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Samee Zafar

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Samee Zafar - Edgar Dunn Company

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Short-Circuit Banking

30 March 2015  |  2430 views  |  1

The definition of short circuit: “to force termination of an ongoing process before its natural conclusion by bypassing one or more intermediary steps” (Source: Wiktionary).

Established industries operate on a set of generally accepted principles or rules. To be part of an industry, a business has to abide by these rules. These rules are good for business and good for everyone. Sellers are required not to misrepresent their services, deliver a minimum level of quality, ensure their customers are protected from losses, and continue to be financially solvent. But sometimes these rules become over-protective so that businesses find it difficult to innovate or innovators find it difficult to enter the industry.

When a new company enters the market and plays with a different set of rules, industry incumbents cry foul and use everything in their power to thwart the efforts of the new entrant. They inevitably complain that the interests of the consumer are being harmed. But these are desperate measures.

There are hundreds of potential industry “disruptors” – every start-up loves to label itself as a disruptor – but very few actually change the rules and short circuit the “core” industry processes – bypassing them to offer an alternative option.

Here are a few examples.

Short-circuiting taxi services

In many cities being a licensed taxi driver requires investment of time and money. Black cabs in London, for example, an iconic part of the city’s landscape, are expensive and driven by “uniquely qualified” drivers who pride themselves in carrying a mental map of the city’s vast sprawl of streets in their heads and for this marvel of memory, they charge some of the highest fares in the world.

Now taxi companies like Uber allow ordinary people with the right to operate as taxi drivers using their own cars and inexpensive satellite navigation systems. The London black cab drivers’ response to Uber’s innovation was typical. They protested, arguing rather disingenuously, that the way Uber calculates its fares is technically against the law. In other cities, taxi and limousine companies have been trying to get Uber banned.

In Spain a judge ordered Uber to stop its ride-share service called UberPop (where it is now trying to fight back by offering a food delivery service called UberEats) and In Delhi Uber was banned after an alleged assault on a passenger by a driver.

Short-circuiting hotels

The hotel industry is a protected and controlled industry and for good reason. A hotel must have the right safety and security apparatus to protect its guests. But now portals like Airbnb and HomeAway help ordinary people to operate informal hotels by letting out their properties as alternatives to those expensive hotels. Hotels don’t like these sites even though they offer far better value alternative to expensive hotel rooms. The company is being attacked in multiple markets – From New York to San Francisco to Berlin for violating housing rules or tourism laws or avoiding all sorts of archaic taxing regulations.

What about banking?

It is one of the most protected industries primarily because customer funds are at risk here. There are also a myriad of rules and regulations that have to be complied with such as Prudential requirements (requiring a minimum level of capital), KYC (Know Your Customer), AML (Anti-Money Laundering) and other measures designed to detect early warning signs of bank failure so people who entrust these banks with their money do not lose out. That is why banks have proved remarkably resilient to any short-circuiting strategies from new players.

Mobile payment companies in developing markets have been successful in short-circuiting incumbent banks by deploying a network of trained agents who act as recruiters of both new customers as well as new agents to increase the network; and as human cash machines with whom customers can deposit or withdraw hard cash. Customers are also able to pay for things at selected shops, receive remittances from relatives abroad, and save some of their money in mobile savings accounts. Agents are able to include customers who previously could not (or did not) access banking services. The shining example of M-Pesa in Kenya which in a few years garnered more customers than all the banks put together points to the vulnerability of traditional banking to short-circuiting strategies in developing markets. No wonder then that when M-Pesa began to demonstrate high growth, banks complained and wanted M-Pesa to comply with the same set of regulations as full service banks which would have encumbered these innovators unduly.

Markets where banking is a mature service (where nearly everyone has a bank account and a payment card and access to online banking) are difficult to short-circuit by innovators. There are a number of challengers but very few successes. These include:

Square – the original provider of mobile point of sale acceptance (mPOS) services (now suddenly the market is cluttered by similar providers) – in the United States enables small and informal sellers to accept credit card payments and has achieved significant success thanks to smart phones and digital technologies. These sellers were not entertained by banks due to their small size and higher risk profile.

Wonga – a high-interest short-term lender which was able to manage its exposure on receivables even when lending to high-risk segments by leveraging new technologies – smart phones, optimised website, and above all the Faster Payments platform developed for domestic payments in the United Kingdom.

Lending Club and Zopa – these companies offer peer-to-peer lending, almost exactly what banks do but in a different sourcing funds from those with extra money that want to keep safe and earn some interest and borrowers who need loans for themselves or their businesses. These and other similar crowd-lending entities have enjoyed significant success, have faced and will face regulatory scrutiny.

A common misconception is that just by applying new technologies, the core banking industry processes can be short circuited. And everyone seems to be enamoured by mobile – using the mobile channel as the front-end to kill off the traditional branch. New companies have propped up who provide prepaid card services fitted with a mobile front-end masquerading as next generation banking. Some think that by providing better reporting they will be able to short circuit banking processes.

In fact in developed markets, it is very difficult to short circuit core banking relationships. Successes that I have listed above were able to focus on areas that were traditionally ignored or overlooked as high risk or low margin or both by incumbent banks.

 

TagsInnovation

Comments: (1)

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune | 01 April, 2015, 08:33

Kudos for a very balanced post. I find it laughable that neobanks think that "they will be able to short circuit banking processes" by "providing better reporting" like how that $3.99 coffee will bust my monthly expense budget! 

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