Is banking on the right track or about to go off the rails?

Banks and the banking system are not unlike the railways in many countries. The railway system has operators of services and core infrastructure. The operators have been competitive for a while now, but the core railway infrastructure is heavily regulated, audited, and checked for health and safety. As a result, providing core infrastructure is not an area that many want to get into, as it is costly and it has high barriers to entry. Competing on the rails, however, is simpler and has far more potential.

In this analogy, the core infrastructures – the railways – include payments systems EBA Step2, ECB Target2, Swift and Visa. The operators on the rails are the banks themselves, but also others, such as payments processing operators Earthport, PayPal and Western Union. You could add a few more in there – maybe station managers of stops along the way, such as next-generation banking platforms Movenbank and Simple.

Most banks believe the system will never change as everyone needs to use the core infrastructure to operate. This structure is licensed and regulated heavily and has been built over many years to provide a global transaction processing service for money. This is why the future will always be with the banks – to transact commercially, you need a bank.

Signal change

But is this strictly true? In the future, will our transactions run on the traditional banking system or will something disrupt and change this?

So far, no-one has disrupted the status quo. PayPal is often cited as the disruptor, but it has not disrupted anything yet. It sits on top of the banking system, but has not replaced it. PayPal adds a fee to the transaction process; it does not reduce fees. Nothing has gone off the banking rails yet.

Digital currency Bitcoin is an example of something that is going off the rails, but it has not yet reached a critical mass to be of interest to the core banking system. If it did, traditionalists would see it as something to be acquired, migrated and integrated into the traditional system.

So, the future will be different, but also the same. How so? The banking system requires stability, resilience, security and safety, so its users can have confidence in it. This system runs most economies and commercial capabilities of countries. Without it, economies and countries would collapse and decline. This is why the system is so heavily regulated and managed, to ensure it delivers that security and safety. Any new operators will therefore either be part of the core infrastructure – the rails – or part of the service that runs on top of the system – the operators. The latter can fail but the former cannot.

If you are part of the rails and railway management, you can have confidence that no one can threaten your position. This is where it gets slightly confusing, however, as some banks see themselves as rails, rather than operators. They have a false sense of confidence in their future, as they believe they are the ones protected.

A new type of train?

This has been true for some historically but, as we look to the future, it will not be the case in the future. In 10 years, lessons will have been learned from having banks that are ‘too big to fail’; the ringfencing of investment and retail banking will be in place; a Glass-Steagall world will have returned; and banks will be allowed to fail.

Ten years from now, the encouragement of competition, the removal of barriers to entry from some parts of banking and the enthusiasm of government to be directly involved in bank operations will have changed the game for (some) banks.

By 2023, technological advances will have moved at a far greater pace and we will see all things connected wirelessly. Transactions will occur without customers taking action; they will just be transmitted wirelessly and in real time. New banks will appear overnight, but they won’t be banks per se, they will be transmitters, exchangers, processors and communicators. Many of these will be enabling commerce, but some will be facilitating communities. All will be offering a service, whether it be financial or just an exchange of virtual units of value, music, entertainment and ideas.

The world of tomorrow is still being created, but that false sense of confidence that it will all be on the old banking rails and controlled by banks is down to pride and complacency. Both of these will lead to a downfall if not contained. You see, what if I’m in an aircraft and don’t need railways?