Analysis of the Age of Perplexity: Rethinking the World We Knew (part 4 - The Conclusion)

If Christians will obey the instructions given to them by Christ and his inspired apostles, they will adorn the religion of the Bible, and save themselves much perplexity and severe trials, which they attribute to their afflictions in consequence of believing unpopular truth.

Ellen G. White

 A Financial System for Inclusive Growth

by

Charles Lamson

 There are differences in opinion regarding the direction, magnitude and speed of the impact of the technological revolution on the global economy. But there are none regarding its disruptive effect on production sectors and companies.

The first sectors that experience disruption coming from the development of the internet and the digital economies were those with a greater informational content in their inputs or outputs: communications, media, music, many distribution sectors, etc. These industries have already transformed completely, with great improvements in efficiency and productivity, and therefore they have been able to offer consumers new and better products at a very low cost.

In most cases, these changes arrived to the market brought by new, more innovative and agile competitors, who are able to satisfy the demands of a quickly growing wave of consumers that have developed new needs and habits, thanks, to a great extent, to the access to more and better information and to the greater connectivity permitted by intelligent mobility (the optimized movement of people and goods).

All this forces companies to reinvent the way in which they design, produce, and distribute products and services, and generates profound changes in companies in their sectors. This is already happening in industries that rely completely on material assets and on physical services to clients, such as the hotel or the transportation industries. Airbnb or Uber both show us that the technological revolution has no sectorial barriers.

Something that is demonstrating great power regarding the disruption of consolidated sectors is the development of platforms that are leveraged in exponential technologies (cloud computing, mobile connectivity, big data, artificial intelligence, blockchain, etc.) that traverse supply and demand, putting numerous suppliers and clients in touch. These innumerable interactions produce an enormous amount of data and information that allows companies in turn, to create and distribute products and services with new features that offer clients a much better experience.

Today, the five largest companies in the world in terms of market capitalization (Apple, Google, Microsoft, Amazon and Facebook) are, basically, platforms of this kind.

The banking system is an industry with an extremely large amount of information: its inputs and basic products are data, or information, and money; and the bank's money is ultimately an ensemble of accounting entries, which is, information.

As a result of this, it could have been an early example of digital transformation. But even though the banking system has changed very much in the last two decades, it has not undergone changes of a magnitude similar to those in other aforementioned sectors. And this is due to several reasons: in the first place, the conservatism of most of the people that have money; secondly, the strong growth and profitability of the industry in the period previous to the recent economic crisis did not encourage radical change; and thirdly, and this is fundamental, regulation, that on one hand limited the freedom of banks to innovate, and, on the other hand, protected them against the entrance of new competitors.

But all this is changing. Basically, it is the clients who are changing. A new generation of clients has grown up in a digital environment and it demands different services and new ways of gaining access to them. Banking's traditional clients are also attracted by the advantages of a new offering, and are increasingly following this trend.

Many new suppliers mainly startups or, in some segments, large digital companies are already supplying solutions to these demands. These companies do not have the costly legacy of banks, and the form of obsolete structures and systems, and can work faster, more flexibly and at a lower cost.

On the other hand, the banking system faces an environment of much lower growth and profitability. With very low interest rates and much more demanding regulation, stemming from the global financial crisis. All this increases the pressure and the urgency for banks to take advantage of the abilities of technology to improve their productivity or ethically.

Lastly, regulators already perceived, together with the risks, the ability of technology to improve the financial industry, and, as a consequence, they are already modifying regulation to reinforce competition, preferably in those segments or products that have a lower impact on its stability. This has favored the entrance of new competitors and market niches. 

Present technologies (not to mention those that may be developed) have enormous potential to transform the banking system. We are already witnessing great changes, but the future implications are almost unimaginable: cloud computing allows the storage and processing of an unlimited volume of data with greater agility at much lower prices. The mobile phone has already radically changed people's lives, and has become the main contact point with banks, with increasingly larger and better functionality. Big data analysis has innumerable applications, and it is absolutely decisive for dealing with the multitude of different financial and non-financial demands in a customized way in real time. Biometry allows for secure operations with clients, without the need of the physical presence or documents. Distributed ledger technologies (such as Blockchain) could eliminate the need for intermediaries and a great variety of transactions, changing the status quo of the banking system as well as that of many other industries. Artificial intelligence makes it possible to automate increasingly complex cognitive tasks, and this alters the way in which clients are served and the solutions that they may be offered. 

All this entails potentially enormous benefits for consumers and companies in terms of quality, variety, convenience, and the pricing of products. And it will also allow thousands of millions of people, in the lower incomes strata, and to whom the conventional banking system cannot reach efficiently and profitably, to gain access to financial services, increasing their chances of prosperity and improving their lives.

The profound evaluation of financial regulation is an indispensable task, but it is also extraordinary difficult. In the first place, because the technological and competitive scenario changes constantly and will continue to do so in the future; and in the second place, because digital means global, and the new regulatory framework must have a much larger degree of international homogeneity than the current one.

The challenge for authorities is to design and Implement a regulatory and supervisory framework that accomplishes an appropriate balance between the improvements in efficiency and productivity, and the preservation of financial stability and consumers' protection. And all this in a changing environment with a multitude of new suppliers provided with state-of-the-art technologies whose implications may not have been tested well enough. That is to say, to support innovation by maintaining an adequate degree of protection against the risks that it entails. 

Together with this, and given the initial diversity of the organizations that participate in the market, from the closely regulated big banks to the startups, including the large digital companies, a balanced competitive field must be created, focused on the fact that similar products and services must receive a similar treatment, regardless of the organization that provides them. And lastly, it must have a "holistic" comprehensive approach, in the sense that it must have in mind all the angles of the question: technological, legal, financial and competitive. And finally, it must be a closely coordinated framework at the supranational level, open and flexible enough to face future changes.

Regarding the participants in the market themselves, they face a very complex scenario. The sector is becoming fragmented due to the entrance, every year, of hundreds of new competitors that join the more than 20,000 banks that still exist around the world. On the other hand, the industry is becoming disaggregated as these new entries break the banking system value chain, offering highly specialized products and services focused on very specific market niches in this value chain. Most probably this trend will reverse in the future primarily because the banking system is the sector that already demonstrated strong overcapacity, something the aforementioned phenomena exacerbated even more. Therefore, we must expect that many banks will disappear together with many startups, whose mortality rate is all always very high. In this way, technological change might be the factor that triggers a much-needed consolidation of the sector. 

On the other hand, the users' convenience demands much more complex and integrated solutions, and points towards the need of re-aggregating supply, and this will require the combination of different products and services offered by different suppliers.

In light of what has happened in other sectors, this react re-aggregation will most likely be achieved through platforms where different suppliers will compete and will also, and very frequently, cooperate to better meet the demands of clients.

Probably, the number of these platforms will decrease, and their scope will become wider due to the huge economies of scale and network that they may generate.

A future might be foreseen in which there are a multitude of participants and the financial industry, most of them highly specialized, and that cooperate and compete in a few large platforms. Therefore, only a few of these participants will have a central role, as the owners and managers of these platforms. By implementing the rules, validating the transactions, and thereby controlling the information generated and the access to the final clients, they represent an enormous source of value.

Obviously, the competition to reach this lofty position will be very fierce, and we do not know what kind of companies will actually arrive there: particularly successful startups? Large digital companies? Banks that know how to adapt to this new environment? Unquestionably, very few of the present banks will accomplish it, but those who do will have to have started well in advance, a very complex and radical transformation process. This is the process that many banks have already begun in their search of excellence in the digital era.

And it is this competition, this search for excellence, that will take us to a much better, more efficient and productive financial system, capable of designing and offering better solutions for a larger number of users (including the thousands of millions that cannot currently access financial services) capable of encouraging growth and an increase in well-being that includes everybody. 

*Main Source: Gonzalez, F., 2018, The Age of Perplexity, pp. 19-23*

end