Emmanuel Daniel, chairman of The Asian Banker and a panel of forward looking practitioners, comprising former US Congressman and co-author of the Financial Reform Act, Barney Frank; Tang Ning, founder and CEO of China's leading peer-to-peer wealth management platform CreditEase; Ron Suber, former president of US marketplace lender, Prosper Marketplace; David Shrier, founder of New Ventures, MIT and R Vivekand, vice president and co-head, TCS Financial Solutions, engage in a wide ranging and riveting discussion on the key influences and factors driving innovation in the financial services industry.
Here is the transcript:
Emmanuel Daniel (ED): The conversation I want to have with all of you is really to pin down what are the elements that will drive innovation in financial services going forward and the extent to which infrastructure regulation certainty helps the process, which is what people in the industry are familiar with today. If we just keep the conversation going, I would ask David, what are some of the disruption technologies coming into place now that we need to be aware of that both puts the regulator on notice and, at the same time, create opportunities?
David Shrier (DS): I’ll answer your question about what is the cutting edge of innovation in financial services two ways. First, I’ll talk about the technologies. Here’s just a quick laundry list: AI (artificial intelligence), blockchain, advanced analytics. These are some examples of a confluence of forces – it’s not one thing. It’s not just blockchain or just AI or just analytics or just communication networks or just-just-just. They’re all coming together at the same time that’s driving this transformative change.
There are a number of implications of that, but I set all that aside. Again, I sit in a place where there’s a new innovation coming up daily, at MIT, so it becomes a little commoditised. What I’ve really decided is that there’s something at a higher level that should drive what we’re doing and that will drive what we’re doing going forward, and it’s values-based.
On the entrepreneur side, I will call it “inspired innovation” or “inspiring innovation” as opposed to just “innovation.” On the investor side, I call it “visionary investing.” People have started to say that profit alone is not enough; that we have a view of the world being different and better, and we want that to be expressed through our activities and through our capital. From that perspective, I think that businesses that do well by doing good, that have both a market rate or better return, and also some positive benefits to society are the ones that are going to win long term.
Because we’re seeing a shift in values. It’s not just millennials, although they are certainly a major driver. A plurality, something like 42% of people in 22 countries that were surveyed by BBMG want to see both profit and purpose. So, when we think about what we do, when I think about what I do with my academic work at MIT, with my start-up Distilled Analytics, it’s solving really big problems for the world that also address market discontinuities that can create tremendous profit.
ED: The question is, how, from this conversation, do we morph an idea of what we need to look for in innovation and how that is panning out? So, we have Barney Frank, who has to map out how the legislation that he’s put in place is going to play out given all the changes that are taking place in finance today. Barney, maybe you can start with a sense of how the Dodd-Frank Act will continue to be relevant.
Where does regulation come in
Barney Frank (BF): Well, we tried very hard to avoid the mistakes of only solving the past problem and not going forward. Obviously, people say don’t fight the mass war, but the war was going on when we were doing this. We were in the midst of it. We tried very hard not simply to deal with things that had shown to be problems, but to give the regulators the power to get into new things, things that we couldn’t think of.
For example, we gave them the power to regulate activities, not institutions. So, there were certain things that, whoever does them, will be covered by these rules. We also specifically set up—and I was pleased to hear David, whom I respect, say some nice things about his work—the Office of Financial Research (OFR), whose job it is to be open. They don’t have any ongoing responsibilities. It’s a federal agency charged with thinking about the future and particularly about what might be problematic and how to deal with it.
ED: Ron, what is your experience with regulation at the moment, and how much of it is Dodd-Frank and how much of it is regulation that needs to be made up as we go along?
Ron Suber (RS): I think regulation’s an important part of making sure everyone’s doing the right thing and that everybody wins; the borrowers, the investors, the savers, the people paying, and the people moving money. So, regulation is also part of innovation.
There’s innovation and regulation in old ways of doing business, and there’s innovation of brand new things, where, as Barney said this morning, the regulation without too much time lapsing will catch up with some of this new innovation.
ED: What is your conversation with regulators like? What are your conversations focusing on?
RS: For Prosper, we are very regulated. We’re SEC registered; we file prospectuses every day.
ED: Were you regulated from the word “go”? From the beginning?
RS: We were not. Our regulation with the SEC started in 2011. We’re also registered with all the states where we have borrowers and investors. We also work with a bank to actually originate the loans, and so we work with their regulator; so, FDIC, OCC, FTC, and others. We’re very much proactive. We want to make sure the regulators understand what we’re doing and what we’re not doing and the benefits that the borrowers and the investors are getting.
ED: Barney, the key in the US seems to be which regulator has national charter and which regulator has domestic; which regulator has an overview regardless of institution and which regulation has purview over types of institutions.
BF: Well, the complication in America, unlike I think any other country, there may be one or two, is that we have state-chartered banks and federally chartered banks. Like Ron just said, he had to deal with both. Right now, actually, the state-chartered banks, the state regulators, protective of their jurisdiction, recently opposed the national regulator that control the currency, who is trying to encourage the new forms of lending. Of course, that’s a problem in any area where the incumbents tend to be resistant.
I have to say it’s kind of interesting for me, because a lot of people in the banking industry, who tend to be conservative, politically, have been preaching to other people in the economy that they should not fight obsolescence; that they should let technology go forward. They shouldn’t dig in their heels and say no. Then, all of a sudden. these entities come up that are doing that to them, like these two gentlemen, and all of a sudden, this notion that you should just go with the flow and not try to preserve outdated forms, some of the bankers have decided they don’t really believe in that.
ED: Tang Ning, give us a sense of your journey in terms of your interaction with regulators as you were building marketplace lending in China. Was it all through the process, or did it start stepping up more lately?
Tang Ning (TN): Several considerations. One is that regulation actually comes later; innovation comes first. Chinese regulators have done a good job in this financial innovation space using marketplace lending as an example of when the industry was fast developing.
The regulators made it very clear what the guiding principles would be in the upcoming regulations well before the details, the implementation, was in writing. I think that market participants were quite aware of what they couldn’t do, what they were not allowed to do. Also, I think the relationship between the regulators and the innovators can be conducive, and also the regulators can also learn from the market’s best practices.
For example, now one key regulatory requirement is that marketplace lenders have to work with bank institutions for fund custodian. Even before this regulation came out, companies like CreditEase had already been trying to work with banks on that front. So, the innovators did it first without regulatory requirements because we really wanted the industry to do well. This is a very good example of how industry best practices have later on become regulatory requirements.
ED: David, what would you say to the idea that innovation in finance that we have seen so far has only ever taken place when a regulator was not watching?
DS: We’ve spent some time on this question of, does innovation only happen around the edges when regulators aren’t paying attention? Here’s what we came up with. First of all, we talked to the regulators and heard their opinions on this. In full disclosure, we offer a white paper on fintech and policy and regulation together with individuals associated with the OFR, although it is not an official OFR white paper; it is an MIT white paper.
I think when you look at successful regulation of technology innovation, the example we site in the paper is the Clinton/Magaziner e-commerce principles. If you remember back in the late ’90s, e-commerce was coming up, and everyone was worried about how it would disrupt existing retail and what the implications were. What should we do? There are all these companies coming up; what are they doing?
The approach that was taken was a very light touch to regulation. This ended up fostering an ecommerce industry that reduced costs to consumers, improved access to goods, and generated greater efficiency. And so, I would view, as a successful implementation of regulation and policy.
In contrast, I look at New York state’s effort at regulating bitcoin with the BitLicense, which had the effect of crushing innovation and crushing new ideas and new companies. Our view is, the regulators, when I’ve spoken with them, the most enlightened ones (or the most honest ones) say to me, “Look, we like to allow things to happen around the edges when they’re small, and when they get big enough to really have significant impact, then we step in to regulate.” They say policy will always lag innovation. It has to, because you have to see a lot of different things tried out before you figure out what’s really gaining traction.
ED: The interesting thing about the regulation that you’re talking about is that there’s regulation to protect what is being created and there’s regulation that stands in the way. Right? So, in the case of the e-commerce –
DS: I don’t think it’s so bipolar. I think there’s regulation to protect what’s being created, to protect free enterprise, and there’s regulation to protect the individual consumer so that you don’t end up creating disenfranchisement and digital exclusion. These aren’t necessarily in opposition, but sometimes they are, and navigating that is non-trivial.
Frankly, before I started talking to regulators and getting more informed about it, I don’t pretend to be an expert, I was more sceptical about regulation. I was much more of a “let a thousand flowers bloom”. The more that I’ve talked to folks who are in the position of dealing with these issues, the more complicated I realise it is; that regulation, when properly implemented, can be a sword and shield to protect the poor and the illiterate.
ED: You were going to say?
TN: Yeah. When we first started, when we invented the marketplace lending model 11 years ago, we didn’t seek any consulting guidance from any regulator. Not because we didn’t want to, just because we had nowhere to go. There wasn’t any such regulatory component in the framework to give us any okay or otherwise.
After the model grew to a certain state, different regulators started to make comments on it. At that time, it wasn’t clear who would be the ultimate regulatory body until last year, it was decided that the Central Banking Regulatory Commission as well as local finance offices and bureaus would be responsible for this model’s supervision. But, I guess it’s a healthy process along the way.
BF: One other purpose of regulation is to protect competitors from each other. It is to protect people from unhealthy competitive pressures. One example, I would give for that was a major piece that came out of the banking committee to the congress before I got deeply involved, and that’s what’s called the Sarbanes-Oxley Accounting bill. What that does is protect you against your competitors playing games with the accounting. It protects you from people showing better results than you by inappropriate things.
I had a conversation with Charles Prince when he was the CEO of Citi Corp. They were using something called the “structured investment vehicle”, which was a way to take debts of the bank and put them somewhere and pretend they weren’t debts of the bank, and you didn’t have to report them. They got in trouble with that, and I said, “I’m just curious; why would you do that?” He said, “Because if I don’t do that, I will be at a competitive disadvantage to Goldman Sachs.” So, part of it is to have those kinds of rules when things are new.
The other issue I’d make about regulation – I’ll give you a recent example where I think regulation has helped innovation in America, and that’s the question of crowd funding and funding for small entities. Congress actually passed a bill that President Obama supported called the JOBS Act or some silly acronym. I hate those acronyms. Over the last few years in America, there have been mechanisms for letting people with ideas get funded and get into a corporate form that was actively encouraged by regulators.
R Vivekanand (RV): That’s generational, actually. In fact, just to go on the point of how regulation helps innovation, if you look at electronic trading, where regulation has driven electronic clearing entitlement. It’s now 25 years old. Today, we are talking about online and Amazon and shopping; nobody remembers going to a broker and buying stocks anymore. When was the last time anyone did that? Two generations back? Regulation drove the whole cycle of making everything electronic, moving assets into electronic form.
That dropped the price significantly, like 20 times lower than before. So, that is tremendous innovation and it’s a whole generation back. Even today there are areas of standardisation where, again, regulation drives it. It is also innovation. It is probably not cool; it’s probably a little bit of boring innovation, but it’s innovation all the same.
ED: Would you then say that Europeans are far more structured in their idea of innovation, because they know what they want at the end?
RV: Focused. I would say focused. The maximum impact, I would say, in cases like these, is in emerging markets, in high-growth markets, in India and China and places like that where there are also a lot of people. The impact of innovation that pretty much originates in the US, in Europe, in Scandinavia, the effect of that on emerging markets is significant, and it’s very rapid. The ability to execute in these markets is very, very high. You can leapfrog a generation, even two, and then bring the innovation to market very quickly.
DS: I’ve been dying to ask Barney a question, perhaps an unfair one. With the benefit of hindsight, what’s one thing about Dodd-Frank you would change or do differently?
BF: First of all, there’s something I always wanted to do but couldn’t because of the politics of it. The stupidest ongoing public policy in America is the fact that we have the regulation of derivatives split between the Security Exchange Commission and the Commodity Futures Trading Commission. Each one of them has ten members, so you have to get six out of ten to do certain rules. That’s one of the reasons the rules were held up.
The problem is that the Security Exchange Commission (SEC) was created to regulate the financial industry, and then the Commodity Futures Trading Commission (CFTC) came along later for the farmers because originally, we had a debate about what would be the jurisdiction of the SEC versus CFTC. I proposed a very simple solution: the SFTC would be in charge of everything that was edible, which was its original purpose; but at this point, the agriculture people believed in the CFTC and the financial people. I certainly would have gotten rid of that.
Secondly, I wanted to do this but I lost out because we needed a 60th vote in the Senate: we allowed the regulators to relax securitisation in home mortgages more than they should have. I do not understand why – if it’s a good loan, I don’t understand why you’d object to some kind of risk retention, and people would say, “Well, you can’t have mortgages unless you can have a 100% securitisation,” which apparently means that there were no mortgages issued in America before about 1975 because we didn’t have any of that.
I do admit one mistake that we are going to fix, I hope, after the Republicans’ overhaul bill dies. The $50 billion level at which you become a serious bank under the FSOC, we can raise that. Yes, it would be great. I mean, Tim Geithner said to me, “Can we merge the SEC and the CFTC?” and I said, “Yes, but not in America.” The politics were too great.
I was sorry that we relaxed the securitisation rule.
RV: If you have a futures and options contact on anything, irrespective of the length, you would think that it is the financial industry because, you know, it has required cushions for the financial industry.
BF: Absolutely, and it has become financial bias.
ED: Tang Ning and Ron, do you believe that your businesses are businesses that are solving big problems in the world?
TN: Very big. China is a big country, and financial services is a big industry. There are like 60 million, 70 million small businesses in China underserved, and several hundred million people underserved, so there is huge opportunity. I’m quite curious; Ron is an angel investor, investing in the future of financial services. I’m curious what he’s seeing these days in the market in the US and around the world.
ED: Actually, another way to ask that question is this: Banks started innovating by taking the business out of the branch and making it available online and then mobile today, and so on. So, where is this trajectory going?
RS: I think one of the key things here is not just having the technology or the data or the artificial intelligence and the machine learning. The incumbents have more technology people than some of the financial technology innovators. What brings us our unique ability is our agility. It’s our ability to move with more speed and more purpose and get to the endpoint.
I’ll give two examples. One is in financial inclusion. There are hundreds of millions of people on the planet and 20 million people in America who have a mobile device. They’re not on 30 days a month; they don’t have an identity let alone a financial identity. So, companies like Juvo and others, which you’ll be reading about, are working with the telecoms and others to get people up and online with an identity and the ability to be on 30 days a month, which we take for granted in the developing world, to then borrow minutes, borrow time, and borrow money.
ED: Every time the banks understand that, they bring it back into banking.
RS: They try. The second one I’ll give you, is in the Wall Street Journal tomorrow, is AvidXchange: A-V-I-D-X-change. A huge deal is being announced where banks and the traditional financial companies like Visa and MasterCard are getting off the old rails and off the old payment systems to come work with the innovators. This is one of my other investment companies.
I think you’ll see companies like Juvo and AvidXchange being adopted by the big telecoms and the incumbent financial companies also. It’s happening right now, which makes it so exciting.
DS: That’s a really great point, that the largest mobile internet provider in India is not Facebook; it’s not some big telecom. It’s an MIT start-up called Jana, J-A-N-A, that Nathan Eagle started out of the media lab entrepreneurship programme. They figured out this interesting thing that if you get people to take certain marketing actions, you can give them minutes, and now they’ve got access.
It’s not some poor man’s internet as some have proposed; it’s actually the real internet that you can get through your phone. So, it’s market facing; it’s a for-profit company, but it’s putting tens of millions of people at a go onto the Internet.
TN: I was in the US three or four weeks ago, and I went to a Demo Day. We saw a lot of still payment and marketplace lending companies. Also, we saw insurance tech companies a lot in the US these days, and also infrastructure companies. How can financial services and institutions become more efficient?
What I discovered and I thought was quite interesting is that in Silicon Valley, entrepreneurs are quite young. They’re like 20 or 30 years old, but in New York, people are just like us, entrepreneurs in their 50s or 60s even. Okay, but these entrepreneurs do like 2B business models, like serving financial institutions. So, I thought that was quite a contrast.
ED: What is the entrepreneur profile in China today? Is there something different between the Shenzhen people and the Beijing people?
TN: Yeah, this is a great question. What we discovered is that when there was a hype, a lot of internet guys, young fellows without too much finance experience, came in, and many VCs had the wrong idea about financial innovation. They looked at the wrong benchmarks, like how fast loan volume grew. It was very easy to grow loan volume, right? Just throw money to people. So, is the money going to come back? That’s the big question mark. Later on, in these recent years, you find that more finance-savvy entrepreneurs have come in to do start-ups, which is very encouraging.
ED: What is the profile of an average American bank in terms of its IT capacity? Would I be right to think that in China the average bank has got excess capacity, and in the US the average bank needs to outsource that capacity?
RV: Outsourcing is a strategic position. I mean, the capacity has been there, but in a sense, it is capacity in a different way. So, I would not think that it has got to do with the bank’s capacity. A lot of times today, it is a question of whether you have the skill capacity in that country or in that region where you want to hire. Do you have the right skills, or do you take the skills from wherever they are available immediately at the right price?
ED: The purpose of my question is this: that in the US, American banks are maybe more likely to buy innovation, whereas in China, the average bank is more likely to absorb the innovation.
TN: Do it on their own. Yeah.
RV: China’s one of the biggest markets, also, interestingly, but then you need to be Chinese in China in the sense that you need to provide very local solutions because it’s such a large nation. You cannot take an American or a European solution and say that it will work. You can take the global standard but you have to make it very, very specific to China. In our own experience, it’s been worth it because once you do that, you have a huge market that’s now available for you.
ED: The ability of large institutions to absorb innovation or the temptation to create it?
DS: I’ve found a couple of things. I’ve worked with about eight different Fortune 1000 companies in my career, helping them build new businesses. Most big companies actually have tens of thousands of good ideas trapped inside their walls. It’s at the doer level, the individual level, and there’s no way for those people to get those ideas up to the top where decisions and budgets can be made and authorised. So, that’s the big challenge that I find.
RV: The harvesting of ideas.
DS: Harvesting and enabling, lowering the cost of failure, increasing the reward of success; that’s very, very difficult for big companies. For a lot of them, it’s easier to just buy a business. Very few large American companies are good at this open innovation process of absorbing ideas.
TN: Yeah. In the US, we see many big financial institutions have their own venture arms doing very interesting things. For example, we have a billion-dollar fintech fund investing globally in fintech companies. We’ve done projects with Goldman Sachs, HSBC, American Express, Experian, and Citi Ventures. Maybe such players have visited their teams and visited their labs. I think they are quite mindful of where financial services is heading and trying to build the ecosystem for innovation.
DS: Here’s the bad news. Josh Lerner at Harvard Business School has done some excellent research on this. The average half-life of a corporate venture executive is one year. Corporate venturing tends to be a lagging indicator of a market top. It tends to be bulimic. The corporate venturing will jump in after the best value has been harvested, and then the market will go down. At just the time when you should be investing and buying things, they get out. They fire everybody; they stop doing anything. Then, VCs come in and take advantage of that discontinuity and grow value, and then the corporates come in again.
I’m hopeful that maybe this time, because the tech disruption in financial services is so profound, that this time maybe will be different. Having looked at a hundred years of market cycles in the stock markets, mean reversion would suggest that is not the case.
TN: I’ll send you our data next year, when I see that.
DS: eah, see if the same individual is still on the job.
TN: Yeah, that’s the thing I was going to say.
ED: What is your gut tell you about choosing winners and losers?
TN: You mean financial innovators of companies? We have very detailed guidelines. In terms of market-sizing growth. Like a business model, a team, so on. We are not like technology focus. We pay close attention to technology, but we are consumer-need focused and business-opportunity focused. So, we have these guidelines.
ED: Barney, you made this comment that legislation should trace innovation, but not far behind. What is the tempo? What is the conversation that needs to happen so it’s always there, and where did we go wrong with Lehman and structured bonds?
BF: Where we went wrong was ideological. It was not something inherent in government. We talked earlier about the Washington consensus, which I think misread –
ED: So, the narrative was wrong, because the narrative was interpreting everything as good, good, good until –
BF: It was an overconfidence in the market, and a denigration of regulation. The market was always better. Alan Greenspan exemplified that when he said with regard to subprime lending, he acknowledged in 2007 or ’08, “Yes, I was wrong; I thought the market was self-correcting.”
ED: There was this blind adherence to market principles, which is –
BF: Well, the saying was, you know the market’s not perfect; but it was an exaggeration of the virtues of the market and of the defects of the public sector, so that the market would always know better than the public sector. That turned out not to be true.
What’s the tempo? It is this: you don’t, from the private/public sector, try to tell the market where to go. You see where it is going, but you watch it closely. That’s why, again, I’ll refer to the Office of Financial Research, you look – the thing is, the market will tell you what it’s good at, but it won’t tell you what the problems are. From the standpoint of the regulators in government, you focus on the potential negatives, and when you identify them, then you’ve got to say, okay, what can we do that will retard the negatives? Like the old song, you’ve got to accentuate the positive and don’t mess with Mr. In-Between. That’s the way it should work, you know; the historical model.
In 1850, there were no large enterprises in America. By 1890, there were, but there were no rules for it. So, between 1890 and 1912, ’15 –
BF: Well, but public policy came: anti-trust, the federal reserve system, the Interstate Commerce Commission. So, they had a good set of rules to deal with big institutions, but one solution can create the next problem. Once you had the large institutions, now all of the sudden you have finance capitalism, the stock market, because they’re beyond the financial capacity of individuals.
What then happened is over the next 20 years, the stock market blossoms, but there are no rules. So, the new deal is putting rules in the stock market. That model, by 1940, that regulatory model worked very well for about 40 years. Then came the money that could do securitisation, etc., and basically by the ’90s, there should have been some rules in place, but the dominant view, including among many in the Clinton administration was the market knows better.
It was doing very well. Part of the problem is it’s hard to make change when everybody’s happy. The ’90s were good years, economically, and so the regulation that should have come in the ’90s was delayed about ten years and only came after the crunch.
ED: Ron, with some of the innovations that you are driving, you’re very confident that you’re not going to make the same mistakes because the information available and the assets that you’re creating are transparent; they are clean. Is that a function of technology? It’s better today in dealing with that than ten years ago.
RS: I think there’s a lot less leverage in the system, and I think some of the innovators have become very, very efficient in removing some of the conflicts that were around earlier in the industry. I think there’s a lot more skin in the game by some of the groups. I think because we’ve been able to work with the regulators, work with innovation and technology, and take these big, total addressable markets, kind of what you said, and create these simple, efficient, online solutions, we’ve been able to take a lot of risk out of the system.
BF: Can I say – I don’t think it ever occurred to me. I think that’s absolutely right. We don’t – in the legislation that was passed known as Dodd-Frank, we ban one thing; we say you can’t lend money to people to buy a mortgage if there’s really no chance they can ever pay you back. Beyond that, whether it’s derivatives, credit default swaps, anything else, there are no prohibitions. We say you have to stand behind it; we diminished some of the leverages.
Here’s one thing that occurs to me that makes me feel more confident about it now and, I think, distinguishes it from the great crash of the dot coms. I hadn’t thought about this; this has been a very useful day for me.
Technology in the financial world has this advantage: the people doing it start with an agreed-upon set of purposes. We want to lend people money; we want to extend credit; we want to aggregate money for businesses. Then they think about how to use the technology to accomplish these purposes, but the technology is the means to the end. We have this wonderful technology; let’s think of things we can do with it.
People in the ’90s, in the dot coms, they were inventing purposes that nobody wanted. In the end, that’s why it failed. People were selling a product that nobody wanted to buy, whereas today, people are making it more efficient to get that product that has a real demand.
RS: I think you just nailed it. Think about online lending. We have the primary market where people and institutions come to the CreditEase and Prosper-type companies. There’s the secondary market where now people can trade and get liquidity and trade amongst themselves. We’ve now introduced very controlled, lightly levered, very transparent securitisation. We will not allow the financial engineers of Wall Street to come ruin this thing that we have built that’s helping the borrowers and helping institutions.
BF: You have securitisation in the service of delivering the product. For them, securitisation was an end in itself.
RS: Correct. So were the derivatives, and that is something that we’re not allowing.
BF: By the way, I told this to Emmanuel. You just hit on the one flaw in the manual’s analogy between the ice business and banking. It’s in their opposite attitudes towards liquidity.
ED: One you need more liquidity, the other – well, it could be insurance and banking, right? If I were to put my finger on two things that will define real innovation in financial services, one will be the balance sheet. That has to change; you’re not carrying assets on your balance sheet. The balance sheet is about providing services, I would imagine.
The other is really that the intermediation business has to go. It cannot be central to the business model of a financial institution going forward, but I don’t see that happening.
RV: There’s just too much vested interest in that. There’s too much business at stake in the intermediation business. There will be continuous disintermediation, but then, it’ll be the system.
DS: Let me challenge that a little bit. I’ll say balance sheet, income statement, and intermediation. On the income statement side, you can optimise costs through renting services. So, you don’t need to build a whole core bank; you can rent all of the things necessary to run a bank these days, including the balance sheet.
ED: Technically you pass that savings on to customers, and they don’t.
DS: Well, a number of them do. Not all of them do, but a number of them do. That’s how they can offer very low-cost or free banking. On the disintermediation side, the reintermediation, let’s look at money transfer as an example. Let’s look at money transfer in one of the most expensive places: Africa. The money transfer rates in Kenya, for example, the incumbents would charge 13% to 15% to transfer money in and out of the country, and you’d have five to seven layers of intermediation between the originator, the transferor, and the recipient.
With some of the newer technologies, M-Pesa’s zero. BitPesa, even better. BitPesa is cheaper than M-Pesa and successfully won a court battle against them. A friend of mine is an investor. So, there’s an opportunity there. Will you see sort of cost decreed over time? Probably. It’s almost inevitable. Then the next wave of innovators will come in and they’ll re-disrupt.
TN: It seems to me that in many, many sectors in financial services, this intermediary position will remain. For example, now the marketplace lending platform becomes a new intermediary. Although it’s not like they’re taking that part of the lending out, being responsible for real-time liquidity, kind of an intermediary remodel. The marketplace lending position is still a responsible position.
BF: Especially for the unsophisticated.
BF: Intermediation is needed for the unsophisticated lender and borrower. Somebody’s going to want to – even, by the way, look, I think I’m sophisticated about some of this stuff, but particularly when I had a full-time job, I didn’t have the time to think about it. I could use my focus to identify a good intermediary. For me, being a wise investor was to pick the best intermediary.
RS: We’re entering this full-on access economy where we’re eliminating the friction; we’re eliminating these intermediaries. Instead of just sharing things, we’re now accessing, whether it’s transportation or music or movies or lodging or healthcare or money. This is really part of innovation, letting people access each other like never before.
TN: I think this really beautiful world of finance is based on great investor education job, and that investor education job can be done much better by us utilising technology, making it very fun and making it very interactive.
BF: I appreciate it, but the limit on that is the educability of the investor, and investors will differ in educability in terms of capacity and in terms of how much of their energy they want to put into that. That is going to be the role for regulation and, for some, for intermediation: to protect the stupid and the unsophisticated and the people who are too busy.
ED: Look at what the banks are doing in areas like bitcoin and ledgers, for example. The idea seems to be no matter what your question, they try to look for the ways in which banks can re-intermediate the process. The whole idea of an open ledger is that there is no centre; there is no intermediator, and it shouldn’t be thought of in that way. They should be agnostic, and they should trust the power of the network as opposed to the power of the –
RV: Someone’s got to pay out the ecosystem.
RV: Yeah, someone has to pay out the ecosystem.
ED: Wouldn’t ecosystems get –
TN: That’s why blockchain hasn’t picked substantially.
DS: A couple of things. blockchain is in its infancy; or, as I prefer to say it, distributed ledger technologies are in their infancy. We are very early in what Gartner calls the “Hype Cycle”. They’re still figuring out what it’s good for, really, but on the currency side, there’s actually a real risk with the idea of a purely distributed currency. Central banks have been starting to play around with a digital currency and they’re running into an issue, which is if you have a true distributed digital currency, you lose all the controls that central banks use to balance and regulate an economy.
A lot of very ideological libertarians were raving about how great digital currencies are, and how we’re going to put everything and get rid of central banks and get rid of what they call fiat currency. Then, one of the larger digital currencies, ethereum, was hacked. There was actually an instantiation of ethereum called the DAO. The DAO was hacked and raised among the most money ever made in a crowdfunding event, $150 million in a handful of days. This was very quickly followed by one of largest thefts ever in financial services. About $50 million of that was basically hacked, although it could have been prevented.
What’s interesting, though, is not that. That’s just sort of like operator error. They could have fixed the bug, and they didn’t. The issue was the reaction of the ethereum community. What’s really, really interesting to me as an observer, as someone who doesn’t own any ethereum, was that all of these folks who previously, just a week prior, had been saying, “Get rid of the interventionists. Get rid of central banks,” were very quickly demanding that someone intervene.
So, the guy who created ethereum basically, it was open source, but Vitalik, the leader of the ethereum project intervened and acted like a central banker on this supposedly fully distributed, community-driven property.
ED: So, early days, it’s not that – the proof of concept probably needs another two or three iterations to reach what is intended anyway.
RV: It’s potential. Yes.
DS: Yet more than that, not all centralisation is bad. There’s a reason that you have the stabilising force of the public sector.
RV: Accountability comes with that.
DS: And accountability.
RV: Accountability also.
ED: What is achievable in the foreseeable future? Last comments from each of you. What would you like to see as being achievable that will give you a sense of plateau that sets the disciplines for the next phase? I think the disciplines that we have for the current phase haven’t moved very much from banking as we understand it: transparency, trust, the intermediation business, all that stuff. As we move more into the network aspect where we need to trust the ecosystem more than we trust ourselves, what are some of the elements that will give you a comfort level?
Elements to be achieved in the future
RS: For me, there’s one element. For me, this is nirvana, and we call this EA&U. It’s education, awareness, and understanding. The borrowers get it, the investors get it, the regulators get it, and the incumbents get it so when we go anywhere in the world and ask people, “What is peer-to-peer marketplace lending? Online lending?” that they understand.
We have this global community where people, no matter where they are, can borrow, and people, no matter where they are, can invest so that there are winners. There’s more yield to the investors. There are better rates and better terms to the borrowers, and there is this marketplace that’s serving everybody.
TN: I think we’ve collectively done a pretty good job on the consumer lending front. Small business lending is the next innovation frontier in lending, in my view, in lending. Also, after lending, there is capital markets; there’s wealth management. I’m hoping that crowdfunding a local advisor can have a good future in the coming three to five years, and I’m hopeful.
After that, we have the insurance industry coming, which is highly inefficient in many regards. This is where model innovation and technology innovation can help a great deal.
DS: We could break the credit trap, that you have to have credit to get credit, by applying new advanced data-analytics techniques. We could bank the 245 million small businesses around the world that today are underbanked if we adopted these new models. Those small businesses create four out of five new jobs. So, we can create greater employment, and thus greater economic prosperity.
RV: I would say two things. One is that in about 18 to 24 months there will be genuine blockchain applications, which will coexist with other core systems that are there today, not to replace, but to coexist in a very pragmatic manner. That is one.
The other trend I would think would be merging of industries. You would have aspects like wearables, which are recommended by doctors but are useful for the insurance industry; recommended by financial services companies and then useful for medical practitioners. It’ll just merge the industry inwards.
BF: I’m encouraged by what I’ve heard about the potential for increasing equity by using the various forums that diminish the human biases that get entered. Also, it’s interesting how the internet plays in this. Part of the problem we have with the unbanked in America is they don’t trust banks. They over-trust the internet; they’ll believe any nonsense anyone puts on it.
To the extent that you get into this kind of peer-to-peer and other ways and then it’s accessed through the internet, you avoid – one, you overcome people’s dislike of banks by giving them something other than a bank to deal with. They’ll go to a paper lender; you should be able to get them to go to their mobile phone.
Also, you have these... that judge people more objectively. Maybe it’s an act of faith that a more objective judgment will lead to better treatment for people who now can’t get credit. Maybe more important is that they get it, but they pay way too much for it. They get it from the payday lender or they get it from a loan shark. So, people get the credit, but you reduce the cost of it.
ED: Okay, I’m going to put in two more questions. Just one question for both of you because I just remembered it, and then I’ll make a comment, too, that will be cut and pasted back. The fact that we’ve got both of you huge players in marketplace lending industries in your respective countries, what would you say – and we also have huge developments in payments for example. What would you say are the fundamental differences in terms of the innovations taking place in China versus innovations taking place in the US, and the choices that are being made in each in this huge ecosystem?
Differences between innovations in China and in the US
RS: I think in the US we’re actually behind China and greater Asia in the mobile usage experience. For us, we see big increases in mobile usage where you’re already there, so for us to get the business truly mobile I think is important.
I think it’s also important for us to really increase the efficiency of what we’re doing so that the online lenders can become cash flow positive, generate earning, and become these bigger public, global, profitable business. I think we’ve seen some examples including CreditEase and Yirendai, which have done a better job, and that’s been reflected in the stock market and the success they’ve had.
ED: What about the choices that the US social media players are making in terms of being agnostic about building their own infrastructure on payments, supply chain, and stuff like that?
RS: You’re starting to see it in the US: Facebook, Netflix, Amazon, PayPal, and others getting involved in moving money and lending money to businesses and consumers, perhaps students, and real estate. I think you’re going to see the financial and the technology groups, in particular the incumbent technology groups, get involved in the online lending payments and money movement as well.
TN: I think that Chinese companies can learn a lot from their US peers and also the US market because the US has a more advanced market in credit infrastructure and in wealth management. People’s understanding of asset allocation is far more sophisticated in the US, so there’s a whole lot we can learn. On the other hand, Chinese companies operate in a more competitive marketplace, and their business model innovation, and in many cases technology innovation, is faster paced, so there, the US companies can learn a thing or two from their Chinese peers.
ED: Gentlemen, this has been an amazing conversation. There are points taken in terms of what we need to look at going forward from practitioners, from people with a good feel of the ground. Thank you very much.
Thank you, gentlemen for joining me in this conversation. What I want to do is to take a view from each of you based on the background that you come from, both from Asia and from the West, in terms of how innovation is evolving and what you would put your finger on to make sense of what is sustainable, what is real, and what is achievable.