Will technology do away with the need for banks?

The name was invented in Venice. Banco referred to the bench from which Jewish money lenders worked in medieval Venice, but the question is: will banks get washed away in a flood made of technology?

As the Bard may have said, ‘That which we call money, by any other name smells so rich’. But what gives it value? All money, be it shells, gold bars or promissory notes, depends on confidence. It is worth what people think it is worth. Notes and coins are money because governments or central banks say they are, but unless people believe them, the money is worth nothing.  Okay, you might argue that gold has an intrinsic value, but even that may be exaggerated. The metal we call gold may look pretty, and sit nicely in jewellery, but you can’t eat it; it can’t keep you warm. Gold does not enable us to produce. We may see it as a place of safe refuge; a place that can weather the ravages of inflation for no other reason than people think it does. And when an asset’s value depends on what people think, on psychology, it faces the constant threat of going out of fashion. That is why George Soros calls gold the ‘ultimate bubble metal’, and why Keynes called it a ‘barbarous relic’.

Now look towards the future. There is a rival to gold, and it really is made of nothing more than belief. However, it has one big advantage over gold that may make its rise to becoming the world’s future money unstoppable. Alas, its rise may cause banks to sink, not so much like Venice, but like Atlantis.

So what is this future money? Answer: virtual currencies.

The forerunner is the bitcoin, and because it has grabbed itself such a head start, it may prove to be the ultimate winner too.

Advantage number one: you can buy and sell it for virtually no cost. So your daughter is studying in some watery city in Italy, or Timbuktu, or the university of Mars or wherever, and she needs money, and she needs it quickly. You have pounds or dollars, but she needs euros, or Malian francs, or red dust, or whatever it is they use as money on Mars. It costs to change from one currency to the other. You can do the transaction, but at a cost. If instead you transfer the money in bitcoins, the cost of the transaction is zero. She can convert her bitcoins into her local currency, and she can do it pretty much within a few seconds. You may or may not believe in Bitcoins, but providing you can complete the transaction in a few seconds, it matters not. . .

Let’s face it, none of us like bank charges. Producers of goods that are sold on for tiny margins, may find that bank charges make the difference between their business being viable or not. Bitcoins can solve that problem. So bitcoins mean that micropayments are viable. For more, see Aspen Institute CEO: Bitcoin Micropayments Will Change Banking 

Advantage number two: the speculative bit has been done. The fact is that bitcoins have value. They have value because people think they do. The markets have given bitcoins that psychological edge.

Advantage number three: they are hard to cheat. There is a record of every bitcoin transaction ever made, and it is subject to a kind of triple ledger system. Each computer that has ever been used to trade bitcoins forms part of that triple ledger. To cheat the system, you would need to hack into all these computers simultaneously. That ain’t easy. In fact, it may be easier to raise Atlantis from the seabed, than to cheat in bitcoins.

Advantage number four: the libertarian philosophy. You may or may not sign up to the libertarian school of thought, but the point is that many people do, and it’s a creed that is gaining in popularity. US Presidential hopefuls such as Rand Paul, or influential thinkers such as Nassim Taleb, agree with the idea, and thus bitcoins have their base support. Coupled with that is a certain disenchantment with banks; a lack of trust born during the finance crisis of 2008. The anti-bank lobby has searched for a voice, and it has found it in the form of bitcoins.

Finally, you have growing resentment about the dominance of the dollar. In recent months, senior politicians in France and Russia have voiced their discontent over the way in which the world’s commodities are valued in dollars. The rise of China means the US has an economic rival. China wants to reduce reliance on dollars. It does not want the international community to use its own currency as a dollar alternative, so bitcoins provide the answer.

Combine all this with the Millennial Generation – that is to say those born within ten years or so of the turn of the century. Studies show they have different outlook on life. If you are older, you may find the idea of bitcoins baffling, but for those born in the late 1980s and early 1990s – the so-called Facebook generation – the concept of a virtual currency is not as strange.

Bitcoins may disrupt banking, and they are not alone.

Banks face challenges on all corners. There is peer-to-peer lending, and crowd sourced funding. Why do we need banks? Well, for one thing, we want to earn interest on our savings; for another, we may want to borrow money. But why not cut out the middle man? Instead of saving with a bank, or borrowing from a bank, why not let savers and borrowers come together? Time was when that was a tricky thing to arrange, but today we have the internet. Okay, banks reduce risk, because they have economies of scale and they lend to lots of people. They can afford a few bad debts. But thanks to modern technology, even this advantage of banks over peer-to-peer lending can be overcome. Loans can be broken up into tiny pieces. If Mr Jones wants to borrow 5,000 dollars. Peer-to-peer lending does not mean that he asks Mr Smith for all the money. Instead, Smith, Schmidt, Chang, Diaz, Johnson, Johnston, Brown, Green, Black and Indigo can all chip in with a bit. That way, Mr Schmidt can earn a return on his savings by lending it directly, but reduce risk by making each loan small. If we have peer to peer lending, who needs banks? See Peer-to-peer lending stock soars in IPO 

Add to that IT legacy systems, as banks grapple with the gigantic task of changing their current IT systems. It is often easier for them to start again, but if that is that case, what is to stop a start-up – a so-called challenger bank – getting in there first, or indeed for Google or Apple – armed with enough money to pay off a medium sized country’s debt – moving in on a bank’s turf. Take Barclays for example. Antony Jenkins, the CEO at the bank, has been talking about technology forcing the bank to become smaller and more specialised. He told the ‘FT’: “It is not all about capital. It is also about investment in technology. We believe that technology is going to drive competitive advantage in this industry and you can’t afford to invest in technology in every place — so you have to pick where you have that competitive advantage.”

Returning to Apple, there is Apple Pay. Currently, Apple is marketing this product in conjunction with banks, but it does not have to be that way. Apple Pay is like a cuckoo to banks. The banks provide it shelter, and look after it, but as it grows, it may return to its family the giant Apple, and banks may be left without a home.

Mobile phones are another threat. Increasingly, we will make more of our payments from mobile phones or other forms of wearable technology. What part will banks play in this change?

Banks may or may not be going the way of the Dodo, but they do risk technology flooding them, and the disruption this will cause will shake the giant banks to their very core. It is clear that many retail banks will not survive, and even those that do will need to find a radical way of trading though the murky waters of technological disruption.