Why we need brilliant banks

I have been a strong advocate of disruptive startups in Financial Services on this blog, dismissing some of the banks effort to try and move as quickly as more nimble competitors. But in all respect, for these innovative startups to launch their services, we need brilliant established banks and payments players. That is why I was surprised to read Finextra’s post Citi slaps down Bank 2.0 rivals in Innotribe face-off.

Banking is, as it should be, a highly regulated industry. After all, its all about money:

Money
It’s a crime
Share it fairly
But don’t take a slice of my pie
Money
So they say
Is the root of all evil today

More than banking only , its Financial Services that need to be regulated, for the best interest of all parties (and no the bankers are not the most important one). There is no better example than seeing the young UK P2P lending industry calling for regulation on their activities http://blog.zopa.com/archives/2010/07/26/need-for-regulation/ and proposing a self regulating framework http://blog.zopa.com/archives/2011/08/17/we-proudly-present-the-p2p-finance-association/  while waiting for the regulator to define its own. P2P Finance Association

Financial Services, to work in a global way also need a level of coordination only achieved through mature players and global coordination. Swift is a prime example. The Society for Worldwide Interbank Financial Telecommunication, is a cooperative owned by its members. It operates the pipes that allows banks to communicate with each other. The most known feature is probably payment, but other messages types are supported, from buying securities, to informing of the merger of 2 companies. In most of the world (the US being one exception). Swift is the common language of most financial institutions.

These skills (operating in a regulated environment, coordinating with different players) are very important, because without them, in the current environment, there can’t be any Banksimple, Wepay or Square. These Financial Services disruptors need a ground of base services (secure holding of funds, ability to communicate with other financial institutions) to propose innovative front-end solutions to their customers. There is no point in reinventing the wheel if you can find satisfactory services with a provider and focus on your core.

But this is where we need brilliant banks / financial institutions. Because what happens when they are not is a total disruptions of their business. The recent post of Kosta Peric, head of Innovation at SWIFT, comparing bank to bank payments and Paypal payments is a prime example: http://copernicc.wordpress.com/2011/09/26/money-transfer-experiment-chapter-1-paypal/. Paypal wins easily on the transfer of small amounts between countries.

It’s difficult, for some part of the financial services industry to realize that a winning strategy for them would be to become highly qualified service providers, top notch commodities. That there is a play in becoming the efficient platform of front end services, to be more like a water service company for a major city. I believe (or assume) that is what Citi has in mind when they announced the release of their B2B API:

If banks want to enhance their own brands they need to scale. And the best way to do that is to open up application programming interfaces (APIs).“Banks need to harness the power of the developers out there,” says Citicorp’s Benjamin. 

Disclaimer: My employer Anthemis is an investor in Banksimple. We have recently invested in an innovative licensed bank in Germany Fidor Bank http://www.reuters.com/finance/stocks/F5RG.DE/key-developments/article/2403061. I am a huge fan of Square.

Banking as a platform – what retail banking can learn from investment banking

I have written before on this blog on how banking, especially retail banking could move to a platform model, allowing other services to be built on top of them. The idea is to let other services develop by themselves (using a set of predetermined APIs to your digital platform) on top of your existing offer. Depending on how the relationship is set between the platform and the services, it can become a source of revenue for the platform.

It may appear as a counterintuitive idea to banks, fearing the commoditization of their business but as proven for example by Apple with the Iphone App ecosystem, being a platform is a successful strategy (in 2011 Apple announced it had paid out 2.5 billion dollars to its developers – their 70% cut)

More relevant for banks, it is a strategy already used in their capital market division, notably by their prime brokerage offering. Prime brokerage is a “bundled package of services offered by investment banks and securities firms to hedge funds and other professional investors needing the ability to borrow securities and cash to be able to invest on a netted basis and achieve an absolute return.” In more details a Prime Broker can provide the following services to a Hedge Fund:

- Office Space (including necessary connections to the street)

- Consulting Services (establishment of the fund, etc.)

- Capital Introduction (putting hedge funds in touch with potential investors)

- Global Custody and Securities Lending (operating as an extended Back Office, sometimes including portfolio accounting)

- Financing (how most Prime Brokers actually makes money)

Basically, a hedge fund would plug itself to a Prime Broker platform to operate, shaving off the cost and difficulty of setting the platform itself. The Prime Broker is compensated by the hedge funds on its platform, through the financing it provides and or service fees. Prime Brokerage is an important offering for investment bank, as shown by  JPMorgan recent expansion strategy.

A very similar setup could be envisioned for a retail banking platform. Startups, pursuing various strategies (niche banking, focus on lending etc), would leverage an existing infrastructure providing core banking functionalities. The underlying bank would benefit from an important aggregated asset base, whereas the services companies would be free to focus more on customer experience, acquisitions etc. It would be relatively similar to the relationship between Banksimple and its partner banks, though on an industrialized basis.

Finovate Europe 2011 : Part 2 [A social world and the rise of the amateur]

With companies like Etoro, Stocktwits, Cortal Consors with Hopee or Fidor, one of the key theme for Finovate Europe was how financial service can be changed by being developed around the interaction of its users.

One of the consequences of this approach is the possibility for successful amateurs to become a direct competition to established business model.

- EToro (voted Best of Show) is an online Forex broker with a major twist. By implementing social trading, it allows users to copy specific trades from others or even follow a specific trader.

As seen in the image above, EToro also has added a gaming perspective to trading, by creating traders ranking and watch lists. For now it seems that what is driving the platform dynamic is mainly the game mechanic, but it could be expected that leading traders may be remunerated at some points for their financial advice (in a way close to Covestor for example).

Note:
* When copying a trade, users get a close equivalent to the precedent trade, but not exactly the same one (but teh same trades when following)
* Etoro assured me they have set a killswitch so that if you follow a trader going “rogue”, they will disconnect its followers’ trade. (more…)

Will financial information become the next “commodity” data?

Bernard Lunn of SemanticWeb, wrote a great post on XBRL and the impact it can have on the different layers of the stack using financial information. His article is greatly detailed  so if you haven’t done it yet: read it!

As quoted in this other article on XBRL Financial Information :

“Anyone can get the information [from the online SEC XBRL filings] and read it, but how to make good use of it is another thing,” Rong says. Today a lot of money is spent on services from companies like Bloomberg and Thomson Reuters to help them summarize and understand the data. “What we do as a business is to make the consumption of the XBRL based digital financial information easier, faster and automatic. That’s the fundamental idea or value

1 .The basis of financial analysis was a time and resource consuming job of data gathering, input in Excel models and analysis. With the introduction of open financial data format, this work will disappear and automated models will be able to run high level comparative analysis. The commoditization of financial data will make it possible for small companies and small shops to efficiently provide financial analysis. (For parallel, the same process happened when ETF commoditized the base of Fund Management by automating strategies and reducing the role of the Fund Manager).

From my understanding, Trefis is a perfect example of this evolution. Built by MIT students and finance specialists, it provides detailed financial analysis for several companies within a small startup structure, which would not have been possible before. It also allows users to modify the values of key hypothesis to verify how models would evolve under different circumstances and propose their own numbers. The commoditization of financial data has clearly made possible the emergence of new services providing financial analysis for free or a fraction of the price it would have cost before.

Another company aiming at the financial analysis market is ValueCruncher, which provides a platform for interactive analysts reports.

2. On the other hand, other players could benefit from this evolution: Yahoo and Google mainly. Yahoo and Google Finance have made the basic access to stock market information free (ad sponsored) and could continue to attack the markets of companies such as Bloomberg, Reuters.  ValueCruncher has a great post on what opportunities this disruption in Financial Information provides to Yahoo. Even if I believe it might not be the most fitting candidate for disruption, I agree with the overall run toward complex information due to the commoditization of Financial Information:

“The traditional financial information providers are worried that on-line finance sites could do to them what Craigslist did to newspaper classifieds. Take a multi-billion dollar industry and make it a multi-hundred million dollar industry – with the benefits flowing to consumers of financial information. Financial information market disruption.

The consequence is a push toward value added information for companies like Bloomberg and Reuters. However as seen in the first part of this post, other competitors  are willing to change this market too. What do you think will the traditional financial information players do to address this new competition? (Reuters free platform and move towards blogging show they are willing to challenge these competitors directly)

Trading as a platform: a natural evolution

E*Trade has announced today that it is launching its open API. You can find the announcement here http://bit.ly/alRkWC and details on the API there: http://bit.ly/dts02c

Based on the documentation it allows to:

• authenticate E*TRADE customers to the E*TRADE authentication servers.

• manage trades and orders, including placing a new order, modifying an existing order,

cancelling an order, or retrieving the status of an order.

I believe this is a key move for E*Trade; its API will allow it to drive more volume through its trading platform with probably less investment on advertising as for its own trading website and applications (but you will probably still enjoy the E*Trade babies on TV )

The first 2 partners of E*Trade are CoolTrade and AbleTrend. CoolTrade allows user to create automated trading based on conditions they can easily create without using a programming language. AbleTrend is also an automated trading engine with built-in strategies, charting options and custom analysis.

There will be soon more partners for E*Trade: the financial analysis space is growing rapidly with companies like Trefis and Wikinvest. There is a real benefit for them in having their users being able to trade without leaving the platform.

And why not, new companies offering HFTaaS (HighFrequencyTrading as a Service) ; with the decreasing cost of computing, it does not seem to be such a far fetched idea…. (well you still need to be able to trade large volumes)