Good morning, everyone. It is a pleasure for me to be here today in Valencia at the invitation of the IVIE, and therefore among people I have known since the beginning of my professional career in the Research Department of the Bank of Spain.
The title of my lecture makes my purpose today clear. Let me say from the outset that you should not expect a terribly innovative vision from me: no, I am not a tech guru. However, I believe it may be useful to share what I have been able to learn about this fascinating and highly relevant topic in recent times.
A few weeks ago, at a conference in Seville, I said that “nothing will ever be the same again.” My intention was to point out that we should not expect the end of this crisis to mean a return to the situation we experienced during the real estate bubble. It is a somewhat stark phrase that seems to condemn us to a worse future, but that is not the message I wanted, and want, to convey. Let us consider the damage that the period of “irrational exuberance” produced: extreme fragility in part of the financial system, over-indebtedness in segments of the household and corporate sectors, and a distortion of the productive model that diverted entrepreneurial talent and resources to a hypertrophied construction sector and induced a generation of young people to give up training to try their luck in the real estate sector. In short, the apparent prosperity of the bubble cannot, and must not, be separated from the consequences of its burst. Ultimately, the “boom” and the “bust” are but two sides of the same coin: an unsustainable development model.
What will the future be like? Certainly, let us hope it is very different from the past. If we manage to have a different growth model—one that bets on stability and competitiveness, on productivity and better worker training, and on innovation—long-term well-being is guaranteed. Perhaps without fanfare, without great apparent improvements, but also without such intense crises. In short, we must value stability more and consider that it is better to grow less, but to do so more consistently over time. In 1994, when I worked at the European Monetary Institute in Frankfurt, I clearly remember my surprise when a German colleague told me that German potential growth was around 2% per year in real terms, and that it was fine because that guaranteed stability. I do not know if we have to settle for 2% or 2.5% real GDP potential growth. I do believe that, twenty years later, I place more value on stability, and I think it would not be bad for us to be a little more German in some respects. Nothing will ever be the same again, and it is good that this is the case.
But the future does not only offer the possibility of rectifying past mistakes. Technological innovation, for example, has been a constant over the last few centuries since the start of the Industrial Revolution. And since the 1950s, the digital revolution has been changing the world we live in. The fear of a digital apocalypse seems to have replaced the nuclear one, and the day we no longer have internet access will mark the beginning of the end.
Irony aside, this digital revolution is going to impact—is already impacting—all aspects of our lives, including finance, obviously. Before analyzing some aspects of this process, let me reiterate the obvious: faced with any technological change, the only thing one can do is adapt. No room, then, for internet neo-Luddism: what would have happened if the Luddite movements had won in the 19th century? The Industrial Revolution would have failed, and with it the subsequent well-being it brought to all strata of society.
There is no doubt that every process of technological innovation has a technical component behind it. In the case of the digital revolution at hand, the main changes are the decrease in the cost of information storage, the increase in information processing capacity (Moore’s Law), and the decrease in the cost of information transmission through the use of broadband.
The increase in data volume and the capacity for computing and transmitting it is reflected in the rise of mobile terminals, which have greater capacity than any mainframe computer from twenty years ago. The mobile phone is at the center of this techno-financial revolution: the increase in social connectivity supported by mobile use affects all aspects of life, including, of course, finance. But it is not the mobile phone itself that drives these changes, but what it allows us to do: we cannot confuse the hardware, the vehicle, with the software, the applications that run through it.
Another important fact relates to the growing use of mobile phones to browse the internet, and how this is much higher in emerging areas, such as Asia and Africa, compared to more mature areas like North America or Europe: while mobile use for web browsing is below 20% in the most developed regions, in Asia it is 37% and in Africa 38%. Even so, the trend is unstoppable: in one year, between mid-2013 and mid-2014, mobile browsing use in Europe increased from 8% to 16% (and in Asia, from 23% to 37%).
One mistake that can easily be made is thinking that this process can be controlled from the supply side, whether in financial services or e-commerce. The reality is that it is the consumer who is establishing not only the patterns of change, but also its speed. Someone mentioned to me that a representative of traditional US retail complained in Davos about customer disloyalty: they would enter his store, look for the product, scan the barcode or QR code with their mobile, and using the store’s free Wi-Fi, buy the product elsewhere cheaper, in real time and online. And I remembered a similar story regarding shoe stores in New York, which were considering charging customers to try on shoes to prevent them from completing the transaction via mobile on the web at the best price once they had tried them on.
As always, then, the consumer is king, and if the mobile phone and tablet become the preferred channels, then e-banking will have to shift toward applications adapted to consumer desires.
Another important lesson is understanding that the digital revolution, like all revolutions, happens from the bottom up. That is, let us not try to dictate to the consumer how they should perform their electronic financial transactions. Let us think about how to respond to their demands when they arise. I dedicate the following lines to this aspect.
We usually think that when faced with technological change, the first to react is the one who ends up winning. “The early bird catches the worm,” as the saying goes.
But experience also reminds us that it is not enough to move first; one must react at the right time. We can recall, for example, the tech bubble at the end of the last century, during which it seemed everything would move faster than it actually did, leaving many e-banking projects buried.
An even more interesting example is provided by Citi’s initiative to bet on information technology… in the mid-eighties! They even acquired a satellite to guarantee the transmission of the information flows that this initiative required. Obviously, the initiative failed, not because the idea was bad, but simply because it arrived twenty, even thirty years before the right time.
Something similar happens, in the opposite direction, with the branch-based banking model. It is clear that the current model of bank branches will be affected by the growing implementation of internet banking. After all, how often do we go to the branch now, when most banking transactions can be done online?
But is a branch closure policy necessarily a success? No, it would not be wise. Firstly, because getting ahead of competitors can represent a great business opportunity… for them. That is, moving too soon can mean losing a good percentage of traditional customers who regularly use nearby branches. And secondly, because the crisis has demonstrated the weaknesses of models based exclusively on electronic means: let us not forget that one of the reasons for the Northern Rock crisis was the small number of branches this British bank had in proportion to its number of customers, the saturation this caused when the crisis began, and the collapse of confidence following media scenes of unattended queues of customers at branches.
In short, banks and other intermediaries must be attentive to technological developments and the changes they induce in customer attitudes (how their demand for services evolves), in order to offer appropriate responses in the short, medium, and long term, and with the appropriate tempo in their introduction.
On many occasions, I have described and praised the Spanish banking business model, based on long-term relationships with customers, who are provided with all types of financial, banking, and non-banking services according to their needs and their evolution over time. Furthermore, unlike what happens in other countries with commercial and retail banks, the IT foundation of Spanish banking is very strong.
On the other hand, Big Data can be defined as the use of large masses of information to detect consumption patterns, potential or actual, that allow for anticipating customer needs. And it is something we can already observe: when one enters an online news page, advertising appears that is adapted to your preferences (in my case, photographic equipment). It is not new; what is new is that, as I have already mentioned, the reduction in the cost of storage, processing, and transmission of information opens new opportunities that did not exist just a few years ago.
What are we talking about in practice when we talk about Big Data in banking? We can think, for example, of the possibility it offers to detect consumer spending patterns, even by segments (age, income, etc.), allowing companies to improve their financial service offerings (geographic location, adjusting business hours, diversifying their range of goods and services, personalizing products, etc.).
We can also think about how to use that vast amount of information handled by financial institutions to help their clients with savings planning for retirement. We can think of a use of financial-fiscal information that allows the client not only to undertake that planning in time but to do so with combinations of products that optimize results based on their personal characteristics. Furthermore, it could allow for adapting the savings strategy to changes in various regulations over time. Of course, the more complex the regulation, the more relevant that contribution of Big Data to planning can be: for example, pension plans in the US, the so-called 401ks, require careful planning that must also be adjustable over the years.
In short, it seems that the opportunities Big Data offers to banks and customers can be especially relevant in a business model like that of Spanish banks, based on long-term relationships and mutual loyalty.
On another occasion, I referred to the possible competition that tech operators may represent for traditional banks. In a market economy, there are no barriers to entry, and if a segment of the banking business (for example, payments) is seen as profitable by a non-bank tech operator, it is inevitable that a new provider of banking services will enter and strong competition will be established. These operators can also attack specific niches of the banking business, causing a deconstruction of the banking business into its various components (payment services, retirement savings, consumer finance, etc.). Their advantages lie in the possibility of designing service platforms from scratch and in their extensive customer base. Against them is, undoubtedly, the lack of experience in the financial field and, above all, in compliance with the extensive and demanding regulations that fall upon the banking sector.
An extreme example, undoubtedly, can illustrate what we are talking about. Alibaba, the well-known Chinese e-commerce website, launched a Money Market Fund in 2013, Yue Bao. Ten months after its launch, its assets under management represent more than 80 billion dollars, it has 125 million participants, and it is the third-largest investment fund in the world.
But we also have other examples illustrating that competition can incentivize innovation in traditional banking. It has been more than ten years since a very successful online payment platform was launched. Ten years later, traditional banks complement, and in some ways compete with, this platform through innovations such as single-use credit cards, cards with instantly reloadable balances, etc. Therefore, the introduction of new tech competitors, inevitable as it is, does not have to mean the end of traditional banking, but rather a driver for its transformation.
As I tend to point out with an insistence sometimes bordering on impertinence, we cannot ignore that one of the major problems represented by the regulatory process launched after the crisis is the enormous growth recorded by the shadow financial system, given the incentives for regulatory arbitrage introduced by the new financial regulation. And we are not only talking about solvency regulations, but also those relating to consumer protection and business conduct rules.
The reason for my insistence is, firstly, that the financial system is fertile ground for innovation, whether through new operators or new products. And, secondly, that risk tends to locate in areas of lower regulatory pressure: it will flee from the sector with stronger restrictions and accumulate where rules are laxer, or even non-existent.
Because, let us not forget, we unfortunately regulate financial companies based on sectoral labels. Thus, the regulations to be applied to an investment product will be different, even if its characteristics are similar, depending on whether it is a banking, insurance, or securities product. We regulate financial companies and products based on sectoral labels that often ignore substantial aspects of behavior or risk. For example, AIG, before the crisis, was more of an investment bank than an insurance company, but it was regulated and supervised as an insurance company, which certainly did not prevent its bailout by the United States government.
The entry of new tech competitors into the financial sphere will represent many problems for a regulatory and supervisory system like the current one. It suffices to point out, for now, how unacceptable it would be if the entry of new players led to an arbitrage of conduct or solvency rules—that is, to consumers exposed to possible abuses and potential system instabilities.
In few sectors of the economy is the time lag between reality—which in the digital world moves at breakneck speed—and regulation—which takes time, especially in the field of EU regulation where consensus is not always easy to reach—more evident than in this one.
Nevertheless, the notable effort of the European Commission not to miss the boat in this area must be highlighted, and I will cite just two examples:
Another potentially dangerous aspect of internet banking relates to the problems of fragility in the face of potential hacker attacks, whether collective in nature or directed at specific clients. This forces banks to invest in both cybersecurity and their own technological developments. And not only that, they also invest in early warning systems that allow communication with customers in case of specific incidents.
But it is not only banks that must be better prepared. Banking users must also be aware of these potential risks and respect basic security rules when using electronic financial service platforms.
In any case, it is not all bad news: regarding the veracity of information, advances toward electronic means of information transmission also increase the quality of said information.
The digital world faces us with new threats and risks; regulation must provide consumers with high levels of security, privacy, and protection—at least as high as those that credit institutions already provide to their customers—and extend these requirements to all agents.
The digital revolution also implies the removal of borders, so only through international cooperation will it be possible for regulation to be truly effective.
We have already alluded to the possible penetration of tech operators into the banking sphere, using both their technological capabilities and their loyal customer bases. But banks also have strengths (such as customer knowledge) and a customer base that trusts, if not banking in general, then “their” bank.
It is therefore not far-fetched to think that if tech operators extend their offer to financial services, banks could also do so toward the provision of non-strictly financial services, precisely by taking advantage of their extensive customer base and the knowledge they have of them. This is something that, like the impact of the digital revolution itself, has an uncertain timeline, but should not be ruled out in the medium term, particularly due to the need for banking entities to improve their current levels of profitability.
The digital revolution is also allowing for improved risk management. This is despite the fact that the crisis has shown that reliance on quantitative models for risk management was, at the very least, excessive. That scientific illusion regarding the possibility of precisely measuring risk caused many problems during the crisis.
In any case, it would be a mistake to think that the digital revolution does not offer the possibility for both banks and various authorities to access a control of potential risks far superior to that which existed decades ago. Returning to redundant risk control systems, which combine both sophisticated ways of measuring risk (Risk-Weighted Assets estimated through internal models) and cruder measures (the leverage ratio), is a good idea. But it would not be a good idea to dispense with the former to focus only on the latter.
José María Roldán, Chairman of the Spanish Banking Association
