Inspiration to write this comes from Pascal Bouvier, albeit our view has formed separately and with a different take.
Bank lending is a complex game but can be reduced to it’s key component: a bank is a lending and investing platform.
Banks borrow money from the public, either through deposits or other debt instruments (such as bonds). This money is then given out to people and businesses as loans. The bank makes a net interest margin, which is the difference from what it can borrow for and what it can lend out.
If a bank wants to make money, it is generally incentivised to lend at high interest rates and borrow cheaply. The lending question is slightly more complicated as risk and competition need to be considered. The borrowing side is easier: deposits are the cheapest form of borrowing.
Deposits are called such as they have government guarantees if the bank were to fail. It makes them secure – a key requirement for many people. Liquidity is the second key ingredient – people might and do want instant access to checking accounts. Banks usually pay no interest on these sources of borrowing but do need to manage the flow of borrowing, usually by adjusting term deposit rates to balance amount borrowed and amount lent.
This is where the key battleground begins.
The Major Australian Banks have huge control over deposits, particularly checking accounts. This helps them fund residential mortgages and business loans at lower rates and provides them with strong profits.
Payment systems and speed play an important part in how much is kept in a checking account. The time spent waiting for a home loan to settle, say 6 weeks, allows a bank to fund itself more cheaply as cash sits in a checking account. The 3 days for a debit transaction allows a bank to hold higher checking account balances rather than the money flowing around the economy. Payments are huge. Payments are also getting interesting as Google Wallet, Apple Pay, Square and Tyro Payments enter and expand in the market.
As new entrants enter the payment space, it becomes more competitive and, in the long term, this means faster. This allows new entrants to also hold checking deposits, reducing the advantage the Major Banks hold on cheap funding. Bitcoin can make transactions instantaneous, so we may not need checking accounts at all. PEXA, a technology company in property settlements and land registry, will speed up settlement times. No doubt that Apple sees value in borrowing cheaply in Australia – it issued a bond here in August. Deposits are on the radar.
The future is awesome. More competition, faster movement of money and most importantly, a change in the way we borrow and lend. This is the FinTech battleground and the opportunity is navigating the upcoming change.