needed access to credit. Furthermore, the banks simply didn’t want to take on more risk. The banks instead of thinking about people, concerned themselves with regulatory challenges and stuck to technology that first saw the light of day in the 1960s.

Online lenders get VC support

Enter the online lenders, supported by venture capitalists who could hear the money dropping into their coffers. Lending money appeared to be an easy and profitable game, however it wasn’t all plain sailing.

Still, online lenders had their customers well figured out: they knew what they wanted and what they didn’t want: they wanted instant access to loans and they didn’t want to visit a physical branch and discuss every detail of their lives with somebody in a suit. That aspect of it all went well.

Online lenders at a disadvantage

However, the economies of lending have been another matter. As fintech expert, Ben Cukier writes, “Loan profitability is driven by the spread (the cost difference between the interest charged on the loan, less the cost of funding those loans), the cost of acquiring the loan, and the default rates of those loans.” From the outset online lenders were at a disadvantage when compared with the traditional banks, because the old-school bankers uses low cost deposits to fund loans. By contrast, the new online lenders had to rely on “raising debt or even more expensive equity,” as Cukier points out..

Enter Big Data

Plus, customers knew the bank brands, whereas the newcomers had to invest a lot in raising brand awareness. But they did have a weapon that the banks did not posses: the newcomers had Big Data. They talked up their Big Data platforms, which use disparate data to better underwrite credit risk in ways common credit scores did not. And, they leveraged this data to target specific consumers on social media, and then used the data they mined from customer behaviour on social media enabled them to dictate borrowing terms.

Fintech is the real financial innovation

This gave the banks a wake-up call, and now bank customers can interact with their banks through apps and even get quick credit approval. Plus the banks offer a range of products, whereas online lenders only offer loans. Then fintech startups came along and offered more help to the big banks. Mark Hookey, CEO of Demyst Data says, “Fintech innovators demonstrated that a data focus matters, however banks can apply that insight at a far greater scale to know their customers and launch new products.”

In the end it is these fintech companies, rather than the online lenders, that offer the promise of a real revolution in lending.

Is Motion Code the answer to card fraud?

On the back of your debit or credit card there is a three-or four-digit number called a ‘card verification value’ or CVV for short. It’s one of the last things you enter when making an online purchase. Its purpose is to act as an added security feature and prevent fraud during ‘card-not-present’ transactions.

However, it isn’t foolproof, because scammers can often discover a CVV, or even guess it, without too many problems. Indeed, researchers have shownthat Web bots making random guesses on legitimate websites can often come up with the appropriate CVV and expiration date to pair with a card number.

Refresh the CVV

Is there an answer to this? Well, the US-based PNC Bank believes there is and it is conducting a pilot test of cards with CVVs that refresh the number every 30 to 60 minutes.

The technology behind what could become an important leap forward for banks and other card issuers, such as neobanks, is something called Motion Code. It has been designed by Idemia and provides an extra layer of security for Card-Not-Present (CNP) transactions and against payment card number theft.

Idemia says: “This technology replaces the static 3-digit security code usually printed on the back of a card, by a mini-screen that displays a code, which is automatically refreshed according to an algorithm, typically every hour.

This solution thus renders copying of card information useless: by the time fraudsters try to use it online, the stolen number will have already changed several times. “

Searching for the ideal refresh rate

PNC began a 90-day trial of cards featuring IDEMIA’s Motion Code technology in November and, according to an Ars Technica report the test run should identify the optimum refresh rate. According to Idemia, “PNC Treasury Management expects to offer Dynamic CVV2 technology to current customers in early 2019, following completion of the pilot.”

Coverage of the story in the Pittsburgh Post-Gazette states, “Card issuers like PNC will be able to customize the refresh interval. The e-ink display is limited by a small lithium battery, so a 60-minute CVV refresh rate offers the card a four-year lifespan, and higher refresh rates will make that lifespan shorter.”

The only downside of using the Motion Code technology is that “motion cards are more expensive than regular chip cards to produce,” the Post-Gazettewrites, adding, “Prices vary, but according to one estimate, they cost about $15 compared with around $2 to $4 for a regular chip card.”

4 trends impacting banks in 2019

Thought leaders ATOS published “Toward next-generation financial service ecosystems”, which analyses mega-trends in financial services and why we should all prepare for a fundamental shift in the next few years.

As its report says, banks are at a crossroads, and the “rise of non-banking platform companies are now disrupting the most profitable parts of the banking value chains. New players could capture up to a third of incumbent banks’ revenues by 2020.”

ATOS has identified four challenges and opportunities that will have the biggest impact on banking, providing they leverage the emerging technology.

1. Faster response to customer demands

Retail banks that adopt digital tech will see a 5% to 20% boost in revenues thanks to an improved service. They will also reduce their network costs by anything from 15% to 35%, and increase customer satisfaction by 10% to 15%. In advanced economies, two-thirds of banking customers execute half their financial transactions online. Customer loyalty is becoming elusive and branches are less relevant as a result. To respond, banks may shift from a product-centric to a platform- centric approach focused on customer-driven strategies.

2. Optimise costs

Fintechs are more agile and have lower operating costs than banks, making for strong competition. Digital banks can enjoy a cost-to-income ratio of below 30%, whereas banks are in 40% to 60%. Banks have some options, including shifting to lower-cost, standardised utility processes for selected administrative activities and using AI to improve customer response times and reduce employee redundancies.

3. New revenue streams

With banking business models changing thanks to neobanks, there is a need for traditional banks to reassess their position. They could position themselves as a hub platform and introduce new services for underserved segments of the community, such as mobile only banking for Gen Z and the unbanked.

4. Develop security and compliance systems

Customer data has now become a ‘product’ for financial institutions and this requires enhanced security and insights, which could be provided by AI. For example, PSD2 requires banks to implement secure application programming interfaces (APIs) to make account transactions and data available to third parties. Developing system using AI-generated insights from civil and military intelligence could dramatically reduce the cost of cybercrime and enhance consumer trust.

There is nothing here that is earth shattering; it is what many have been saying throughout 2018, yet the banks continue to be slow in their response. Perhaps 2019 will the year they wake up and start moving forward.

How big banks could decentralise money

One effect of the emergence of cryptocurrency is that it has made a lot of people rethink our relationship with currency generally, and with the big banking institutions.

For example, in June 2018, Switzerland held a “sovereign money” referendum in which Swiss citizens rejected by a ratio of three to one a proposal to end fractional reserve banking and give sole money-creation authority to the Swiss National Bank. Cryptocurrency wasn’t mentioned in the proposals, but it was on many people’s minds during this vote.

Why? Because the fact that cryptocurrency exists means that there is a very real possibility that global economies will “disintermediate banks from money” as Michael J. Casey suggests, and he also claims that the leaders of this change will not be the activists one typically associates with bitcoin and other crypto assets, it will be the central banks themselves.

They will initiate the move towards a true “money of the people”, because they will have to in order to “remain relevant in a post-crisis, post-trust, digitally connected global economy.”

A non-governmental currency

This might be an anarchist’s dream situation, but for those who want money removed from government control, the move to digital currencies will encourage more competition worldwide by opening the door more non-governmental digital currencies. Plus, when smart contracts are used to manage exchange rate volatility, it is likely that we will find that the people and businesses involved in international trade will no longer need to rely on the dollar, Euro or British pound as the cross-border currencies of choice.

There hasn’t been much enthusiasm for a central bank-issued digital currency (CBDC), largely because the banks didn’t really like the idea. The Bank of England has done research into the concept, but BoE governor, Mark Carney then warned about financial instability if his bank supplied digital wallets to every citizen, because this would then give the man in the street the same right as regulated commercial banks to hold reserves at a national bank.

Inefficient banks

Basically, traditional banks are the problem and not just for cryptocurrencies; they are inefficient with respect to fiat money as well. Their technical, social and regulatory infrastructure is past its sell by date and it’s a costly system. Banks maintain centralised, non-interoperable databases on outdated, mainframes. They rely on multiple intermediaries to process payments, plus ledgers that have to be reconciled against each other using time-consuming fraud-prevention mechanisms.

Banking solutions

There are solutions though: one is to gradually introduce CBDC stating with non-bank financial institutions and cascading it down through corporations and smaller business to individuals. A central bank set CBDC interest rate would also help and could be part of managing the money supply. It is more likely that this will happen first in the developing world where there is a greater need and appetite for something like a fiat digital currency that offers protection from inflation. In the developed world, the banks may take longer to get their heads around the concept of moving away from decades old systems, but they will have to respond somehow, because the crypto genie is out of the bottle.