Cover story: What is a bank?

What is a bank? It sounds like a simple enough question, but ask fintechs, e-money providers, regulatory and financial services experts — even the average person on the street — and you will probably get a multitude of different answers.

Definitions will range from a deposit-taking institution that takes short-term deposits and lends them out on a long-term basis, to those more talking about a bank’s purpose: trusted stores of value or trusted financiers you turn to at significant moments in your life.

When it comes to explaining the multitude of different financial services and the firms that provide them — banks, asset managers, hedge funds, private equity firms, payment service providers, fintechs, telco providers, neobanks, e-money institutions — a single, simple definition of what a bank is no longer seems to suffice.

“The traditional definition of a bank as a deposit-taking institution is a good starting point,” says Reinhard Höll, a partner at McKinsey in Germany. “But does it tell the whole story? No, and it definitely does not cover everything.”

While traditional banks account for half of the global banking market’s capitalisation, which was valued at $14.5tn as at May 2022, according to McKinsey’s 2022 Global Banking Annual Review, the other 50% is made up of specialists and fintechs — up from a 30% share five years ago.

In addition to good old-fashioned banks, you have new entrants, such as fintechs, neobanks and e-money institutions, that offer services traditionally provided by banks — cards, accounts, spot foreign exchange, payments, transfers and loans.

In sub-Saharan Africa, where mobile money accounts are more popular than bank accounts, what is a bank is a very relevant question, says Jeremy Awori, group CEO at pan-African bank Ecobank.

“If you restrict yourself to the traditional bank definition, you constrain yourself to people’s perception of what a bank is,” he says. “So, now we’re hearing more banks wanting to be called financial services institutions. It is actually not the label that will make us relevant, but providing solutions to meet the financial needs of the people, anytime, anywhere and affordably.”

Fintech commentator, The Banker columnist and author of Digital Bank, Chris Skinner, distinguishes between those firms doing transactions and payments, versus those that store value. “The latter is a deposit-taking bank which needs a licence to be trusted,” he explains. “And the former can appear to do the same, but they’re not the same. They’re not providing stores of value with a licence of trust.”

Is it still a bank?

But today, these ‘trusted stores of value’ banks are starting to look a lot like the fintechs doing transactions and payments. “People would be pleasantly surprised to come into a bank and actually see what it looks like today,” says Jamie Broadbent, head of digital, innovation and design at RBS International.

“They would find that it resembles a cutting-edge technology company or a fintech much more than it does the picture of a stuffy old bank.

“There’s balance sheet management, there’s risk, compliance — all those kind of traditional functions that still need to exist. But in terms of how we develop and deploy technological advancement, and improve digital journeys for our customers, we operate in a way that is far more akin to a modern day fintech or a technology provider.”

Take Société Générale for example. The 159-year-old French bank feels more like a tech company these days. It has an application programming interface platform called Treezor that provides banking-as-a-service to fintechs. Its SG Forge platform issues security tokens.

An e-commerce offering is being discussed and following its 2022 acquisition of business-to-business leasing specialist LeasePlan, it has emerged as a European leader in mobility solutions, including electric vehicles. Does this sound like a bank?

Claire Calmejane, chief innovation officer at Société Générale, insists the business model is still banking. “That’s why we chose to put financial services solutions in our definition. Trust and managing risk is what we’ve been doing for 159 years, and we are aiming to develop our new activities with this legacy as our key driver.”

Instead of deposits, mortgages, savings or loans, other banks talk about purpose-driven outcomes. “Technology and digitisation has brought great innovation to the financial sector,” says a spokesperson for BBVA. “This has huge implications for our business model, and most importantly how we serve customers and generate value interactions with them.”

Using technology and data, BBVA says it is going beyond traditional banking services to provide personalised and proactive support in financial health and sustainability. But it insists that this is what it has always done — adapting to new times, and new client demands — and that being a bank is still about the provision of deposits protected by the Deposit Guarantee Scheme.

However, Teana Baker-Taylor, vice-president, policy and regulatory strategy, Europe, the Middle East and Africa at the USD Coin and Euro Coin stablecoin provider Circle, believes banks are currently having their ‘Kodak’ moment, driven by Gen Z. This group thinks about investing and banking entirely differently to previous generations, she says. Yield, for example, may be secondary to environmental, social and governance considerations, and Gen Z may not be as attached to depositing their money in a bank as previous generations.

“They want greater choice in financial solutions, which will drive the unbundling of banking services and ultimately change the way retail banking works,” says Ms Baker-Taylor. “They’re going to demand a more tailored experience, not just in the removing of friction that a lot of fintechs have already achieved, but solutions that really meet their investing and savings objectives.”

In retail banking, the question of what constitutes a bank is being reshaped and redefined. “In the UK and US, ancillary banking services have been chipped away at,” says Alex Marsh, head of buy now, pay later provider Klarna UK. “How many people nowadays actually have their mortgage with their current account provider? They always used to go hand in hand.

“Do I need to have a credit card with a bank? Increasingly, people are saying, ‘I don’t actually need this credit card. It’s not bringing me any value.’ And so, you’re down to the current account, which is the only bit that has remained sticky with banks.”

People need banking, not banks

Yet, over time, Mr Marsh believes the current account — one of the few remaining features that still distinguishes a bank from a non-bank — will eventually migrate to non-traditional providers, thanks to open banking. “What we’re seeing now is younger generations that have never had that first bank account with an [incumbent] bank,” he says. “They’ve gone straight to apps like Monzo or Starling … and bypassed the traditional banks.”

For younger customers, the organisation or brand is more important than the term ‘bank’, Mr Marsh adds. “Do [young consumers] recognise the difference between an e-money account, a bank account, or an app like Chip that sits over a number of banks, but gives them good access to really competitive rates? Less and less will they feel the need to have that direct relationship with a bank,” he says.

In Africa, banks have built linkages between their systems and telco providers so customers can move money between their bank account and their mobile wallet. Some telco operators now provide financial services, such as loans of up to $50. While they’re not lending vast sums of money, says Mr Awori, they are still leveraging the capital of banks to lend. But they are not regulated like banks.

“We’re seeing increasing focus on the different providers of these services, and I think the regulators are really catching on to it,” he says. “Banks, frankly, have also upped their game by providing relevant financial services all in one place, through channels such as mobile banking, that other players may not be able to provide. So, there’s definitely a strong place for banks on the continent to be really relevant and ubiquitous.”

Banks are not being disintermediated, but they are definitely being distributed and redefined, says Mr Skinner. “A lot of what technology is doing is changing payment structures and then applying the same techniques to savings, investments, loans and wealth. We’re seeing so much being taken away from banks — particularly the margins — that if all you’re left with is holding deposits, that’s not necessarily a good place to be.”

New entrants may have infiltrated parts of banks’ value chain, says Nigel Moden, banking and capital markets leader for Europe, the Middle East, India and Africa at EY, but fundamentally, in the life moments that matter, he believes the integrity of what a bank is and the clarity of how a bank is different are still there.

Even in Africa, where just 20% of the population is banked (according to the World Bank), Mr Awori does not believe there is a loss of understanding about what a bank is or what it does. “However, the lines are definitely becoming more blurred,” he says. “People will think more about who’s going to provide me with the solutions I need.”

But, again, those solutions do not necessarily need to come from banks. Take embedded finance — financial services delivered at the point of need or sale. Could it blur the lines even further when it comes to this burning question of what is a bank?

“When customers start using things that feel like financial services, but that come from a retailer, travel agency or their automobile club, it becomes very unclear what is the bank here,” notes Max Flötotto who leads McKinsey’s global retail banking practice.

“There is this old saying of Bill Gates’, ‘People need banking and not banks’, and consumers in most cases, don’t really care.” However, Mr Flötotto says there will always need to be someone in this game who is regulated and can take care of all these things, even if someone else provides the interface to the customer.

Trust comes with regulation. So, if banks are the trusted stores of value, the question becomes whether customers trust a brand or app more than they do a bank?

There are two forms of trust, says Mr Skinner. “One is trust in the fact that I can get my money back [if something goes wrong], and the other is trust in the institution that’s transacting and storing my money. The latter is completely irrelevant; the former is the reason why we need banks.”

But Mr Höll says trust will not win over every customer. “There are a significant number of customers that are willing to try out new things and have flocked to neobanks, for instance.” McKinsey’s Retail Multichannel Survey of 20 countries also shows very clearly that this trust differential is much smaller than it used to be, he says. “So, ‘trust us because we are a bank’ will be a very risky strategy.”

Fractional reserve banking

Following the recent collapse of Silicon Valley Bank (SVB) in the US, customer deposits poured into banking behemoths like JPMorgan and Bank of America. But the idea of banks as trusted stores of value did not emerge completely unscathed from the latest banking crisis.

According to Kevin de Patoul, CEO of Keyrock, a Belgian crypto market-maker, the collapse of SVB and the issues that it caused for stablecoins brought a lot of learnings as to what people now consider to be safe. Circle’s USD Coin (a stablecoin pegged to the US dollar), for example, hit a record low of $0.87 as some of its reserves backing the token were held at SVB.

“When you have a stablecoin that loses part of its stability not because of it belonging to crypto, but because of the very little portion that is actually held at a bank that is as traditional as can be, everybody in crypto starts to be afraid of banks and not of what is happening in crypto.”

Mr de Patoul adds that he is not convinced that the logic of banks being the only custodians or safe havens completely holds these days. “Some parts of what we see in digital assets, in terms of being noncustodial and transparent, will need to be incorporated in the current fully centralised [financial] system. Trust in banks is durably shaken and just going ahead as it is today is not going to fly.”

Anthony Watson, founder and CEO of The Bank of London, says banks are fundamentally, meant to do three basic things, which is to securely hold, move and lend money. The Bank of London is a UK-based clearing, correspondent and wholesale bank that claims to be the world’s first mass-commercial bank to hold 100% of its clients’ deposits unleveraged and unencumbered on reserve at the Bank of England — something referred to as 100% reserve banking.

“But how can a bank hold and move money securely if it’s loan-based, highly leveraged and takes credit or maturity risk? In my view it can’t. We strongly believe not all banks should be loan-based, credit risk-taking institutions. But should all banks be like us? Absolutely not. Society needs access to credit.”

However, access to credit is based on a model of banking where banks take risks with customers’ deposits by lending them out, and keeping only a fraction of those deposits to hand for withdrawal. Hence the term fractional reserve banking, which is how most banks operate today. But on the new financial rails being created by things like decentralised finance, crypto and digital assets, many believe this form of banking has its challenges.

“A bank’s role is to create credit and we need them to continue to do that,” says Ms Baker-Taylor. “But the ability for us [at Circle] to maintain a stable token is that those reserves backing it are always available to be immediately redeemed by the token holder. They are not fractionalised; they are not hypothecated in any way. And so that’s where this unbundling comes in.

“Is there room for the existing banking model as it is today and the role of credit creation? Yes. But should it be linked to deposits that are used for payments? I would argue there is enough evidence to suggest that’s probably not a great idea.”

“Maybe new forms of money do not need a bank at all,” ventures Ioana Surpateanu, a non-executive director at CryptoUK. “Instead, they need the co-existence of a variety of systems that can serve different types of clients and demands.”

Banking as we know it serves a great purpose as economic growth is based on risk-taking activities and access to credit, but Ms Surpateanu says the current financial system is extremely leveraged and has severe limitations. And in the current economic and high interest rate environment, she says the modus operandi of banks is being recalibrated as people move deposits out of banks and into high-yield, relatively risk-free instruments.

But at this point, Mr Höll of McKinsey says we have not seen a vastly superior business model to fractional reserve banking, which has many advantages in terms of monetary supply and injecting money into the economy. “My gut feeling is that consumers will want to have something that explains what a bank is. We may have different shapes and forms of what it is, but at the end of the day, we need to keep it simple for the consumer to limit confusion.”

Security and heavy regulation

However, consumers may already be confused by the proliferation of new entrants, specifically e-money institutions, which can issue e-money, provide access to payment services and move money — services that look and feel like a bank, but that do not carry the same levels of protection.

“The definition of a bank is pretty clear,” says Sean Kiernan, founder and CEO of Greengage, an e-money distributor with a platform lending business that services small and medium-sized enterprises, crypto firms and high-net-worth clients. “It’s a deposit-taking institution that uses deposits to leverage via fractional reserve lending and add interest margin. That is the regulatory definition of a bank. However, if you go on the high street and ask people if Revolut, for example, is a bank, I would bet money that they would all say yes.”

Mr Kiernan says e-money providers like Revolut provide a service, and do it very well in terms of offering better rates than a high street bank. But have e-money institutions muddied the waters in terms of what is a bank?

“I wouldn’t say muddy the waters,” says Mr Kiernan, “because we are very transparent to our clients. They have to sign that they understand that they’re opening up an e-money account. It’s a different model that we have to educate and inform. On the lending side, part of the reason why people are coming to us is that they’re not getting loans from banks anymore.”

Bradley Rice, a partner in law firm Ashurst’s financial regulation practice, says the e-money regulation was designed to increase competition in deposit taking and payments. “But it has been more successful than regulators anticipated.” Many institutions, including the likes of Monzo and Revolut, started out as e-money institutions, he says, as it only takes three months to get an e-money licence, compared to 12 to 18 months to become a bank.

However, following the collapse of German payment services firm Wirecard, which raised questions over the safety of funds kept by e-money institutions, Mr Rice says regulators are looking at safeguarding and governance, and ensuring money that comes into an e-money provider is segregated. “It’s only when the rubber hits the road and companies start to fall over that suddenly there is this flight to safety to ask, ‘Who is a bank, who’s secure, who’s heavily regulated, and where’s my money the safest?’” observes Mr Broadbent of RBS.

“E-money providers don’t have the same level of regulation or protection that banks offer. So, I think we’ll increasingly see banking-style regulation extended to anyone that does banking-like activities, which may not fit the traditional description of a bank.”

But Ms Surpateanu says the regulatory pressure card is occasionally used as the default excuse to support a specific type of conservative business model. “There are entities that are not regulated and they offer services similar to those of banks in a more efficient way, which makes the debate not necessarily about regulated versus unregulated entities and subsequent implications, but more about access, security and reliability of financial services,” she explains.

“The choice ultimately becomes one between a heavily leveraged, intermediary powered system and an incipient, innovative system that is fit to serve the largest economic network in the world — the internet.”