Apple Pay turns ‘1’ – The Myth of Fintech Disruption

 Apple did pick up a big compartment within the financial services industry that can be potentially revolutionized by a tech innovation almost a year ago when it launched the Apple Pay. At the event Chief Executive Officer Tim Cook sounded quite collaborative when he described that the magnetic stripe card payment process as broken for its reliance on plastic cards “outdated and vulnerable magnetic interface”, “exposed numbers”, and insecure “security codes”. The collaboration with the existing players in the eco system as the underlying got reflected when JP Morgan the largest card issuer in the US put a live stream on large screens in its lobby in NY without spelling   the reason detaire for such a live stream on the day Apple pay was to be announced.

The core value of fintech that triggers a disruption lay in an Uber like experience while dealing with their bank - simple and interactive as customer’s best user experience is now the benchmark for all their business interaction. Apple Pay does offer that even as your phone is asleep or you are in the midst of something else as the image of your default credit card appears when you get close enough to the NFC terminal. Just a tap to pick another card in lieu of the default one. It all ends up when you lightly put your finger on the Touch ID sensor to approve it. What if my iPhone is lost, I just need to suspend payments via Apple’s Find My iPhone website. Thumbprint being the pre-condition for payment authorization a thieves shouldn’t be able to make purchases.

What a contrast to the ‘disruptor’ who aim to do away with the existing ecosystem -MCXs’ promoted ‘CurrentC’ which requires  the  users to  unlock their phones -> open the CurrentC app -> enter another four-digit PIN-> scan a barcode.

Retailers pay anything between 1 to 3 % to card-issuing banks on every credit-card transaction they process as ‘interchange fees’. This is what the worlds’ second largest retailer in terms of market capitalizations –‘Walmart’ has been fighting out so as to stall this massive out flow. The result being MCX driven ’ CurrentC’ . CurrentC supports debit card, pre-paid card, or store-specific credit card with the intent to disrupt credit cards. Hackers made off with an e-mail list of early testers. It should be borne in mind that CurrentC stores encrypted payment information in the cloud, and requires both a driver’s number and social security number for identity verification .All these to be sweetened with exclusive offers, coupons and promotions.

The first three days of availability, Apple Pay had more than 1 million credit cards registered across 220,000 participating vendors when launched last October. By March 2015 over 800,000 Bank of America customers have loaded 1.1 million cards onto Apple Pay, while JPMorgan Chase & Co. has said that there’s been “good growth” in the number of cards its customers are loading. Visa Inc., the world’s biggest payments network, said that 43 banks, representing 75 percent of volume on its U.S. network, have enrolled to use the token system on iPhones to authenticate purchases (http://www.bloomberg.com/news/articles/2015-03-31/apple-pay-running-into-hurdles-at-checkout-counter-survey-finds-i7x95shl).

 All these in a back drop of NFC contact being blocked for Apple Pay across the MCX consortium. Potential Apple Pay users is about 14.4 million given the fact that only 18 % of iPhone are iPhone 6 and above with over 7 million store in the US .The biggest fillip being announcement by Best Buy to join the Apple Pay bandwagon. Best Buy is a notable member of the MCX consortium.Apart from getting operational in the UK and all set to be in Canada in few days from now Apple is speculated to be making its China foray as Cupertino has already registered an entity within the Shanghai free-trade zone that will be charged with coordinating Apple Pay called Apple Technology Service Shanghai Ltd.

 Two things Apple Pay notably lacks are automatic coupon redemption and loyalty rewards besides fraud. Some issuers have found that up to 8 percent of Apple Pay transactions were fraudulent, compared with 0.1 percent on traditional payments cards, said Julie Conroy, an analyst at Aite Group. With the frauds happening at the registration stage with criminals typing stolen credit-card numbers into Apple Pay and trying to make purchases with their iPhones.

On their part in the partner banks have made changes in how they activate customers’ credit-card accounts. In a  reciprocated  move Banks are offering a lower rate to apple for transactions they normally accept from credit card transactions they expecting that they will make up for the lower rates by processing new types of transactions that are currently being done with cash or other payment methods. Credit card fees being charged to hedge against fraud will possibly come down as apple deploys finger print signature. Automatic coupon redemption and loyalty rewards is being worked upon by Android Pay. Apple incorporating the feature in future is a realistic expectation.

Samsung also has potential with its forthcoming Samsung Pay feature as it uses both magnetic and NFC technology. So also Android Pay whose users will be north of 1 million outlets in U.S. locations and in over 1,000 apps. Both trying to leverage the ecosystem is yet another addition to the collaborative model.

MCX does have its challenges but with Walmart backing time will tell which weighs more ‘disruption’ or ‘collaboration’.

Fintech Insurgency - Disrupting IT Outsourcers Silently By Partnering The Banks

Accenture’s not talking about outsourcing so much these days, but can pitch a strong digital message, says CEO Pierre Nanterme which resonates across the Atlantic when Andy Murray, British tennis ace made headlines recently and this time it’s off the court by teaming up with Seedrs, an up-and-coming British crowdfunding platform through which small companies sell stakes in themselves.  

Approximately 4000 fintech startups are active with a dozen of them being valued at over $1 billion .Most being tiny though they are growing fast. Lending Club, the biggest fintech lender, has arranged $9 billion of loans since launching in 2007 compared to $885 billion of credit-card debt in America alone. While fintech groups do business in the billions Banks deal in trillions. Few in Silicon Valley or Silicon Roundabout want to take on that heavily regulated bit of finance. Many admit they depend on the Bank. After all, you need a bank account to use most fintech services.

1.      Fintech target only the opportune areas in the Bank and the associated complicated process aligned to them without targeting something end to end.

2.      Fintech are not monoliths as  there is a clear distinction between the fintech startups that have built systems they want to sell to banks or that require banks to work with them, such as Aire and GoCardless, and fintech startups set up to compete directly with the banks, such as Ratesetter and TransferWise.

3.      FinTech companies are extracting the most profitable portions of the banking model, leaving banks stuck with high overhead and less profitable products. Around half of all (retail) bank customers are unprofitable already as Banks follow a loss leader pricing strategy

Fintech companies have constraints apart from scale and size in terms of

1.      They are not well-staffed and suited to deal with consumers' financial services needs as they have  desks to deal with technical-support issues & to displace banks, it will take a lot more than just “technical support."

2.      Banks also have a major edge over startups when it comes to cybersecurity. The implication is that since smaller tech firms cannot afford to make that kind of investment, they will remain beholden to banks.

Bankers and Silicon Valley types are fond of framing their rivalry over the future of financial services as ‘A winner-takes-all game’. That’s  certainly is not what is the result of the ‘Bankers and Silicon Valley’ rivalry rather it’s a story of two sides  surviving one another — and may even needing each other.

While the Banks will be left to deal with infrastructure and regulatory issues thereby allowing the Fintechs to free up money and resources to concentrate on developing new technology. The Fintechs don’t expect to get charters in US,UK, Canada, New Zealand, Australia  or elsewhere and here is where the banks are needed but  at the back end. “The banks and fintech firms are settling into a pattern of mutual dependence and the ‘Balance of Power’ getting reflected in Banks’ pouring investments into innovation labs and acquiring customer-friendly startups.

"Banks are recognizing now that the only way forward is with tech companies that own the customer experience," Brett King, the founder and chief executive of mobile money-management service Moven, said in a characteristically bold declaration. Besides for Banks’ it’s difficult to innovate fast when you are a brand as  apart from  reputational risk there are a range of rules an established financial institution must adhere to – everything from regulation to security. To recoup their resulting market losses and mitigate the threat of FinTech insurgents, traditional banks and other legacy players in the financial sector are discussing a range of strategies, including charging more for low-margin services, closing bank branches to cut costs, and the most substantial one- Acquiring, Partnering & Launching/Funding FinTech companies.

Last year Barclays launched their own fintech incubator and Santander set up a fund to invest in fintech companies, while this year Visa Europe has launched an accelerator called Collab.

Rhydian Lewis, CEO and founder of the peer-to-peer lender RateSetter  believes that Banks don’t yet know how to incorporate innovations into normal business. For that reason, he says, fintech start-ups generally don’t have to worry about having their ideas copied or stolen by banks: “Good intentions are not enough, banks need to change their ability to take new innovation to market if they want to see a return on their investments in the fintech community.”

As customer expectations extend beyond categories, successful solutions must move beyond silos. The environment it operates in, the devices on which it works, the winning themes - they could all be redundant in a longer time-to-market. Enterprises must hence focus on quick execution of ideas, in stark contrast to how they have traditionally operated. Digital Transformation moves to a different beat as it is in a space where forces driving the ecosystem are in a state of constant flux.

Infosys , Indian outsourcing major has made two acquisitions – that of Panaya and Kallidus – but the total value of these acquisitions is less than $ 0.3 Billion. This doesn’t even match the incremental cash flow the company has got in just one financial year. According to Infosys, its liquid assets stood at $ 5.50 billion on March 31, 2015.Wipro has gone in the same lines and bought ‘Designit’ and sits on a cash pile of over $2 billion. Accenture has acquired ‘Chaotic Moon’, ’PacificLink’ and ‘Bright Step’ to consolidate its digital capability is a space of less than a month.

Accenture’s early investment in digital services capabilities continues to pay off with the firm reporting a 30% increase in digitally-derived revenues for its latest quarter ending March 2015.Is this the beginning of ‘outsourcing being a progressively a less talked word if not a ‘dirt’ word? With cash stock piles and a few Fintechs of approximately 4000 valued at over a Billion USD its shopping time for outsourcers.

Burning cash is another thing.

Confronting the digital disruption - A Banks’ Anti Dote

Francisco González, chairman and CEO of Spanish banking group BBVA states that 50% banks in the world could disappear by ignoring digital transformations and that BBVA will be a software company not a bank anymore by 2020, he points out the disastrously antiquated systems incl. IT systems, "spaghetti" systems totally unable to cope with the deep transformational impacts of digital on banking ecosystem & inability to see competition coming from digital players.

While European clients made contacts with their bank using mobile which is 11 time over that of the internet, in Latin America mobile has overtaken as an interface with bank overtaking all channels being put together. The world is increasingly moving towards a digital path. With over five billion mobile phone users, and data-traffic from mobile growing at an amazing rate of 26 per cent year-on-year, we are at the inflection point of digital adoption. This tectonic shift in consumer behavior demands businesses to increasingly focus on tapping the potential of this market. Unheard were thing like IoT (Internet of Things) which today help us to re-imagine a business through Digital. . Every enterprise wants to strike the next big idea and spend enormous amount of intellectual capital in ideating the next disruption and antidotes for the current disruption. The prophecy of Francisco González at least has got a strong trend towards it

Future-oriented business transformation requires an experience-driven process that moves beyond categories to deliver a meaningful, valuable, and competitive experience to customers. A customer’s best user experience is now the benchmark for all their business interaction. This is so opposed to traditional business transformation processes which are driven by off-the-shelf technology. This leads to an extension of existing organizational silos that separate product and service.  Customers expect an Uber like experience while dealing with their bank - simple and interactive. As customer expectations extend beyond categories, successful solutions must move beyond silos.

The environment it operates in, the devices on which it works, the winning themes - they could all be redundant in a longer time-to-market. Enterprises must hence focus on quick execution of ideas, in stark contrast to how they have traditionally operated. Digital Transformation moves to a different beat as it is in a space where forces driving the ecosystem are in a state of constant flux.

Based on their maturity and commitment banks’ can be classified into three broad categories;

Digital is a project (project by project basis, Pilots and gradual deployment)

Digital is a business (cross functional team mixing IT, distribution and marketing ,Test and learn approach with parallel testing and big bang deployment ,Flexible and agile execution with regular review)

Digital is a core value (Pure digital model, pure player model that accelerates digital transformation, dedicated lean IT)

The third category being on the offensive seeking business leveraging technology by employing agile teams with fast time to market with entrepreneurial mindset backed by web enabled IT teams.

Irrespective of the above approach the organization needs to be anchored by four dimensions namely;

Client centricity (Agile IT organization and cross functional teams studying the customer desires leveraging the power of social media and maintaining live interaction with clients)

Openness to innovations ;Integrating IT and marketing to create an Agile organization that merges client needs with solution delivery at a fast pace

Organizational flexibility ;The proliferation of new technology and faster time to market call for a fundamentally  flexible IT platform that is able to integrate external cloud service .A deep cultural change by integrating the front end and industrializing the back end .In effect a deep rooted cultural change.

Technology centric approach ;Leading banks are creating a smart middleware layer that computes and processes customer and business intelligence with state of art technology and interfaces .Ultimately such middleware will be opened up to third parties.

Looking ahead:

Most banks have started the journey which is still in the mid path. Banks have no time to waste as customer behavior radicalizes on account of technological boom in terms of IoT, spread of smart phones and 26% yoy increase in internet traffic. While today 50% of the phones are smart phones, in 2020 it will be 80%.This makes a strong case for operational agility .Leaders will offer true expertise from highly skilled professional everywhere as banks build a strong digital foundation and launch digital value proposition. While branches may be added by digital players to show case their brand but the overwhelm trend is that of an app focused front end, a central core connected database hosted on cloud and a backend which is industrialized and outsourced.

The inevitable pressure to reengineer the operating models with an end to end process review taking into account proper allocation of both human and technological resource .Rest is what time will tell.

Anti-Money Laundering From False Positives to Real Positive with Predictive Modelling & Big Data

Anti-Money Laundering From False Positives to Real Positive with Predictive Modelling & Big Data

The False Positives

“If any financial crimes compliance people out there have just plugged in a monitoring system and think that they’re done   you’re going to be flooded with alerts without any context,” warned Bank of America’s Bill Fox .This explains why most banks have conversion rates that are more like 5-7% .Banks need to go beyond their monitoring systems so as to see impressive results in terms of efficiency as they need not hire large numbers of staff to sift through alerts from their monitoring systems. Hence the need to create an in-house system that compiles formation from different sources such as its monitoring reports, news reports, alerts issued by regulators, and far beyond & much more  & then turns that feedback into “events,”.

Challenges Ahead;

False positives and very low rate of conversion reflects the deficiency of the AML set up. Besides the stiff regulatory fines .The below will tell how soon the current system with a meagre 5 to 7 % conversion rate presently will become defunct;

1.    There are more than 5 billion cell phones. By 2020, experts predict there will be more than 50 billion connected devices.  Assuredly, criminals and criminal organizations will be attracted to this new financial and communications medium s as to leverage them

2.       With M-Payments will come  digital value smurfing to probably replace or at least out do   traditional money laundering, “smurfs” which places small amounts of illicit or dirty money into financial institutions in ways that do not trigger financial transparency reporting requirements. Dozens or even hundreds of digital smurfs could then be directed to transfer the value to accounts controlled by organized crime. 

3.    Law enforcement will be further challenged by issues such as venue, jurisdiction and competency. The expertise to systematically track M-Payments simply does not exist.  A lack of physical evidence further handicaps law enforcement investigations, as there may not be any cash or money equivalents to monitor or seize.  If the conveyor or recipient phone is destroyed, it may be impossible to reconstruct or determine the information that was on the phone. Here the mortar branch ceases to exist.

4.    Today's trade-based money laundering activity goes beyond traditional laundering of criminal funds to include terrorist financing and intentional efforts to circumvent international sanctions, “Criminals turn to this as it's a classic needle in a haystack — an $18.3 trillion business formed of a "web of complexity that involves finance, shipping and insurance interests operating across multiple legal systems, multiple customs procedures, and multiple languages, using a set of traditional practices and procedures that in some instances have changed little for centuries . This state of affairs is exacerbated by a number of factors, especially the lack of data sharing between customs, tax and legal authorities and a tendency to rely on AML procedures designed to target cash smuggling and financial system misuse. 

5.    While key players in terrorist networks may be identified by the international community as terrorists, many of the lower-level, tenuously-connected contributors to terrorist networks remain unknown. These low-level contributors, prompted by group actions which mimic popularized crowd funding strategies have become another source of financing and physical resources for ISIL. Social media platforms unintentionally provide an effective method for terrorist groups and their sympathizers to exploit this technology for terrorist financing purposes.

6.    A symbiosis is developing between organized crime and terrorist organizations. Sharfuddin Memon, director of a Karachi citizens’ crime watch group, described the motivations behind this activity: “The world thinks this is about religion, but that’s a mistake.  It’s about money and power.  Faith has nothing to do with it.”

The Way Ahead

The new innovations also provide platforms to criminals as well which the current system will most certainly will not be able to cope with .So the need to extract and analyze in-house and external data, both structured and unstructured as the illegal process is all about taking ‘dirty’ money and making it ‘clean’ passing funds through an intricate and interconnected network of people, places & things and their inherent but otherwise unseen interconnections. The current approach and the AML solutions which solely focuses on entity-level (person, business, corporation) or transaction level risk scores, without viewing them within the context of the greater network risk score.

At the same time a myriad of business data exists. Communications and social media are growing exponentially. Industry calls these massive data bases, “big data."  Concurrently, there have been major advances in data mining and advanced analytical capabilities that can help organizations derive the “intelligence” from this vast amount of data.  Data warehousing and retrieval are enhanced by cutting edge technologies that search, mine, analyze, link, and detect anomalies, suspicious behaviors, and related or interconnected activities and people.

The good news began in 2009 with the invention of ‘Spark’ (by UC Berkeley ) which is  a powerful open source processing engine built around speed, ease of use, and sophisticated analytics. Spark is a general-purpose engine used for many types of data processing. ‘Spark’ comes packaged with support for ETL, interactive queries (SQL), advanced analytics (e.g. machine learning) and streaming over large datasets. For loading and storing data, Spark integrates with many storage systems (e.g. HDFS, Cassandra, HBase, S3). Spark is also pluggable, with dozens of third party libraries and storage integrations. Additionally, Spark supports a variety of popular development languages including Java, Python and Scala.( https://databricks.com/spark/about)

In furthering this crucial piece of innovation Tresata and Databricks announced this March a real-time, Spark and Hadoop-powered Anti-Money Laundering solution earlier today. Tresata’s predictive analytics application TEAK, offering for the first time in the market an at-scale, real-time AML investigation and resolution engine leveraging ‘Spark ‘.It is certified to run on Databricks Cloud, Tresata’s TEAK is breaking new ground and offering Banks, Retailers, Telcos & Regulators the only quick start, rapidly scalable AML solution.

Hope this is a harbinger of an era where ‘false positives’ is a term of the past making the regulatory burden more meaningful .At least meaningful to the extent that Banks don’t get the hit of ‘Reputational Risk’ and the billions of dollars  outflow accounted to penalty.

That in effect frustrates the crime & terror networks.

Social Media Banking as ‘keystone’ of the Digital Transformation Arch

Social Media Banking as ‘keystone’ of the Digital Transformation Arch

As we overcome the ‘hype cycle ‘ with mushrooming technology innovations , banks in their quest for a ‘Next generation Banking ‘ model  with ‘social media’ will have a forward integration with the digital bank &  the backward liaison with the ‘intelligent (based on analytics) multichannel’. The upstream taking care of the integrated multichannel architecture, powered by analytics (real-time event management, etc.)  & need based offerings optimized by channels. At the other end remains the Bank as trust center leveraging the power of the power of mobile and payment services with the ‘Social Media doing its critical role of ‘ Customer engagement ‘based on personal interests, leveraging influencers and increasing customer intimacy’ as its listens, monitors, markets with optimized offerings and iterates the feedbacks back into the product.

In the ‘as is’ business scenario banks mostly cluster customers through traditional drivers (such as average revenue, cross-selling rate) and engage them on a “push” basis to a ‘To-Be’ in a rather tectonic shift to what a “Socially Engaging” Banks do. In the later interactions being much more personalized with banks clustering customers based on their interests and intentions communicated via their actions on social media (for instance, by “liking” or sharing something). The resultant being such clustered customers &   having dialogues with them daily on relevant subjects and offer products when customers need them. The bank subsequently becomes a daily partner, able to address client needs and play an active role along the entire purchasing path, instead of only engaging the client in the final phase.

In the game plan banks needs to be a listener as it sets to collect relevant feedback to feed other key components and tune initiatives vis-a-viv Customers ,Brands, product and initiatives. The feedback being in shape of customer complaint & sentiments with respect to existing products thereby enriching the customer profile as it sets to iterate its offerings. For the same the banks need to set up the following-

·         Build Communities

o   Based on products, financial needs, non-financial needs and customer segment

·         Engage users

o   Based on Q&A sessions, “Offline” caring after online interception ,Customer care , Contests (to get influencers) ,  apps/videogames & Virtual branch

 With iterations to the existing products being always a continual exercise the banks set up on path for the ultimate step –product offering (leveraging the social information) and the same as members pass on the same to member

On the upstream where banks need to plug in the backward linkage banks could design an integrated customer experience based on a streamlined multichannel, approach and architecture whereby the multichannel customer experience is based on the right combination of online and offline processes and can be enhanced by focusing on dedicated advisory services (remote or digital). This enables banks to create micro-segments based on uniform demographics and social behaviors, and form the basis for defining strategic profit pools. The increased capture and application of customer data, properly managed and updated through an advanced CRM platform, can help enhance the value and return on product catalogues, commercial campaigns based on realtime propositions, as well as lower distribution costs by optimizing capacity by micro-segment preferences. Pervasive analytics based on effective customer data collection, micro-segmentation and predictive modeling to determine the most effective basket of products 3. Real-time interactions management that can increase conversion rates from inbound and outbound contacts

The branch is downstream should be the platform for opportunity to become a “one-stop shop” and satisfy all relevant customer needs starting from a unique point of contact built on partnership and customer trust. Analytics and marketing capabilities linked with mobile services are required. This means the bank must be able to leverage customer information gathered through the mobile device, such as mobile transactions (m-payments) and geo-localization .Once the payments solution is in place, the customer base can be better protected and the risk of customers changing providers is reduced, given the increased natural trust for payment services provided by banking institutions versus companies from non-financial sectors. In this way, the bank can assume the role of trusted advisor, supporting customers with financial and non-financial offerings and opportunities,. For all needs linked to economic choices such as buying a house, a car, or even supporting the customer preparing for marriage, the bank is able to support the customer from the very beginning and continue to do so throughout by leveraging its partnerships with non-financial institutions.

Facebook and Linkedin will be the operator for the “Share experience” ecosystem, Google for the “Search” ecosystem, big telecommunications companies for the “Connect me” ecosystem and big banks for the “Economic choices” ecosystem. Google also is an important player in the NFC ecosystem given its relationship with MasterCard and Citi has been allowing retailers more data about their customers thereby helping merchants target ads and discount offers to mobile device users near their stores.

In continuation of the privilege provided to retailers ,Google Wallet is passing payment information over existing payment protocols (including MasterCard PayPass and Visa PayWave), and the Nexus S smartphone—which Google developed with Samsung—is already enabled for NFC transactions.

Internal Models of Banks – Making them more ‘Comparable and Credible’

It can be said with reasonable authority about the contemporary global banking system that investors in bank securities and counterparties to banks’ derivatives conduct their transactions on TRUST and not on trustworthy ratios that can help them assess banks’ true credit quality.

As we draw parlance to Greece , since the Global Financial Crisis of 2007-09, increasing evidence came out that Greece “cooked their books” – essentially lying about the country’s financial health in order to comply with the European Union’s prerequisites to joining the common currency. Some say it still went on up to 2012.Hence as a take away from Greece crisis we can transpose the same modus operandi among banks when it comes to their internal models.

The Basel committee’s goal continues to be to curtail bank regulatory arbitrage, that is, banks moving their activities to countries with weaker capital rules. Internal Models of Banks – Making them more ‘Comparable and credible’ is in lines with this goal

So why counterparties & investors rely on trust?

Those internal models to determine credit, market and operational risks so as to measure their assets’ risks. This determines the amount of capital the banks need to sustain unexpected losses. The banks are not required to disclose the details of how they calculate risk-weighted asset ratios. Hence there is no way for investors, bank analysts or the media to accurately compare banks’ risks.

Banks’ also adopt politically influenced practice of determining the ‘probability of default’(PD) of their home country’s sovereign bonds at zero, no matter what the rating agencies or market signals like credit spreads say. That would have a negative impact on banks in Russia and some European countries, including Greece, where the credit quality of sovereign bonds has been deteriorating. However Banks in the United States that invested in United States Treasuries would not be hurt, though, because yields and ratings imply practically a zero chance of default for United States debt.

How does the Basel committee see the way forward?

a.      The Basel committee is seeking to make the risk-weighted asset ratios comparable. That would help the market to discipline banks by selling bank bonds or shares if it does not like the level of risk the banks are taking.

That may not be altogether possible as it is impossible to perfect uniform standardization of how banks calculate their risk-weighted assets given the fact that banks business models and risks are different. However the critics of such standardization should never forget that   standards as to how the banks calculate their inputs be made stricter and certainly more transparent. This will make banks' risk ratios more meaningful to market participants, investors or the media.

b.      If the Basel committee recommends changing that practice, banks investing in home sovereign bonds that are not investment grade will have to raise equity, increase their retained earnings or jettison risky assets to comply with Basel’s minimum capital requirements. There cannot be a stretched criticism to this action given that we all have seen Greece, Ireland and Iceland among many.

c.       The Basel committee envisages more responsibility to technology employees, compliance officers and auditors. These classes of employees are all too often derided with the shortsighted moniker of “cost center” and not given the necessary resources as they are not generating revenues like traders or lending officers. Most they pay such professionals receive don’t incentives them to better perform their essential functions.

Probably this is the  point where you hit the ground is your internal environment where you ask yourself the question- Am I lying to myself? .It’s the ‘single point of truth’. As Indian IT czar Narayana Murthy says ‘In God we trust others bring facts’.

Many large banks continue to struggle with collecting high-quality data, pulling together risk exposures and identifying counter party concentrations accurately and rapidly. Banks’ technology systems, data and reporting processes require significant investment both financially and in personnel.

The infrastructure has to be built for the future superstructure to thrive for every time we need not wait for Herstatt to remind us that the ‘horses have run away from the stable’. The alternative to data is trust which apart from deceit on boarded Greece into the Euro Zone.

It’s an easy choice between data and it related infrastructure and governance inclusive of personel versus TRUST which relied on Greece historical significance and contributions to Europe in terms of developments in civilization, mathematics, philosophy and literature to bring it to the fold of euro zone.

Mobile Banking – The Biggest Branch!!!

HSBC's oldest customer to download its banking app was 108 years old!!!

FDIC says that “In terms of technological change, there is little evidence that the emergence of new electronic channels for delivering banking services has substantially diminished the need for traditional branch offices where banking relationships are built."It does stand true when one see a rather marginal decline of branches in the US from 99,550 in 2009 to 94,725 in 2014. But can we ignore the average number of teller transactions per office declined by 45% between 1992 and 2013, from 11,700 per month to 6,400 in a backdrop where customer base has increased manifold. A recent survey finds that 19% of people aged 18 to 29 visited a bank branch which is 29% age group 30 to 49.

Mobile banking spread is twofold -  While on one hand it serves the’ Client Aspiration’ on the other it ‘Reaching the unbanked populace’

Client Aspiration

British banks (British Bankers' Association) are seeing stronger growth in mobile and internet banking from customers in their 70s and 80s than younger generations as nearly 2.3 million people aged over 70 are now using internet banking which is equivalent of 30 percent of that age group. Over 450,000 customers over 60 are using banking apps on smart phones, iPads and other tablets.

RBS launched ‘Touch ID’ which would be available for nearly one million Apple iPhone users that have RBS or NatWest mobile banking apps. The technology recognizes customers' fingerprints and they don't need to remember a password to log in.RBS added that this move is part of the bank's reaction to a decline in customers using its branches and growth in those banking online and via mobile phone apps.

Indias’ largest private sector bank ICICI launched the ‘pocket’ in the last fortnight which is open to anyone, whether they are ICICI account holders or not. No documentation or branch visit is necessary and funds can be added from any bank account in the country.

‘Wintrust Financials’ uses technology from Fidelity National Information Services where the customer uses an app to preselect the amount of money to be withdrawn. Then, the customer visits an A.T.M., and — without inserting a plastic card — presses the “card less cash” button. A Quick Response code appears on the screen, which the customer scans using a smartphone, and the machine dispenses the bills.

Reaching the unbanked populace

The Indian Prime Minister in a bid to end “financial untouchability" for the unbanked populace launched an ambitious scheme which resulted in opening 115 million new bank accounts. Of those, 80 million have no money. The answer seems to be in ‘payments banks’ to  bring bank to the door step of those 80 million accounts with no money spread across 600,000 villages.

Payments banks in India  could cut the use of cash in an economy where nine out of 10 transactions are still paid in notes and coins and kick-start the use of low-cost payment forms like mobile money that have been used by only one in every 300 Indians. That compares with 76 percent of people in Kenya, Africa's mobile money pioneer, where Vodafone's M-Pesa affiliate dominates the market. India like Kenya is targeting its Mobile operators .Retailers and Other payments company have applied for license .The opportunity is seemingly so vast that it has attracted India’s retail major the ‘Future group’ too apart from pre paid wallet companies like PayTM .One should not miss out ‘Tech Mahindra’ which has plans too .So what does Tech Mahindra is known to do? It’s one of the top IT outsourcing companies in India. To top it up India’s’ largest corporate house – Reliance Industries has tied up with India’s’ largest bank of India -State bank of India who asset is close to USD 400 billion with 17000 branches.

 A bank with 17000 branches with deep penetration across the worlds’ seventh largest country certainly is strongly forecasting a trend .

Social Media Banking – Balancing challenges and opportunities is the way forward

The figures below would indeed be very tempting to not only make a case for social media banking but to jump to the conclusion that social media is the future of banking .Take the case of Facebook with over a billion monthly active users, YouTube is close behind with 800m unique visits per month and Twitter has been growing fast but is still at the level of only 200m active users of which 25% are from mobile devices. Over 60 % in the US one sees the opportunity and potential in Brazils’ 34%, Indonesia’s’ 25% and India’s’ 6%.To top that all social media use is skewed toward younger age groups in the US with 83% of 18-29 year olds are social media users. Further on the lucrative side the galloping increase in use of smart phones .Certainly Banks can ‘leverage social media as a channel to personalize customer interactions at relatively lower cost as compared to branch banking or call centers. Besides banks can enhance customer intelligence by combining it with social analytics to get deep insights into customer behaviors, sentiments, and needs in terms spotting trends, generating leads & tailoring products earlier  as 90% of customers trust recommendations posted on social media websites and 71% are more likely to make a purchase based upon social media referrals. Partly the statistics has been leveraged as some banks backed by social analytic tools have achieved reduction in marketing costs and achieved higher conversion of leads. The speed is indeed slow and the approach cautious.

DenizBank from Turkey has been one of the success stories using Facebook and stands out for being the first to adopt such. Geographically diverse banks have adopted the platform with an overwhelming focusing on sales and marketing and some allowing access to accounts and allowing payments. Probably the longest stride has been by India based ICICI Bank which provides meaningful banking functionality through Facebook. The Facebook app is hosted on secure ICICI servers, and requires the customer to enter a debit card number and password before it can be accessed without leaving Facebook. This January it followed with allowing money transfer on Twitter.

A ‘constraint’ approach has been adopted by banks  as surveys after survey reveals the heavy involvement of the communications departments in many banks as mostly social media has been used as a tool as a brand communication tool and for corporate social responsibility activities. Besides it has been useful as a customer engagement tool where Banks are finding that customers are very open on social media and are willing to be engaged by the bank in a way they might not in another context. Banks are also looking at how to make use of the power of social media for advocacy – using promoters to get positive messages out for example relating to new products or services, and how to influence this process in the appropriate way. It’s possibly that social media also brings greater risks – lower bargaining power and influence, and greater risk of brand damage. Customers are empowered to voice grievances widely, and have much greater transparency to features and price.

The Bank must comply with applicable laws and regulations as when it engages in these activities to engage client in lending, deposit services, or payment activities .As such they should remain aware of developments involving such laws and regulations. Failing which they are exposed to ‘Compliance and legal risk arise’ .This concern is particularly pertinent to an emerging medium like social media. Failure to adequately address these risks can expose an institution to enforcement actions and/or civil lawsuits in form of defamation or libel risk when there is broad distribution of information exchanges. Emerging areas of BSA/AML risk in the virtual world is an area of concern which the banks should be aware of .Things like virtual world Internet games and digital currencies present a higher risk for money laundering and terrorist financing.

Reputation risk may surface when consumer information is handled carelessly. The privacy disclosures are to be made as required under laws like Gramm-Leach-Bliley Act (GLBA) in the US .Every geography has its whole lot of regulations. Privacy laws being just one of the compliance requirements. It may not be enough if  the Bank  complies with applicable privacy laws in its social media activities and provision needs to be made for any unto toward reaction if any consumer information like someone in public posting confidential or sensitive information like  account numbers on the financial institution’s social media page or site.

Reputation risk can also emanate from negative publicity at times even when the bank has not violated any law. Such can happen through comments made by social media users, spoofs of institution communications, and activities in which fraudsters masquerade as the institution. As a hedge the Banks should consider the use of social media monitoring tools and techniques to identify heightened risk, and respond appropriately so that they address the threats in a timely manner.

The Bank can potentially risk its reputation given the public nature of social media as it addresses customer complaints and questions whether its timeliness or appropriate. The participatory nature of social media can expose a financial institution to reputation risks that may arise when users post critical or inaccurate statements. Social is vulnerable to account takeover and the distribution of malware as well. Employees’ communications via social media may be viewed by the public as reflecting the financial institution’s official policies or may otherwise reflect poorly on the financial institution, depending on the form and content of the communications. Employee communications can also subject the financial institution to compliance risk, operational risk, as well as reputation risk.

The Bank should regularly monitor the information it places on social media sites. This monitoring is the direct responsibility of the Bank, as part of a sound compliance management system, even when such functions may be delegated to third parties. However the Bank’s ability to control content on a site owned or administered by a third party and to change policies regarding information provided through the site may vary depending on the particular site and the contractual arrangement with the third party. The Bank should preferably do a cost benefit analysis of using a third party along with a due diligence as to the benefits of using a third party to conduct social media activities. Financial institutions’ incident response protocol regarding a security event, such as a data breach or account takeover, should include social media, as appropriate. Aspects like the irrelevance of a social media site have to be provisioned for.

The tempting statistics on one hand and a host of regulatory requirement iced by the fragility of ‘Reputation Risk ‘ is something that requires a rigid cost benefit analysis as Banks move forward as they move ahead in reorganizing their business in response to state-directed capitalism – regulation reshaping the industry and dictating business models, face demographic challenges – changing priorities and opportunities for growth & Social and behavioral change – rising customer expectations and the need to regain public trust. As of now it seems to be a job well done.

Why delay in ‘Volcker rule’ may not be unreasonable?

Why delay in ‘Volcker rule’ may not be unreasonable?

The   Federal Reserve delayed by two years compliance with the Volcker rule that bans them from betting with their own money through investments in risky hedge and private equity funds. However the delay did not affect the ban on proprietary trading, which Banks’ must stop by July 21, 2015.

Acting under the provisions contained in section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the Volcker Rule the Federal Reserve Board gave banking entities until July 21, 2016 to conform investments in and relationships with covered funds and foreign funds that were in place prior to December 31, 2013 ("legacy covered funds"). It also announced that it intends to act next year to grant an additional one year extension thereby giving a two year period until July 21, 2017.

Section 619 authorizes the Board to extend the conformance period for one year at a time, and not more than three additional years in total .As laid down in the act Section 619 of the Dodd-Frank Act provided banking entities a grace period until July 21, 2014 to conform to its requirements. The first extension given was given until July 21, 2015. The Banks’ had pressed hard for the concession, contending that they could suffer big losses if they had to sell the stakes and Fed’s argument that markets could be roiled if the Banks’ had to sell their fund investments by July 2015 is contested.

In a statement issued by Mr. Volcker in the aftermath of the delay reads “It is striking that the world’s leading investment bankers, noted for their cleverness and agility in advising clients on how to restructure companies and even industries however complicated, apparently can’t manage the orderly reorganization of their own activities in more than five years,” Mr. Volcker said, “Or, do I understand that lobbying is eternal, and by 2017 or beyond, the expectation can be fostered that the law itself can be changed?”

Banks’ do have substantial challenges and may probably find some respite in the space provided by the Fed ‘reprieve’ .Such may arise from challenges posed by the Dodd Frank Act, Basel III and others from the regulatory perspective besides a host of business challenges which impacts Banks’’ bottom-line and top line which is touched upon below

 Proprietary trading versus market-making and hedging

It is not possible at least simple to distinguish between the two without impairing one or the other. Market-making and hedging is nothing but principally buying and selling debt securities which resembles proprietary trading which Volcker rule seeks to prohibit. The activities involved in market-making and hedging is buying and selling debt securities which have the potential to be mistaken to be proprietary trading. Similarly JPMorgan Chase lost over $6 billion which the bank (“London Whale”) said was a hedge against possible losses on a large portfolio of EU securities. A contrast view was that the hedge was a fake, a cover for a proprietary trade that went awry. So hedges themselves can be subject to differing interpretations.

 Trading of securities versus investing in securities

There has never been any evidence that the proprietary trading of securities had anything to do with the financial crisis. Rather it was investing in securities .To be specific securities backed by subprime and other low quality mortgages. The subprime crisis was triggered by a large decline in home prices, leading to mortgage delinquencies and foreclosures and the devaluation of housing-related securities. Declines in residential investment preceded the recession and were followed by reductions in household spending and then business investment.

This is all in contrast to the popular perception that the financial crisis was triggered by trading in such toxic securities.

Trading securities versus lending

Lending is as riskier as trading securities. A bank commits cash to the control of the counter party for an extended period of time and the bank seldom has effective control over the way the borrower uses the funds .The possibility of loss being always inherent to it. Lenders can seldom recall a loan when they foresee problems for the borrower. The default of mortgages led to the decline of the MBS and the CDOs while trading securities, on the other hand is simply buying and selling. There is of course always the danger that a bank’s inventory of securities will decline in value, but at least the banking entity has control over it at all times and can sell it quickly if it foresees adverse events in the future.

Bank holding companies (BHCs) and the BHCs’ non-bank subsidiaries

There are strong “firewalls” between Banks’ and their BHCs and non-bank affiliates. This being in place so that so that these firms cannot use the bank or its insured deposits for their own purposes. In the garb of trying to defend insured deposits, it actually severely restricts the legitimate and valuable activities of non-bank affiliates of Banks’. These restrictions will be very harmful to the financial system and hence the U.S. economy.

 Undoing decades of innovations in Banking

Banks’/Bankers being natural and knowledgeable participants are naturally advantaged to understand the direction of markets, interest rates, and events that influence both. By prohibiting this activity, the Volcker rule may inadvertently push banking activities back into a past.

 Harder for companies to meet their cash

Virtually all large companies in an economy now fund themselves by issuing securities like bonds, notes, and commercial paper and restrict resorting to borrowing from Banks’. Companies have found that issuing debt securities is more efficient than borrowing from a bank.

The stock market is an example of a market where trading occurs and has a vast numbers of buyers and sellers as distinguished from a debt which is thinner though the debt market is much larger in dollar size. The major investors are mostly insurance companies and pension funds which buy debt securities to hold them to term and earn interest, not to trade them. In the event of a pension fund deciding that it wants to sell a debt security, it cannot readily find a buyer ready to bid as a participant in the stock market can do. The eventuality being taking a sharp cut in the value realized on the sale in case of a delay to find a buyer. This is where the Banks’ pitch in to alleviate such holders from their dilemma by acting as intermediaries as lubricate the market by buying bonds from sellers and selling them to buyers. Without them the “spread” between the bid and ask prices for the bond would be much wider, and that means it would cost firms more to buy a bond and they’d get a lower price when they sell it. If this becomes the regular pattern in the market for debt securities, it will be harder for companies to meet their cash needs by issuing these securities.

 Basel – III

Basel III not only redefines the qualitative and quantitative aspects of capital requirements but reduces leverage ratio through back stop leverage ratio, increases short term liquidity coverage and increases long term balance sheet funding. With the advent of LCR Banks’ will be required to hold substantial low yielding assets to meet the needs of short term liquidity. The raise in bench mark for both qualitative and quantitative aspect of capital may require Banks’ to raise capital. In 2009 10 out of 19 Banks’ failed the stress test and required a capitalization of approx USD 75 b. The introduction of LCR means that Banks’ need to invest on low yielding assets to meet their liquidity needs thereby compromising on profitability  .For meeting the needs of NSFR Banks’ need to find bulk corporate deposits worth maturity greater than a year  in a market with lesser appetite for term debt. This will increase cost of fund .To meet the needs of leverage ratio Banks’ may have to sell off low yielding qualifying assets thereby triggering the possibility of a downward spiral of prices.

The scope of change required for compliance to the Dodd-Frank Wall Street Reform and Consumer Protection Act, and its impact on market participants is enormous involving precise and massive co-ordination within the organization across businesses and functions, operations and IT

·         It is pertinent to identify opportunities so as to leveraging existing processes that can be reused and retooled

·         Planning for the changes required with a holistic view of all new, on-going (Commitment to FRBNY, consolidation of accounting rules by IASB/FASB) and parallel (Basel III,ECB/ESMA) regulatory changes, but prioritized and grouped by criticality and cost-effectiveness

·          Assessing the client value proposition emerging out from the shift of OTC derivatives to CCPs from a bilateral trading will be challenging. There will be enhanced cost on account of such switch.

·         The defining of a new Target Operating Model (TOM) and effecting changes to people, process and technology so as to meet the execution of a business strategy transformation road map of projects is needed. This is a challenging proposition.

·         So that the organization speaks the same language it is imperative to develop policies, processes, risks, controls and other key data elements so that they are common across.

·         It is indeed an enormous task for Banks’ to understand the impact accruing out of 243 pieces of rule making with around 60 Studies and 170 Reports itself. Leave side the need to develop policies, processes, risks, controls and other key data elements so that they are common across.

The Act has been heralded as the most significant in terms of scope and scale of change since the Glass Steagall act of 1932. It’s not only the Banks’’ but also their IT partners who have a huge task in front of them. Given the sheer magnitude and the complexities with rather conservative timelines it is important take a step back and look at the regulation in the context of international and other regulatory changes that are happening in parallel. It’s prudent to spend time in understanding the direct and indirect impact it could have on the technology landscape .The Banks’ always understood the challenge though their tone might have been seemingly ‘anti regulatory’ or ‘lobbyist’. The Fed has understood this and so have the law makers. At least the furore over the Feds announcement can also be reasonable.