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Better Banking
The Future of Finance

Mohamed El-Erian has a very smart piece up at Project Syndicate in which he speculates on the rise of a new generation of disruptive startups in the financial sector. A large-scale transformation is likely, he argues, because today’s entrenched companies are facing the twin challenges of increased regulatory pressure combined with unnaturally low interest rates.

El-Erian:

As a result of these two factors, established institutions – particularly the large banks – will be inclined to do fewer things for fewer people, despite being flush with liquidity provided by central banks (the “liquidity paradox”). And banks and broker-dealers can be expected to provide only limited liquidity to their clients if a large number of them suddenly seek to realign their financial positioning at the same time. But this is not just about them. The fact is that providers of all long-term financial products, particularly life insurance and pensions, have no choice these days but to streamline their offerings, including a reduction of those that still provide longer-term guarantees to clients looking for greater financial security.

This creates an opening just as a new generation of consumers is coming of age in the era of hyper-personalized à la carte services. We’ve already seen some innovation taking place in the personal lending space, where companies like Kabbage and Lending Club are trying to provide smaller loans to individuals and entrepreneurs using algorithms that take things like social network behavior into account when assessing creditworthiness. And though the luster of the bitcoin experiment faded some as early adopters lost money when hackers hit a couple of exchanges, peer-to-peer platforms remain highly promising.

Will we get an Uber of banking out of all this ferment? Perhaps. Or perhaps more likely, as El-Erian suggests, we’ll get a proliferation of new services as the titans of the financial sector either try to “self-disrupt”, or partner with (or outright buy up) the innovating start-ups.

From the customer’s standpoint, however, these changes will not just be welcome, but may well be necessary. With the employment landscape of the future likely to demand much more flexibility from the workforce, the consumer-facing parts of the financial sector need to adapt as well.

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  • MartyH

    Last Christmas selling season a business associate and I were talking about ways to fund our holiday inventory bulge.He had taken a Kabbage loan and thought that it was reasonable. I ran the numbers-they were charging around 60% annual interest! He couldn’t believe it was that high until I walked him through a spreadsheet that reached that conclusion through three different methods.

    What really got me was that they gave ground nowhere. The monthly payoff amount ended in 33.33333 cents each month for six months, so they rounded it to 34 cents for all six months. On top of charging usurious interest rates, they chose to take an extra two cents from the borrower. What a bunch of cheap a-holes.

  • FriendlyGoat

    What is an “Uber of banking”? Is it a startup that the market values at 40 billion or so for matching borrowers with lenders, taking an enormous cut and shifting risks to all parties except itself? Just wondering.

    • Andrew Allison

      What you describe, absent the nonsensical valuation, is the current financial system, which has consistently proven adept at privatizing profit and socializing loss. Disruption of this pernicious system, which relies upon cozy relationships with regulators and legislators and is facilitated by the revolving door between government and industry, is something devoutly, but probably futilely, to be wished for. This is an equal-opportunity issue which has been facilitated by both sides of the political spectrum (c.f. Pelosi getting rich through her husband’s highly questionable business activities — google “pelosi husband business” for the sordid details).

      • FriendlyGoat

        MartyH below describes an innovation that is a bit of a rip-off for people who don’t know better (as his associate didn’t.)

        When TAI mentions an Uber of banking—–as though THAT would be some great thing—-I’m just wondering what they dream of. Lower costs for borrowers and customers? Or higher?

        • Andrew Allison

          You raise a couple of interesting points. First, and foremost, is the economic illiteracy of consumers (one of the failings of our so-called “education system”). Second, I think that what TAI is suggesting is something which Jacksonian Libertarian would endorse, namely the feedback of competition, etc. Like it or not, it’s caveat emptor, but the more options that are available, the better the chances for the consumer.

          • FriendlyGoat

            Lack of real-world economic education is a huge problem. I live in a state where the payday and title-loan lenders are still going wild without rate caps. Rates are commonly several hundred percent on loans rolled forward again and again. We literally have more physical locations of these loan shops than we have fast-food restaurants in the whole state. We have a GOP governor and a GOP house disinterested in disrupting these practices. The lenders’ lobby is quite effective

            HOW is a school supposed to tell children that ALL of these shops are rip-offs without incurring the ire of the industry and the GOP governor who supports the whole charade? How are they supposed to teach against a service that a lot of the kids’ parents are using?

            And then there is the biggie. Everybody is telling everybody these days that “tax cuts create jobs”—when they don’t. We can’t even start educating our adults honestly—-due to political spin. How do we even start telling children any truth on these most BASIC of economic ideas when an entire “business community” doesn’t want that truth told?

          • Andrew Allison

            Could we please, pretty please, dispense with the ideological BS and discuss the issues. If you think that your State is in any way unique in the abuse of consumers by lenders, you are mistaken; and, as it has throughout history, the corruption of government occurs everywhere, pace my reference elsewhere to how Pelosi got rich. As to the how of consumer protection, IMO schools in a capitalist society have a duty to make students economically literate. The subject of whether tax cuts create jobs, while interesting, is completely irrelevant to this discussion.

          • FriendlyGoat

            1) Actually, some states do have rate caps on lending.
            2) There is no economic literacy of any kind worth having in the United States which renders irrelevant the question of whether tax cuts create jobs. You know why? Because the Republican party is constantly spinning that they do and people need to know whether their dear GOP is telling them the truth. For average people who really need to know how to vote, they need to know whether some crackpot’s 10% (flat) “Tithe Tax” will

            “Get This Country Going Again”——or——“Doom Most People to Serfdom”

            It’s one or the other. It’s not both—-or maybe. It’s not a book of curves and graphs. It’s truth or not truth.

          • Kevin

            Payday and title loan lenders exist because banks can’t or won’t compete for business from these customers, who are high risk borrowers with a desperate need for a modest amount if cash.

  • Jacksonian_Libertarian

    “unnaturally low interest rates.”

    We are 7 years into Deflationary “Great Depression 2.0”, and no one is willing to recognize the fact. In a normal inflationary economy the Fed’s printing of a Trillion new Dollars every year would have created double digit or hyper inflation, but that has NOT occurred. Why not? The answer is because lenders have not created new loans and there by expanded the money supply of our fractionated banking system. So while the Fed has been printing huge amounts of new money, that has not resulted in an expansion of the money supply, and the M3 money supply is unchanged from 7 years ago.

  • Kevin

    I don’t see major financial institutions giving ground to smaller newcomers. The new regulatarory environment is punishing for small players. The regulatory capture by these large instructions ensures that future regulations and enforcement actions will be deployed to crush any threats to these institutions.

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