Can Banks Disrupt Themselves?

Payments are the Internet’s next frontier, says Manu Sporny, who chairs the web payments group at the World Wide Web Consortium, the organization that sets Internet standards. Then why is it that Google, Apple, Facebook, Twitter and IBM all participate in the organization but large financial institutions are conspicuously absent?

“That’s the type of reach that banks need to think about when they think about standards — how people in the future are going to communicate with one another,” Sporny says.  Sporny is leading work on the consortium’s payments protocol, PaySwarm, a license-free, royalty-free, online payment system that gives anyone with a website the tools to collect small or large payments and raise funds through crowd-sourcing. Like other emerging payment systems, it has the potential to cut banks out of transactions. But Sporny hopes banks can use PaySwarm to develop new services. “It’s possible the old banking model will be disrupted, but with the system that we’re building we hope that the banks end up disrupting themselves and move forward,” he says.

Payswarm is expected to launch before year-end as a free plug-in feature for WordPress sites, which account for nearly a fifth of all web sites. It’s a long-term project aimed at making instant micropayments of just a few cents possible to help content creators generate income from their web sites. Payswarm boasts military-grade security and anyone can put money into the system using any credit card or U.S. bank account, much like PayPal or Dwolla.

“We’re solving the hard problems at the World Wide Web Consortium in the web payments group,” says Sporny. “All the banks need to do is join and participate if they want to have input into the direction of these standards and specifications,” Sporny says.

It is in their interest to do so. Few of the new generation of consumers may have set foot in a branch, but many are dipping their toes into new payment systems that cut banks out of the picture. Dwolla, for example, a 12-person start-up in Des Moines, Iowa, offers a disruptive online payment system that processes between $30 million and $50 million a month in transactions online and through mobile phones. Its lower fees save customers 2%-8% on traditional transactions; they also don’t charge the typical 30-cent processing fee.

“People don’t realize how quickly change can happen,” says Uday Goyal, the founder of seed investor Anthemis Group, pointing to the speed at which Amazon created a virtual business end-to-end by digitizing first the distribution of books and then books themselves. It reshaped a centuries-old industry and closed thousands of book stores. “What’s fascinating is if you think about financial services, you don’t really need to go down all those steps because the product itself is already digital. There is no physical manifestation of a financial product,” he says, during an interview in his office overlooking London’s bustling Oxford Circus. “In the next two to five years, there will be a massive contraction in the number of branches for a number of banks in more developed markets.”

As new technologies begin to shake the financial services landscape, experts say banks need to embrace innovation by finding new partners and new business models. Banks should be asking themselves: “Where is the market going? How do I react to the fact the pricing on my transactions is going to fall to zero? How do I re-engineer my systems to let’s say monetize data? How do I work with other people in the value chain so that they can work with my infrastructure,” says Goyal, who was previously a senior technology adviser at Deutsche Bank and Credit Suisse and is a member of Swift’s enabler committee, which looks at innovation and new initiatives.

Through Anthemis, he now identifies and invests in start-ups that are challenging old banking practices and structures that were inherited from the industrial age, and replacing them with cheaper and more efficient information-age solutions. One of them is Germany’s user-friendly, customer-centric Fidor Bank (see the story on page 11). “If you look at customers per employee or revenue per employee, or any one of their metrics, they’re 100 times or 1,000 times more efficient than a big bank and that’s because they haven’t had the legacy of the existing infrastructure to fight with,” Goyal says. The future, he says, might be banks like Fidor which engage customers and build innovative products, while traditional institutions safeguard the money at the back end.

“Banks are going to have to realize they can no longer own the whole value chain over the next two to five years because that customer distribution and the innovation around that distribution is going to happen outside them,” says Goyal. “The ones that embrace the opportunity to work with these companies I think are the ones that are going to survive.”

Moving close to developers in Silicon Valley is part of Citibank’s strategy for keeping pace with change. Chris Kay leads the Palo Alto-based Citi Ventures team, which hunts for new business models and technologies. “The intention of going out and partnering with start-ups and entrepreneurs is part of a broader strategy to make sure that we remain at least a step ahead of what our clients and our customers need,” Kay says.

“What banks need to do, and what we’re trying to do, is to be in the flow of those trends it’s better to be at the table with these entrepreneurs and looking for opportunities for us to get better and to take some of their new ways of thinking and bring them inside and scale them rather than just say ‘This is going to be happening to us’,” says Kay.

Citi Ventures met with more than 600 start-ups last year and invested in eight of them, Kay says, adding the group put down roots in Silicon Valley and Shanghai so it can spot developments sooner and bring new ideas to the market faster.

“A start-up can go from an idea, rent server space and get something scaled with a credit card,” he says. “It’s amazing the speed at which disruption is happening, especially in financial services.”

J.P. Morgan has brought thinking from Silicon Valley in-house to promote change. Vipul Shah said he joined the bank as its global head of strategy and business development for its treasury services business after years at PayPal to push J.P. Morgan’s business models and technologies into new territory.

“There is a recognition that did not exist not that long ago around, ‘Look we can’t take our eye off the ball in terms of how we continue to drive new value to our clients’,” Shah says. “Technology has accelerated dramatically in the last decade or so, the lines are blurring, and what newer players are able to bring to the table is fresh and innovative thinking around how we can blur those lines,” he says.

Start-ups see payments in terms of what is technologically possible, not the distinctions that banks hold onto, due to the historic evolution of processes. New players may see no reason to draw lines between high-value or low-value, high-speed or low-speed, urgent or non-urgent, domestic or international payments. Shah says.” I do think there’s a symbiosis that can occur with banks retaining that very critical responsibility as a trusted agent and then also seeking to integrate new capabilities and opportunities that the emerging player will bring,” he adds.

Regulation will be the biggest barrier to change. A “thick layer” of rules aimed to stop money laundering or terrorist financing will limit innovative payment technologies in the wholesale space, Shah says. But he predicts consumers will push innovation along by demanding services on cell phones or other mobile devices and by migrating to cheaper or more efficient payment systems.

“We’ve got to make sure that we are pushing the envelope on driving value for our customers or somebody else will,” Shah says. “They’ll rightfully take share from the banks.”