MIT’s report, authored by Alex Lipton, David Shrier and Alex Pentland, is called “Digital Banking Manifesto: The End of Banks? – It reinforces the research carried out by FinanceFeeds which deduces that outside of the FX trading desks, the very same banks are not remotely modern, creating endless difficulties for FX firms and prime brokerages alike
The Massachusetts Institute of Technology (MIT) is worldwide renowned for being one of the finest academic establishments in the world, producing heads of industry, inventors of world-changing technology and world leaders, MIT’s alumni and professors are most certainly those to be listened to when they provide rationale as to why a legacy service that the world relies on is coming to its twilight years.
This time, it is the traditional banking sector that is the bete noire of MIT’s research.
Yes indeed, the highly sophisticated interbank electronic trading departments of Barclays, Citigroup, Goldman Sachs, HSBC and Credit Suisse, which between them from just one physical facility per company, process 49% of the entire world’s FX order flow, are bastions of corporate efficiency.
London leads the way in terms of institutional financial technology, and has done for over 30 years. Just 0.0009% of Europe’s workforce are employed in the City’s financial center, yet it accounts for 16% of all of the tax receipts for the entire continent.
Connectivity, access to global markets, relationships with counterparties and prime brokerages, top quality platforms which provide FX liquidity by streaming indicative prices on an in house and third party platform basis are the lifeblood of the global financial sector, the profits vast and the channeling of revenues into R&D in order to form the future of the entire financial markets structure being paramount among plate glass institutions.
Thus, these are not recipient of MIT’s wooden spoon.
It is the ‘legacy’ traditional banking aspect that the university’s Connection Science Department considers to be the major contributor to what will end banks in their current form.
…. and rightly so!
MIT’s report, authored by Alex Lipton, David Shrier and Alex Pentland, is called “Digital Banking Manifesto: The End of Banks?” cites the lack of innovation in the banking sector and how it compares to other industries.
The academics rightly say that banking has hit a brick wall in innovation, concurring with FinanceFeeds’ conclusion when investigating the methodology of mainstream banks in their retail and corporate operations outside of the provision of FX liquidity – ironically some of them being the very same companies that power the global financial markets.
Indeed, there is clearly far more profit in operating one central office in which the global markets are traded to the tune of trillions per day in notional volume, by comparison to having the real estate, human resources, logistics and overheads of running retail branches that deal with small-money current account holders and borrowers, but this dichotomy is far too great to be sensibly sustainable.
One specific finding by MIT is that the academics consider by way of diagnosis of the situation, suggesting that the lack of innovation is a result of “weak competition” between banks, which subsequently leads to other problems, such as less-than-satisfactory customer service and so on, yet these institutions continue operating despite these flaws, as customers do not seem to have any viable alternatives.
This rings absolutely equal to our findings, which are very relevent to the FX industry.
A notable ‘dinosaur effect’ is that it is becoming increasingly difficult for new FX brokerages, and FX service providers wishing to diversify into the brokerage sector to be able to establish bank accounts with mainstream financial institutions.
Whilst this is not necessarily a new dynamic, a recent investigation by FinanceFeeds has uncovered that banks in regions that are very populous with FX industry participants are becoming very strict with regard to the risk management aspect of allowing any entity associated with the FX industry to open bank accounts.
This ranges from brokerages, to signal providers, technology vendors and developers of ancillary services, once the words ‘retail FX’ come about, the banks retract.
Bank of Cyprus is a case in point.
So stringent is the compliance and risk management procedure within the Bank of Cyprus these days that many entities looking to establish a bank account for the purposes of operating an FX firm or a service provider to FX firms could possibly be rejected, even if well capitalized, or even worse have its capital locked in an account whilst the account holding company jumps through hoops for months to satisfy an old-fashioned, paper-led bureaucracy in which one hand does not talk to the other.
Bank of Cyprus is a particularly inept bank, whose International Business Unit (IBU) deals with the majority of overseas-owned FX firms in Cyprus, and is staffed by automatons with a ‘civil servant’ mentality. This is no good whatsoever if your business depends on uninterrupted access to bank accounts. We are very aware of several cases of this level of incompetence at Bank of Cyprus, proving the MIT research to be correct.
During the summer of this year, research by FinanceFeeds showed that when attempting to open a new corporate banking account with the Bank of Cyprus’ International Business Unit (IBU), it was stated that it is entirely possible to open a client money holding account or a business account for maintaining operational capital for any other type of client-facing business, or e-commerce entity, but when FX was mentioned, the offer of both a client assets holding account and a business account within which to store operational capital was withdrawn by the bank.
This is particularly interesting bearing in mind that Cyprus has a very highly developed retail FX industry, and the island’s banks do not act as interbank FX dealers, instead their core business being providing accounts to firms based in Cyprus which are often owned by overseas entities, with a mainstay of the national economy being the FX industry.
Despite this, the bank identifies extending business accounts to new FX firms as a high risk activity.
Looking toward the largest financial center in the world, from which six Tier 1 banks handle 49% of all global interbank FX order flow, London was the next port of call.
HSBC and Barclays demonstrated an interesting dichotomy: FX trading is for banks only!
When explaining to HSBC’s business banking representative via the telephone banking service, the representative did not know what FX trading was, despite the vast majority of the world’s liquidity providers, FX brokerages and supporting businesses being based in London.
After a substantial period of time on hold, having explained in granular detail what FX trading is, to a representative of the business banking division of HSBC, the company which overtook Citi to take the number 1 slot as the largest global interbank FX dealer in 2015 with 5.4% of all global FX client volume executed electronically via its single dealer platform, the reply came back “Retail FX firms are not entities that we deal with unfortunately.”
Answers from Barclays, whose BARX interbank FX platform is third in the world in terms of interbank FX market share, echoed those of HSBC. According to a representative at Barclays business division today, FX brokerages are outside the company’s remit.
Selecting a specialist business orientated bank with an ethos that serves clients via recommendation is also anathema to the FX industry, it seems.
A meeting with Handelsbanken, which does not have High Street branches, yet operates across the United Kingdom, via referal from existing customers only, deduced that the same outcome would be proffered should a corporate customer approach the bank for a client account or operational capital account if that client was a retail FX firm.
“Unfortunately we are am unable to open an account for a company in this business. Whilst the paperwork all looks in order, these regions are high risk in relation to our risk assessment on money laundering. Handelsbanken’s business model is to operate in local markets with customers operating in those local markets” came Handelsbanken’s response.
“In effect I can’t build a case to support the bank dealing with Directors based outside my local market in a country with a high risk rating” continued the Handelsbanken representative.
“This does not help your requirement to open a bank account in the UK and I suspect that you will find that you get the same response from most UK banks” he concluded.
He is indeed correct – although this extends far beyond the UK.
Citigroup, the world’s largest FX dealer by a considerable margin which conducts 16.1% of all global order flow from its Canary Wharf headquarters has been the number 1 FX dealer from 1976 until 2015 when HSBC overtook it with its corporate client base representing the largest in the business, recently stated that according to its internal risk management assessment, extending credit to OTC brokerages has a 56% potential default risk, thus the counterparty credit aspect is now a major point of interest in which brokerages are finding it harder to get credit for the purposes of FX trading via prime brokerages.
On this basis, better prime brokerage relationships are being formed and technology firms are forging an ‘ecosystem model’ to facilitate best execution despite the difficulties associated with counterparty credit risk, however Citigroup also has expressed its dissent for FX firms wishing to open operating capital accounts with the firm, the answer being a firm no.
For this reason, many established firms are able to work with banks in regions with a very highly regarded financial markets environment, as they have maintained their relationships with banks for several years and have large capital bases.
All of London’s existing spread betting and electronic trading firms have very large capital bases and long standing relationships with banks in the Capital, however being a new entrant to the market, no matter how much capital is able to be registered, the banks will absolutely not take the business.
Even having an FCA license and proving that a broker has excess capital to cover positions is not of any consequence.
For this reason, many firms have looked wider afield, however clearly the established firms with proven track records among large banks are at an advantage, whereas those wishing to either start a brokerage or expand their business into other territories are likely to either be given the cold shoulder, or have to eschew offering clients top-drawer banking facilities when depositing or withdrawing funds.
Indeed, the establishment is, well, the establishment and the newcomers will have to look elsewhere, meaning outside of the Tier 1 structure.
Another example of old-fashioned corporate ineptitude is the propensity toward lending money via traditional means such as mortgages and consumer loans to those with no job or capital, yet restricting banking services and counterparty credit to FX brokerages which are well capitalized and are conducive to strengthening the most profitable and efficient aspect of a bank’s business.
Well capitalized FX brokerage or PoP and want credit from a large bank to operate a brokerage? No chance. Got no money, no job and want a 95% mortgage? No problem!
he largest British banks in terms of interbank FX order flow are Barclays (via the BARX platform), with 8.11% of the global market share, HSBC with 5.4%, RBS with 3.38% and Standard Chartered with 2.4%. OK, Standard Chartered is South African, but it is a completely British venture from historic times until now.
These are the very same banks that exposed themselves to vast unrepayable loans to retail customers, including credit cards, unsecured borrowing and perhaps even more remarkably, allowing retail customers to make their own declarations about their earnings and existing assets, which often were wildly exaggerated, meaning that mortgages were granted to those who could not afford to meet the commitments, ultimately contributing to the collapse and government acquisition of many major British banks.
Some 8 years have passed since the dark days of the bank runs and the credit crunch, however an investigation by FinanceFeeds demonstrates that the banks are shunning well capitalized FX brokerages and restricting prime of prime relationships even to firms with massive capital bases and highly complex risk management policies in place, yet the very same banks are making a return to offering 95% loan-to-value mortgages to retail consumers with no savings and no real proof of income or collateral to guarantee the repayment.
Added to this, the banks are not even profiting from this very much, as the interest rates are so low that they are almost negligible.
In the FX brokerage business, one of the most difficult professions is to head a division of a liquidity provider or prime brokerage in a capacity which requires forging and maintaining relationships with banks. The butting of heads over where to dispatch order flow plus the continual metaphorical grilling that the bank desks give prime brokerages with regard to which flow was offset against what, with a watchful eye on risk all the time.
Companies in London with capital bases of over $500 million and market capitalization figures running into the billions are the bete noire of banks, yet anybody can walk into a retail high street branch of the same bank and walk out with a mortgage secured on a house whose value may go down, not just up, having self-declared a fictitious income and having committed very little personal capital toward the transaction.
Local branches of HSBC and Barclays have set up stands in the front of their entrance halls, with a friendly and polite sales person proactively approaching retail customers who enter the branches to conduct counter transactions to see if they can sell them a mortgage with only 5% downpayment and no ‘bureaucracy.’
However, if you are the head of PB relationships at a large brokerage, you are likely to be butting heads with the risk management teams of the very same banks to get orders processed.
Derivative asset exposures at Barclays in 2015 were £295 billion, which was lower than reported if netting was permitted for assets and liabilities with the same counterparty, or for which Barclays holds cash collateral.
Similarly, derivative liabilities for 2015 stood at £295 billion. In addition, non-cash collateral of £7 billion was held in respect of derivative assets. Barclays also received collateral from clients in support of over the counter derivative transactions.
This is the same bank that began offering a 100% mortgage to retail customers in May this year (!!).
UK household debt is among the highest in the world, despite the flourishing economy and London’s towering financial prowess.
The Office of Budgetary Responsibility has made a forecast that by 2019, household debt in the UK will be 182% of household income, which is not sustainable, yet the same banks that are restricting credit to very conservative, risk-aware and highly experienced prime brokerages and FX firms with huge capital bases.
Fair value of derivative assets, together with the value of those assets subject to enforceable counterparty netting arrangements for which Barclays holds offsetting liabilities and eligible collateral.
Credit readily available to those without capital, and restricted to those with capital
Want a bank account with a large overdraft facility, a credit card and a 95% mortgage but you have no savings and no capital? No problem.
Want a bank account to store operational capital for an FX brokerage, no credit at all, and are prepared to deposit £2 million, plus a segregated client money account? The computer says no.
FinanceFeeds spoke to one particular FX brokerage CEO who recently explained that one day, the bank simply closed his company’s account, with no warning, making it impossible to draw money and operate the business. It then took a few days to move to another bank, with lots of reluctance from the bank staff, meanwhile making the operational aspect of the business very difficult indeed. His words were “I will never forgive them.”
All the while, the same banks are profiting from the order flow sent to their interbank FX divisions via aggregated liquidity feeds from the very same brokerages that they are bearing down upon, plus the interbank FX and electronic trading businesses of the banks are far more profitable than the retail banking divisions.
Indeed, many banks are centralizing the retail divisions as having high street branches is no longer a viable business in many cases, yet the FX business makes up a substantial share of their revenues, without having to have a network of physical branches which cater for low-value transactions and vast call centers to support customers.
Banks quietly reintroduced the ‘liar loan’ – a derogatory term used for self-certification mortgages, in January and have now begun pushing them hard. When called up on this by authorities, it was quickly removed from the market, demonstrating the disorganization and willingness to take very high risks by paper-led traditional banking departments of the very same banks that are investing in top quality matching engine technology, automated ledger development by way of blockchain, and continual enhancement of single and multi-dealer platforms – state of the art meets Noah’s ark!
If you buy a brand new house, it is possible to ask the construction company to pay the 5% downpayment, and then take 95% from the bank, with almost no questions asked.
Whilst quid pro quo has indeed given way to quid pro no quo. Unless of course you have no money and no job, yet want to borrow from a bank.
One way in which the MIT academics foresee digital banking influencing the future of finance is through a “Bank of Things” (BoT), where a customer’s banking service can automatically resDigital moneypond to needs such as recommending contractors, organizing bids, and arrange financing if it is notified of a damaged roof, for instance.
While the report says there will undoubtedly be a potential to improve existing banks by digitizing and automating back and middle-office operations through distributed ledgers, it also considers the possibility of these technologies making banks defunct altogether.
The paper says that, despite some current challenges, there could be a future that integrates what it calls “invisible banking,” the ability to store money without friction. Exactly our point!