Vertical vs. horizontal banking infrastructure

Horizontal banking infrastructure

Back in 1980’s banks in the Nordic worked together when it comes to technology and payment solutions. In Norway we got “Bankenes Betalings Sentral” (BBS) (Banking Payment Central) a joint IT company to support payment between banks and their customers. In 2010 BBS was merged with PBS (Denmark) to make Nets as, and is now operating in Norway, Denmark and Sweden. As a result, payment in the Nordic was far much faster and better and efficient than anywhere else in the world. This has up to recently also given the effect that PayPal and other alternative payment platform has not gained high penetration.

The payment infrastructure was vertical, whatever bank you used they was linked to the common payment infrastructure. If you for example had you bank account in Spare Bank 1, and used a ATM from Nordea bank, it worked perfectly well. And the cost for the customer was very low. When banks customer paid in store and online in Norway, they used “BankAxept” a joint payment solution. Up to recently almost all customer payment in restaurant, shops and store used the POS (Point of Sale) BankAxept solution. In contradiction to for example Germany where you needed to use ATM from the bank you banked with. Today most ATM uses Visa or MasterCard, and the effect is the same as in the Nordic, only that cost of withdraw from ATM is higher.

The beginning of the end?

In the Nordic banks started to balkanize this strategy some years ago. DnB have their Vipps, Danske Bank have their MobilePay, Spare Bank 1 has their MCash, Nordea have SWIPP, and so on.

Even if they use Nets for payment in the back, the front seen by the shops and customer have changed. Grocery stores, shop and restaurants need to have multiple payment solutions at their cash and payment counter as different bank is not seamlessly connected. The result is that stores and restaurant need to choose what bank and POS to bank with. Banks compete with each other to have most stores, restaurants and online-platforms on their customer list. (at least in Norway) This increases stores cost and complexity. And worse it increases frustrate of banks customers, both the end private person customer and the small and large stores.

And who is losing from this in the long run – banks are. On top it opens up for new payment platforms like Apple Pay, Google Wallets, Klarna, STREX and others where banks are not necessary a part of the payment value chain.

PSD2

PSD 2 (Payment Service Directive) is a new EU directive for vertical banking strategy. Banks have to open up for trusted 3^rd party software provider to aggregate information from all EU operating banks. This includes issuing payment transaction. I guess EU’s strategy is to create more competition among banks and give customer better services. PSD 2 is agreed on, and will come in full effect from 2019. Each country has some time to change their laws to align to PSD2.

As long as banks irritate customer and large store chain by Balkanizing the payment infrastructure the future becomes easier for 3^rd party providers to take large part of the payment volume in the future.

Vertical infrastructure

Once upon a time people banked with one bank, and some do still. You received your salary there, you have all your loans there, you have you MasterCard there and you do all your payment there. Some even used same brand for all their insurance.

You might call this a silo.

Not many people do the same today. They might have loan where the interest rate is lowest, Credit Card where fees are lowest or travel insurance is best and do their pension saving where expected profit and future money level is highest.

Younger people tend to swap banking more often than older people, focus on smarter banking and best-of-breed. Younger people become banks main customer in the future - the trend is clear.

  

The new programmable economy

I have been diving into the Blockchain technology last 4-5 months. The deeper I come the more I understand that this technology might change our future dramatically. It is not a next version of what we do today, it is something completely new.

I just read a Gartner document with the title “Hype Cycle for the programmable economy”. And I loved the word programmable, because that’s what this is all about.

I will not dive into Blockchain here, and recommend you to watch some of the videos on YouTube or read any of those hundreds of excellent articles online. In one “transaction” on the Blockchain one can store a script. This script can be triggered by an event.

Scrip might like this:

Peter transfer 100 Euro from his dya-2-day wallet 36273fae36462cce4637 to his pension fund wallet no 3217eah3523e25623526 every month the 10^th. When the amount is more than 100 000 Euro, the monthly amount is reduced to 25 Euro. When Peter is older than 70 years old, the transfer stops. If the interest rate is zero or below, do not transfer next month.

From http://www.dnacapsule.com/

The business logic is inside the transaction in the distributed database of Blockchain. The database is distributed, meaning that it is outside the bank’s technical infrastructure.  It is transparent to other banks, central bank and regulator. 

It is 100 % safe and with, if possible, better security that present payment and banking systems. It is something completely new.

This means that most of the computer system that all banks run today might be obsolete in 5 to 10 years, so are a lot of the processes internally in the bank. But is not only banks, it is telecom companies, supply chain management, hospitals, pharmacy industry, hotels, …. you name it.

Algorithm in the future of banking

This blogpost is based on an article in Harvard Business Review January-February. This again is based on the book Algorithm Need Managers too, by Michael Luca, John Kleinberg and Sendhi Mullainathan.

Algorithm and robots are on the agenda for most banks and financial institutions today. Big Data analytic can aggregate large number of data, both from internal sources in the bank, from the market (stock exchanges, Forex markets, interest market and other markets) and other external sources. It is the way we use the date and how we design our algorithm that makes the difference.  And that we do understand what algorithm is not good at.

Netflix had a million dollar competition some years ago to develop an algorithm that could identify which movies a given user would like, teams of data sciences joined forces and produced a winner. But it was one that applied to DVD – and as Netflix user’s transitioned to streaming movies, their preference shifted in ways that didn’t match the algorithm prediction. It is a difference between movie one would like to buy and the movie one would like to stream now.

Within marketing there are algorithms that estimate what information users are likely to click on. Google have such algorithm. The target of clicks for the marketing company is to sell more, generate revenue and profit. Most of these clickable algorithm does not estimate efficiency of sale and profit, “only” what generates most clicks. It is important to know what these kinds of algorithms is good at and what they are not so good at.  

In the latest Avengers movie, Tony Stark (also known as Iron Man) created Ultron, an artificial intelligence defense system tasked with protecting earth. But Ultron interprets the task literally, concluding that the best way to save the earth is to destroy all humans.

This is the core of an algorithm – is does exactly what it is designed to do. We human might have soft goal. For example it might be best to have a short time loss, for a long time profit. We might strive for equality – even if it causes organizational pain in the short term.

Often one algorithm is used in different situation. There are a lot of example where for example a marketing algorithm works perfect in one country, but not at all in another country. So - design you algorithm for each situation is of extreme importance.

Also remember that correlation still doesn’t mean causation. Suppose that an algorithm predicts that short tweets will get re tweet more often than longer ones. This does not in any way suggest that you should shorten you tweets. This is a prediction, not advice. It works as a prediction because there are many other factors that correlate with short tweets than make them effective. This is also why it fails as advice: Shortening your tweets will not necessarily change those other factors.  

New technology like Blockchain enables banks to easier automate and leverage on technologies like robots and algorithm.

When will banks really leverage on Blockchain?

Most banks today invest in the Blockchain technology. But so far none have launched a “killer app” or any user case that could not be done better with the “old” technology. But I think it is only a question about time before someone present something with real value.

The technology is far too premature to add real value to banks as it is now. Diving into the technology is a about basic discussions like record size, programming language, how to design smart contract script classes, what platform to choose (Chain, Eris, Intel, IBM Open ledger, Ethereum on Microsoft Azure, Ripple, etc.). And I guess there will be more platforms in this competition soon.

Then it is the question on consensus mechanism, what is safe enough and compliant to regulations. And finally the speed & scalability issue. No one have so far managed to set up a Blockchain network in a sufficient size handling 15 000 to 20 000 transactions per second. 

Despite the fact of maturity; bank, tele companies, companies within logistics and other sectors worldwide invest billions of USD in research, piloting and testing this new technology.  Something will change, that is for sure.

I was presenting at BSK Blockchain day on Thursday last week giving 5 reasons for why Blockchain MIGHT revolutionize the financial industry. It is not difficult to find even more reasons. BSK is a union of Norwegian banks.  In the audience were approximate 150 people from many banks, central banks and financial authorities.

https://www.fno.no/contentassets/d30e15c520ab45bcafbfbc74e3aa41ea/program-for-fagdag-om-blockchain.pdf

So back to the question, when?

My guestimate is 1-2 year before the technology is ready enough for a “killer app”. During this time banks will pilot, get some experience and get their “hands dirty”. Then when the technology is mature enough they are ready to launch real value, in 3 to 5 years from now.  Remember, at one point in time banks need to integrate the new technology into their legacy IT architecture. At larger banks this is often a complicated and a time consuming project.

Experience in technology last few years shows that a “fast follower” strategy is not a good strategy, and I guess same thing this time.

SWIFT - Will banks use Blockchain, the technology behind Bitcoin?

Yes they will.

At least they have decided to put a lot of energy and investment into finding out if they can use it. Nordea and SEB in the Nordic are members of the DLG (Distributed Ledger Group) together with some 40 other banks, including Goldman Sachs, Citibank, BBVA and Santander. There are other groups of banks as well.

Blockchain may completely revolutionize the whole banking industry.

It might enable you to pay your invoices at close to zero cost and in seconds. Even payment cross borders of countries will be low cost and almost instant. The technology also enables contract to be shared and securely signed between banks and customers, so called “smart contracts”. “Smart contracts” might also include a Java Script type of macro, for example “First change ownership of the asset, then do the payment”.

I will come back with a better description on the Blockchain technology within a few weeks. 

For now I will just inform you that I will be on a Blockchain panel at SWIFT Nordic conference in Oslo early March.  

Have a look, agenda day 2:

https://www.swift.com/insights/events/swift-nordics-regional-conference-2016

When will crypto currency replace kroner, USD and Euro?

This might be a question to ask. You might think – this will never happen. I am not so sure, but it might take 30-40 years. First in parallel with SEK, NOK, DKK, Euro, USD and other currencies, then as a replacement.

Version 1 - Gaming.
It kicked-off with all these online games early 1990. In wargames you can buy weapon for money, using your credit card. In less violent games you buy house, farms, dolls, masks etc. for money online. But you first translate your Euro and dollar into a crypto currency, and then buy what you need. For example Japanese DeNA has a Moba Coin, NHN has a Line Coin Kakao Talk has a coin called Choco and Tencent have a coin called QQ. Moba Coin had a volume of 689 million USD in 2012. QQ (China) had a volume of approximately 900 million USD in 2005. QQ was also used for payment of other products and services in the real world, as the Chinese banking infrastructure was less developed.

Version 2 - Bitcoin
From Wikipedia “Bitcoin is a digital asset and a payment system invented by Satoshi Nakamoto, who published the invention in 2008 and released it as open-source software in 2009.The system is peer-to-peer; users can transact directly without needing an intermediary. Transactions are verified by network nodes and recorded in a public distributed ledger called the block chain. The ledger uses bitcoin as its unit of account.”
If you look at the Bitcoin monitor you will find that daily number of Bitcoin transaction first week of December was around 200 000. The value was around 5 million USD, and more than 350 000 accounts are registered.

The main reason for cryptocurrency is that the “leakage” in present banking system are too large. Cost of transaction is far too high. Sending money from Europe to Asia might cost up to 8 % of the transferred. That is not sustainable in the long run and in our more and more digital world.

Version 3 – WorldCoin

As far as I know Worldcoin do not exist, but something like it might in the future. To open a digital wallet you need to go through all the KYC processes that comply with the regulator. Regulators might grant a “master” role in the network, overlooking all payments and contracts. In addition to payment worldcoin also accepts “Smart Contracts”, and all banks using the same protocol.

I will come back to this later on. This first blog post is for testing the blogging. I will try to have a new blog post every two week.