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Change and Disruptive Payments In the Banking Industry

Posted by Brandes Elitch | Sat, Jul 30, 2016 @ 10:00 AM

ABA Symposium on Disruptive Payments

People used to say that a banker’s life was as easy as 1-2-3: take the money at 1%, loan it out at 2%, and be on the golf course at 3 pm! This isn’t as far-fetched as it seems since banks are paying about one percent for deposits, and (as I write this) the Euro LIBOR market is negative and USD LIBOR is 1.40%.

You might think bankers have a pretty uncomplicated and structured life since everything is regulated for them, and if they follow the rules, they will get a 1% return on assets just for showing up. This might have been true once, but today a banker’s life is impacted by the Three Ds of banking: disruption, dis-intermediation and disappointment (in the efficiency ratio and the earnings calculus).

This month, I attended the Global Payments Symposium in Manhattan by the American Bankers Association and its subsidiary BAFT, and the resounding message was all about disruptive payments. Here are my favorite takeaways from the event.  

Setting the Stage for Disruptive Payments

First, there are a lot of people who want to be bankers, but don’t want to be regulated or meet the compliance and capital requirements dictated by the Fed, OCC, FDIC and CFPB. These people are called collectively “Fintech.” Current disruptors include companies such as PayPal, Venmo, Dwolla and OnDeck. There are hundreds of Fintech companies, if not thousands, in the wings.

They believe they have a shot at disrupting banks. While consumers overwhelmingly say the only party they trust with their money is their bank, surveys show that most consumers are very unhappy with the service level of their bank and would readily move to another bank that could provide better service.

Fintech start-ups are targeting a retail banking market that provides 40% of the revenues and 60% of the profits for banks. There are even more banking businesses, however, that are under attack besides consumer finance, mortgages, retail payments and wealth management. You are probably familiar with SMB lending (small and medium-size business) spurring all the alternative on-line lenders out there right now.

Banker Pain Points

When you ask a banker what keeps them up at night, they will typically say, “new regulations and what impact they will have, growing the net interest margin, and lowering the efficiency ratio.” The latter is the ratio of expenses (not including net interest expense) as a percentage of revenue — the lower, the better.

To put things in perspective, there are about 6,000 commercial banks in the country now. About 200 are large banks and the rest are called “community banks.” Big banks have over $50 billion in assets; super-regional banks have from $10-50 billion in assets; and the third tier is banks from $1-10 billion in assets (assets are loans to a bank; deposits are liabilities).

Since the financial crisis of 2008 — which caused an existential crisis for the largest banks — the federal government has been busy regulating the banking industry to make sure it doesn’t happen again.

This typically means that the largest banks, the ones deemed “systemically important” and “too big to fail,” must raise capital and shrink assets. One concern is that only banks that have assets in the multi-billion dollar range will be able to meet the requirements of the Dodd-Frank Act, the FFIEC’s compliance driven culture, and an avalanche of costly and complex rules already in the federal pipeline.

The U.S. Treasury’s FinCEN has expanding expectations for cyber-security, the Patriot Act, the Bank Secrecy Act and compliance with anti-money laundering (AML) rules. In this regard, bank examiners look at strategic planning and governance compliance, including capital planning and succession planning. At smaller banks, operational risk such as resiliency and internal controls are the big compliance issue.

One observer, the Bank Lawyer’s Blog, states flat out that “there has existed a dynamic since before the financial crisis that favored larger organizations. The federal government is making it impossible to be small. … The federally-mandated regulatory compliance burden is crushing Main Street’s banks, while the compliance hurdles to jump are being set ever-higher.” This is serious.

One external manifestation of this is that we lose about 300 banks to mergers each year. At that rate, we will be down to about 4,500 commercial banks in a few years. Some observers feel that in five years we will see the number of federally insured credit unions drop from 6,000 to less than 600. Furthermore, no new banks have been chartered in 2011, 2012 or 2014 while none so far this year either. This is serious.

It is tough for banks to make much of a net interest spread when the cost of funds is almost zero (fed funds are .5%) and the prime is 3.5%. Banks really need a higher level of interest rates in general to make a more acceptable return for their investors. It is now unlikely that the Fed will raise rates this year. For a bank, this is serious.

Making Friends with Disruptive Payments

In addition, there is uncertainty about current trends such as mobile wallets, faster payments and how much collaboration banks should have with Fintech companies. While Bitcoin seems to be recognized as more of a speculative commodity than a currency, it appears — for starters — that Blockchain has real potential to completely replace large-scale traditional payments solutions, particularly in trade finance, mortgages and securities.

A recent study by PriceWaterhouseCoopers stated that some bankers believe as much as 20% of their financial-services business will be at risk to Fintech by 2020. Banks are looking for new ideas and new solutions that address regulatory processes, streamlining of payments, next generation analytics and beyond through innovative technology. There is some urgency about it. This is serious, too.

Summary and Solutions

The ABA symposium explored some of the solutions that banks are considering right now, and underlined just how wide-ranging and all-encompassing this effort is at very large banks, especially in the realm of disruptive payments.

At CrossCheck, we process billions of dollars in payments every year for our customers. Thus, we need to be fully cognizant of the changes in the banking industry and how they might affect our customers. We belong to numerous trade organizations in the banking and finance space, and we have regular conversations with our bankers to make sure they: (1) know us very well; (2) know how our products and systems work; and (3) know who our customers and target markets are. We understand that bankers — beyond being our customers — constitute our most important business relationships, and we have followed this belief for the last 33 years.

CrossCheck clients can be assured that we are continually engaged and up-to-date on what is happening in the commercial banking industry. When it comes to checks taken at the point of sale, we are doing the banking for our clients. Download our Payment Glossary today for use as a handy guide on your virtual desktop.

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Topics: Brandes Elitch, Independent Sales Organization (ISO)

Written by Brandes Elitch

Brandes Elitch is Director of Partner Acquisition for CrossCheck Inc. A certified cash manager and accredited ACH professional, he garnered a Master of Business Administration from New York University and a Juris Doctor from Santa Clara University.