The disruption of the financial industry
Note: This article is a collective work by the futurologist Jens Hansen and digital expert Carsten Lexa.
Digitization brings us disruptions in a wide variety of industries. Newspaper publishers, video rental companies, retailers, bookstores — all have already undergone a major transformation. The change in the retail business for books was particularly bad especially in the USA. In 2011 the book chain Borders went bankrupt followed by Book World, the former number 4 in the market in 2017. The number 1, Barnes & Noble, had to dismiss more than 1,800 employees in 2018 — how long the company will manage to survive only time will tell. None of the major companies in the book industry were able to persist against Amazon, because Amazon destroyed the established business models with innovations.
Change in the entire financial system
Now imagine that something similar happens in the financial industry. Startups or the big digital players like Google, Amazon and Apple turn the business models of banks on their heads with innovative concepts. The banking industry would probably not be prepared for such a disruption right now. And we are not talking about the bank managers who do not think enough about new business models or recognize them too late. The digital disruption of the banking business models is about more than a radical change in an industry, it is about a radical change in our entire financial system. And so the disruption of the banking industry is fundamentally different from upheavals in all other industries.
What is this assessment based on? Any major change in business models has so far led to the market exit of the largest players in the industry. But what happens when the biggest banks in the world lose their business fundamentals? When bills can no longer be paid, profits fall into the red and there is no hope for a positive change? Then those companies will have to go bankrupt, just as their counterparts in other industries have done before them.
Banks must not go bankrupt
However, as we learned during the last financial crisis, the system does not allow for this. Following the Lehman Brothers crisis, the world has learned that big system-critical banks must not go bankrupt. A bankruptcy of one or more major banks would mean a collapse of the entire financial system as these banks are heavily interconnected and interdependent. Mutual loans or derivative positions would trigger a domino effect that would cause one institution after another to tip over. This is the first time that we have come to a point where digitization is no longer just turning industries around, but raising the fundamental systemic question. For the foreseeable future, our financial system will no longer be compatible with advancing digitalization – no matter which creative ideas bankers come up with.
Fundamental change is near
Some may say that we are still a long way from such scenarios. But let’s just take a look at how close we have come to a fundamental change. From our point of view, the business models of banks are attacked from three different directions. On the one hand, there are the big digital companies, such as Google and Facebook, which are expanding their highly successful online platforms to include banking services. On the other hand they are attacked through startups that are radically transforming traditional business models with digital technology. The third risk to banks’ business models comes from the fundamental decentralization of bank services through concepts such as blockchain. Here, the idea of banking without banks is developed. The banking services are executed via a fully digital ecosystem that spreads across millions of computers worldwide.
Online platforms with banking services
Let’s start with the big digital companies. These have recognized the banking market as very attractive. The provision of services relating to account and payment transactions is of particular interest. Both Google and Apple already offer specific payment solutions. That they will not stop at this can be seen from the fact that banking licenses are an important issue. Google for example has already received a license for Europe in 2011 and Facebook followed in 2016. Amazon has decided against a banking license, however, it is pursuing cooperation with the bank J.P. Morgan. Together, a private account for the customers of Amazon will be offered.
Such cooperation of banks with digital companies can be seen at various levels, in particular in marketing activities such as social media campaigns or in-depth data analysis. The bad thing is that the bank always sits on the shorter lever. Their own core services are easy to copy, while the vast reach of companies like Google, Amazon, or Apple is impossible to replicate by banks because these are based on the phenomenon of network effects: the more users use a platform, the more worthwhile it is for others to participate. Facebook and Amazon, in particular, have become successful through this effect. Others, such as Google or Apple, provide a comprehensive ecosystem that gives them access to potential customers. Time is clearly playing against the banks here. While today they advertise that the customer can now retrieve account information via Alexa or Siri, they forget that it is precisely these services that can replace their entire investment advisory service in the future. Why should we still go to a branch office in the future to buy products sold by biased bank advisors, when better and more neutral advice can be provided at a lower cost at home with digital assistants?
New ways of banking through startups
Extremely motivated, but with less potential to attack the banks head-on, startups think of new ways of banking. They bring product innovations to the banking industry, make it easier to use accounts, or lend money to individuals via online platforms. The ideas of all these startups are extremely good, but they can easily be copied by banks. All these concepts require a large number of customers to become profitable. Now startups have little access to bank customers. As a consequence, we assume that such startups with good ideas are mostly bought by banks in the hope that they can improve their market position through innovative ideas. The dilemma of startups is that they cannot rely on network effects as the big digital companies can. Unfortunately their business models rely on economies of scale. Exactly these economies of scale play into the hands of the banks with their large customer base. For this reason, here we expect (and find) more cooperation than real competition from startups.
Radically new business models through cryptocurrencies and blockchain
The picture looks quite different when we look at cryptocurrency and blockchain. This technology enables such radically new business models, that it is capable of destroying even the business models of Google, Amazon or Facebook. It provides for a complete decentralization of online platforms, where no single company can dominate an industry. The blockchain technology allows banking services such as payments, stock exchange trading, investment or lending to be completely processed without traditional banks. The technology is still relatively young, but the potential is already very clear.
A new world financial system
Looking at the three angles of attack that could result in a radical change for the banking industry, it is most likely to come from either the existing large digital corporations or the blockchain technology. No matter from which direction it will come in the end the innovation leap will finally reach the banking industry. It will affect not only individual banks or the banking industry as a whole, but the entire world financial system, because the previous system of interdependent banks is not needed for the new business models.
Especially problematic about this development is that the political leaders are not prepared for this disruption. Neither the financial crisis nor the expected radical digitalization of the banking sector has led to a fundamental change in the financial system. Finally we may end up with a new financial architecture, designed by large digital companies. With this perspective, it is particularly important for Europe to develop visions for a new financial architecture today, visions that can survive the next financial crisis and are also compatible with the increasing digitization. For this, banking would have to be completely rethought. This is a mammoth task for politics, which has yet to be recognized.
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Carsten Lexa is the former Chairman of the Steering Committee of the G20 Young Entrepreneurs´ Alliance (www.g20yea.com) and was as President of G20 YEA Germany the host of the G20 YEA Summit 2017 in Berlin with the topic “Digital trends in furure business”. A corporate lawyer by profession and equipped with his own law firm, he advises German and international clients (who want to do business in Germany) in corporate and commercial legal matters. He is, by invitation of the European Commission, a participant in the annual SME Assembly. He is a member of the B20 Task Forces and was from 2014 to 2017 the General Legal Counsel and also a member of the national board of JCI Germany (WJD — Wirtschaftsjunioren Deutschland), the biggest organization for young leaders and entrepreneurs in Germany. He is also the co-founder of “Gründen@Würzburg”, the startup initiative of the German city of Würzburg.
Jens Hansen is an independent futurologist and speaker for digital transformation. He researches future innovations, which have the potential to turn our lives upside down. To find out about the impact on economy and society he keeps an eye on technological change and disrupting new business models that shake up traditional industries. His customers are well known names from a broad rage of industries, business associations and public authorities. On www.zukunftsstark.org he gives some insight into his work. He holds a degree in business administration and a Master in international politics. In his former professional career he did process optimization within the banking sector and worked for different digital Startups in the area of business development, automatization and strategy.
