Part 1-Perspectives on Banking-The Past

In the following 8 posts I will provide some foundational insights that I believe are background to, and relevant in the likely future evolution of banking and finance, a future that I believe will include a melding together of the traditional fiat fractional banking marketplace of the past hundreds of years, (“trad-fi), with the evolving web 3/Blockchain/AI/IofT? world of cryptocurrencies and “De-fi” and related. I intend to make these posts a little humorous and almost entirely numbers, metrics and ratios free? !!,…(there are gazillions of analysts’ reports to read !), so this is more of a conversation, (well a monologue actually !). I do not think cryptocurrencies will replace the banking infrastructure that has been developed through trial and error, (boom and bust!) over centuries, but that the traditional system will evolve, taking the best of the blockchain digital currency world/functionality as we continue to build technology solutions and innovation in our financial products and services.

The Fiat, fractional banking model of Banking has been developed for hundreds of years, with its origins in the Medici’s of Florence and before. With apologies to Banking and Finance Historians, after barley, clay pots, shells and bits of metal, we tried pieces of paper (let’s call them Promissory Notes) which were issued, bought, sold, traded/discounted etc in “coffee houses” to represent present and future trade flows/deliveries of real world assets, (there were no “digital assets”, there was no “IP”), these pieces of paper enabled fungibility, divisibility, liquidity, portability, speed of execution, trade and trading, with the? (“yes, you got it !) trade winds” ultimately deciding the “value” of the pieces of paper. So, over decades we got better and better at this, shipping “technology” (i.e. advancements), wars (“winner takes all”, let’s call it “capital formation”!) and the learning curve on “how to do it” (risk assessment risk management), and “how not to do it” (learning from the greed/fear cycle, economic boom/busts, what we might today describe as “through the cycle management”), and all of this was instrumental in developing trading and financial frameworks that have fundamentally improved our societies and economies in transformative ways.? If Cosimo Medici and his mates in the Medici Bank of 1397 A.D. could see the interconnected, real time, banking, finance and international trade world of today, they would indeed turn in their graves, (or should I say mausoleums !).

Of course, there have been many spectacular failures in the history of Banks and Banking, It’s an interesting industry, Banks create money by lending to a customer, they (literally) balance the books by accepting (issuing) deposits (i.e. borrowing) from other customers. The neat trick is that they lend (let’s say) 10 times their net worth in “risk” loans to individuals and companies in the expectation (hope !) that the good folks who have deposited money with the Bank won’t all come along on the same day looking for their money back ! Of course I am simplifying things enormously, and Banks are managed with an internal score card of limits and restrictions on capital and liquidity that ensure (usually !) that the greed/fear, boom/bust of human nature is managed “through the cycle” in a sustainable way. And just to be sure, the Banks are regulated in a sophisticated and “close and continuous” way by the National Regulators who (rightly) impose various limits and restrictions on the day-to-day metrics of a Bank in order to keep the system safe. Yes, it still results in failures, recent examples (even after the lessons of the Global Financial Crisis (GFC) of 2008-12), include Silicon Valley Bank and Signature Bank in 2023. “How can this be ?” you ask, “surely they know what they are doing at this stage ?”. Well, “yes, they do know what they are doing, …in general!”, but there are a lot of banks out there in the world, and sometimes idiosyncratic issues (that’s a posh banking/regulator way of describing specific “mess ups” related to specific Banks and their Management’s (lack of) competence), results in a bank rescue or failure.

But the safety rails around Banks (aka the improved performance of Bank Management in managing cycles (significantly boosted by technology) and recognising banking is a long term game, mainly of perspiration, as opposed to inspiration), and the aforementioned regulation, ( Basel framework ensures minimum international standards of regulation and risk management in Banks) and other national regulations ensure we are continuing to evolve in a positive way. And that’s the key word, “evolution”, the “experience curve”, “trial and error”, the melding together of our societal and economic advancement, the interconnection between the two (finance and societal development) has brought us to where we are today.

So, Today, we have in general well managed and well regulated Banking institutions. There has been an enormous focus on purging the (greed) sins of the past with the building of better, more long term, inclusive, diverse cultures in Banks, (a huge subject in it’s own right, and subject to countless books, blogs and experts), and connected to that, better risk management and better qualified management. At the core of this is that Banking is a long term business, we lend money for (let’s say) 20 years, the bank expects to get the money back, (not normal in business, if I sell a pair of shoes, I’m hoping not to see them again !), a Bank’s balance sheet looks quite different to other industries, (think for example about the concept of “cash flow”), and I think it’s unfortunate that Banks are therefore compelled to “quarterly trading updates”, trying to hammer what should be a long term business (square peg !) into a short term update (round hole), the urgent keeps getting in the way of the important !. Anyway, I digress !, that’s for another day.

These well managed Banks were an asset to Society through Covid, (through the transmission of Government support and liquidity, as well as managing and supporting their customers well in general with the Bank’s capital and liquidity) and have weathered multiple official rate/base rate increases in major economies over the past two years as Monetary Authorities battled to bring down run away double digit inflation on the back of the Russian invasion of Ukraine and all it brought to the world in the context of fossil fuel trade flows, prices, and strategies, (just like in the time of the Medici’s !). For example UK Banks have absorbed 14 Base rate increases, an increase in the base rate (from 0.1% to 5.25%), and EU Banks 10 base rate increases (from 0% to 4.5%), frankly something I would have thought highly improbable three years ago and at the limits of the parameters of the stress simulations that we would have applied on an ongoing basis to Bank balance sheets in the normal course. There remains decades of work to do to ensure Banks are more and more fit for purpose, are of positive value to Society, are inclusive, and do not ignite another global economic and therefore social crisis. Banks are the arteries of the modern economic systems (which tend to be capitalistic in nature), they are intermediaries between sellers and buyers of money, money is the fundamental tool on how we engage in economic activity, and therefore Banks have a very special and indeed fundamental influence on “life as we know it”. I subscribe to the view that strong economies have strong banks and strong banking infrastructure, with the corollary also applying. Banks got a well deserved very bad name because of their devastating contribution to the? GFC, but they are on the way back, are trying to rebuild customer trust (multi decade quest), and, as mentioned, are building better cultures. They are also far more intrusively supervised, and all in all that’s a good thing, given the Banking position as the “artery of the economy”.

Banking and Technology. Something that is often overlooked is the historic evolution of banking with technology. Banking, has in general, kept up to speed with the evolving technological advances in our societies. Of course, this has been a requirement in terms of staying relevant and commercial/profitable. In recent history think payments, and convenient credit, the first credit card was introduced by bank of America in 1958, today there are around 2.9 billion credit cards in the world !, the average American citizen has 4 credit cards !.? This is a technological advancement as much as a financial one. Securitization, although having developed a very bad name in the years coming into and through the GFC, is a financial and technological advancement, Computer Science has changed the world and our capability around productivity reaching every sector and industry, but nowhere more than financial services where billions of customers and accounts are managed in near real time through relational databases. The internet, the Cloud, API’s and digitization in general, has created financial disruption, unicorns, web scaling (think of financial technology and delivery leap frogging in developing countries in areas such as e-money and payments) at a rapid pace over the past 20 years. So, Banking, often criticised for its technology deployment continues to modernise and utilise technological innovations. It’s a difficult area because we are dealing with a very complex “product” and customer journeys, significant legacy, and even more significant responsibility to customers (data, financial outcomes and the like).

There are some basic muti-decade banking trends that are well documented and continue to keep expensive consultancies in fine fettle. I will run through a few in my next post.

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