Technology will end banks’ customer data monopoly

The big banks face big challenges from the royal commission but that’s only one of the pressures on them.

The banks no longer have a monopoly on their customers’ data.

Flick through the Commonwealth Bank’s annual report from 1991, the same year the banking behemoth’s first tranche of shares listed on the stock exchange, and you get a snapshot of just how much banking has changed. For the bankers, that is. That year, the chief executive earned $375,000, or a little over $700,000 in today’s values. Fast forward 25 years and the chief executive made $12.3 million. He was not alone in being so well remunerated: the top 211 bankers at the big four banks took home $313 million in pay and bonuses last year, according to an analysis by The Australian.

It’s been an extraordinary ride. But how different is banking in reality?

In 1991, CBA had 50,700 staff; last year its payroll covered 51,800 people. Its return o n assets, equity and capital structure are all much the same too. To be sure, everything is much bigger. CBA’s total assets, for instance, have increased from $89 billion in 1991 to $976 billion last year (the population increased 40 per cent in this period), as it helped fuel households’ voracious demand for (mainly home) loans.

Financial services’ share of economic output has risen from 4 per cent in the early 1980s to a little below 9 per cent – a bigger share than in the UK, Canada or the US.

But for customers, things have not changed very much. Banking still revolves around plastic cards, deposits and loans, and bank branches still dot our towns and cities. Huge banks maintain control of all aspects of the financial system: if anything the big four banks are even more dominant, holding 80 per cent of banking assets.

Just how much that will change after the royal commission into financial services will depend on how government reacts to the commission’s findings. Already it’s clear that banks are curbing their lending and there will be a trickle-down impact on property, long a pillar of economic growth. Less heavily regulated non-bank lenders are likely to try to take high-margin business from the banks, and this in turn could lead to banks shedding staff as they shift their offerings.

‘The reputational cost to the banks may prove highly damaging but it is technology that is poised to wreak havoc on traditional banking business models.’

But the revolution – which is just beginning – is prompted only partially by the royal commission. The reputational cost to the banks may prove highly damaging but it is technology that is poised to wreak havoc on traditional banking business models.

“The banks are distracted by the royal commission, but there’s a sea change coming – from the rise of data,” says Ross Buckley, a professor of law at the University of New South Wales.

Three of the big four banks (not Westpac) have announced plans to sell their wealth management divisions but Kevin Davis, professor of finance at Melbourne University, says: “People are putting the banks’ divestment of their wealth and insurance arms down to the royal commission but it’s not just that; the economics are changing.”

The real challenge facing the banks is not so much what the royal commission will recommend next year – although tighter regulations could have an impact on profits – but the fact they no longer have a monopoly on their customers’ data. That knowledge about customers’ behaviour and needs is shifting away from the major banks to tech companies.

“For centuries the party best placed to price credit or insurance, the best placed to assess risk, has been the party that knows most about the customer, and that’s been the banks,” says Buckley. “Now your phone knows everywhere you’ve been, how long you’ve been there. It knows more than your spouse does. All of that data can be analysed with artificial intelligence.”

Regulation still makes it difficult for competitors to act on this information, but that too is changing. From July 2019 the government will phase in what’s called “open banking”, giving a big boost to would-be competitors.

“It will give banking customers greater access to the data their banks hold on them and the ability to direct that it be safely transferred to trusted and accredited service providers of their choice,” federal Treasurer Scott Morrison said in May.

It might sound arcane, but the change will give more nimble competitors, with lower fixed costs than the banks, far greater ability to compete. Banks will be forced to send your details to a third party if you ask them to. These new fintech businesses are using digital technology to take customers and profits away from established players and they are salivating at the prospect of such access to such valuable information.

“The next five years will be the golden age of fintech, finally providing some competition for the big four,” says Anthony Nantes, chief executive of Wisr, an Australian peer-to-peer personal lender riding the fintech boom. Wisr’s loan approvals by value rose 136 per cent over the past six months, alongside a 118 per cent jump in customers.

While the increases seem large, fintechs are only nibbling around the edges of the big four banks’ vast profits. In the US and the UK, the fintechs’ share of the personal loan market has increased to 30 per cent and 14 per cent respectively; here it is about 1 per cent of a $100 billion loan market.

Bigger bites are on the horizon though, if superannuation funds turn their attention to mortgages. Fintech businesses will be able to partner with super funds – or supermarkets or airlines – to help them price credit and interact with potential borrowers.

“It could be possible to offer a range of banking-like services without a banking licence,” Nantes says. In Europe, pension funds have taken around 10 per cent of the mortgage market. Here, that would equate to $176 billion in mortgages – easily achievable by a sector with a growing pool of assets worth $2.6 trillion.

On the payments front, the New Payments Platform, which began this year, should increase the speed and ease of making payments between bank accounts for households and businesses. In combination with the open banking reforms, it should encourage new players to join Apple in offering new payment services too.

The royal commission has highlighted what can happen when an oligopoly controls the financial system.

In the meantime, the royal commission has highlighted what can happen when an oligopoly controls the financial system, where employees are motivated by bonuses linked to financial targets. If the case studies thrown up so far are any guide, changes to the way bankers are paid will be high on the royal commissioner Justice Hayne’s list of recommendations, due next year.

One top Australian fund manager, under strict anonymity, says “the banks’ credibility is blown – and the underlying issue is Key Performance Indicators. The banks, especially the Commonwealth, are run by a McKinsey control system – you divide the business up and give each set of managers incentives. And you pay and promote them if they achieve the KPIs and fire them if they don’t.”

These practices are not unique to CBA.

“Pure self-interest is not sustainable in the long run,” says Nicholas Morris, a British economist who has been struck by the extraordinary cost of the Australian fund management industry, penning a book about it subtitled “A cautionary tale”. “That means you need to give attention to things other than money in remuneration. And you need also to make sure you enforce responsibilities and duties, and make sure where people have duties they are held to account.”

“We have now seen that KPIs have created truly awful incentives,” our anonymous fund manager says. “This is ripping off individuals but it is not a critical threat to the stability of the economy.”

Laurence Kotlikoff, a professor of economics at Boston University, would disagree, arguing that malfeasance in banking is a bigger source of financial instability than most people think.

“It’s not just Australia,” he tells The Deal. “It’s happening through time and across the world. Economics basically has gone along assuming, wrongly, that nobody is dishonest – you might need to bribe people to get them to do something, but nobody is fundamentally dishonest. Every crisis you look at has some villain, a small handful of people who have engaged in malfeasance on a major scale.”

Kotlikoff says it’s “rubbish” to suggest banks have changed much since the GFC.

“Fundamentally it’s the same structure,” he says. “The lessons of that crisis were not learned whatsoever. The two problems are leverage and opacity, and there is nothing in the new US rules, or any other reforms around the world, that addresses those things.”

‘Because we avoided a severe financial crisis, understanding of the economics of banking is poor in Australia.’

Big banks in the US and Australia are still very complex, and they have debts at least equal to about 20 times their shareholders’ capital, making them fragile. As well as ushering in a slimmer financial system, the digital transformation of banking should help ease these concerns. Fintechs are not highly leveraged – only banks can create loans and deposits – and their much smaller size makes their businesses models more transparent. The lending they facilitate, from mortgages to credit card debt, is more stable because it’s typically “peer to peer”.

Says Davis: “Banks borrow short term [deposits] and lend long [term], whereas super funds are taking in funds for the long term. Mortgages would fit super funds better and it’s a safer financial arrangement.”

Because we avoided a severe financial crisis, understanding of the economics of banking is poor in Australia.

“Being given control of the financial system, or parts of it, is a privilege,” says Morris. “It’s something that the state confers on you.” Participants are licensed, gaining unique access to a line of credit with the Reserve Bank and a de facto government guarantee on borrowings, which dramatically lowers costs. The big four banks look more like government departments, with free scope to set their own pay, than innovators. Even their lending decisions hinge on arbitrary risk weights and prudential rules set by regulators.

This combination has generated extraordinary “rents” – what economists call incomes far in excess of what is required to keep people or resources doing what they’re doing.

Says Kotlikoff: “The Bitcoin phenomenon is partly keeping money safe, or away from dishonest bankers. Technology is letting us escape from the grips of this industry.”

And in the meantime, the commissioner is helping out the new competitors. “Anecdotally, we saw a huge increase in site traffic at Wisr whenever another critical story appeared around the royal commission,” says Nantes.