February 16, 2009

The 20th Century of Central Banking is over.

If there was a post-of-the-month award, this would be it. Over on Digital Money, David Birch reports on how the banking world is waking up to the changing map:

... was [the panel's] position that technology is no longer an issue and that (first) regulation and (second) business model are the key challenges.

You've have to read the lot to get the context. Now, Dave knows all this stuff, but he reports from the center. So unfortunate truths are only allowed to be written about by fringe observers like myself, we have to wait a decade or so before the light from the writing on the wall reaches into the dull committee rooms of the central bankers.

So it transpires that the decade of unfortunate message is now drawing to a close. Bad news is piling up, a bit like a crisis of financial truths. Firstly, the above point that technology of banking is cheap and easily replaceable, if not exactly fungible. And, now the second point: Payments and banking are decidedly different beasts, and can and will be separated from each other:

Incidentally, since Robert was on the panel, I couldn't help but mention John Reed's famous statement that "one day, banking will be a line of code in a big network" when I asked a long and boring question about what is meant by "banking" and what the goal of banking about banks might be (if not something concrete like reducing the total social cost of payments). I was trying to ask whether the narrow banking meme might grow to divide the banking business even further: a kind of narrower banking that doesn't include payments, which would then be regulated separately.

(my emphasis throughout.) Which of course raises the problem for banks of lack of easy access to cheap and easy deposits. Which kind of rips the guts out of the banks' business model. Which likely causes them intense pain. Which was predicted. But predictions aren't food on the table. Now, Dave brings forth the evidence that this is precisely what has happened:

Here you have a scheme that has gone from nothing to five million users and a hundred million euros per month in interpersonal transfer in 18 months. What a fantastic success. Now, faced with this clever use of new technology to deliver a much-needed financial service in an economic and compelling manner, the local banks went to market with more innovative solutions. I'm joking, of course. What they actually did was what too many banks do when faced with a small and nimble competitor, which is to go whining to the regulator to get the competitor banned.
In the marketplace, bankers accuse M-PESA of encroaching into their turf, arguing that its exemption from Central Bank of Kenya's (CBK) stringent and costly regulations has enabled the mobile phone operator to offer "banking" services on the cheap. [From Business Daily Africa - the international window into East African business opportunities - M-Pesa success stirs banks' fury as five million subscribers enrol]

The banks have a choice. Either go to the regulator, and whine, or re-invent their business model. The first one might work, short term (read the blog to find out what happened), but unfortunately the cat is now out of the bag.

Payments as a separate business works and works well. Indeed, separated payments work stunningly better than payments as a captured subsidy for banks, but the cost of subsidies was well understood to be acceptable, at least by those who believed in banking as an industrial model. However, consumers have a different view, they have always demanded free and untied payments when available, and won't trade two bits for the concept of banking. So this new view will eventually sweep the world.

Long term, banks must now prepare for a new business model, sans payments. Now, I'd love to help them do that but cannot. Firstly, CHYP always get the fun jobs, and secondly, we still have the problem that they will make more money if they stick their head in the sand and deny it. This is a time-honoured process, and it was the one that led up to the financial crisis. It's even got a formal name: "cash cow." So the problem comes down to whether there is a bank that wishes to act strategically rather than tactically, and the betting is that they won't be looking that far ahead.

But the end result is now clear:

M-PESA has forced a realignment in the market pricing of money transfer services.
Following an aggressive expansion of M-PESA, commercial banks have been forced to eliminate charges on their customers when sending cash. [From The Standard | Online Edition :: Regulator gives M-Pesa a clean bill of health]

We must also throw a nod towards the regulators' position here. In the past, the European Central Bank(s) banked on banks and not people; they kept in place the restrictions of the E-money directive by basically (but deceptively) saying that "payments is banking." Now however the lesson of missed opportunity is clearer (again, predictions weren't food on their table). Europeans use PayPal on ebay, WebMoney continues to do well, there are others. If one cellular operator succeeds why can't others? If we can send an SMS globally, why can't we all join M-SEPA in Kenya? Dave says:

This is why the European Commission is hoping that the new regulated categories of Electronic Money Institution (ELMI) and Payment Institution (PI) will allow even banks to set up highly competitive low-cost payment services.

There are two barriers here, and they both need addressing. Firstly, the iron grip of the regulators over banks is over. Not because they don't still have that possibility, but because they've been revealed as captured by the banks (financial crisis) and the business is changing such that the model of central banking is no longer usefully relevant. The 20th century was the time when the central banks truly ruled all they surveyed, but we see little with eyes that are 100 years old.

The second barrier, this time brought clear by Dave in a way I failed to do is that of the failure of the Anti Money Laundering project. As well as failing to do any damage to ML, it is now clear that the sum result of the project was to raise costs, and as a consequence to alienate the poor. M-SEPA apparently capitalised on this stupidity, in the same way that PayPal, e-gold, WebMoney and other electronic systems did, and has now seized the marketplace in its country.

The AML project breached the laws of economics. Possibly this is best encompassed by Goodhart's law, which says that if you put a control here, the money will flow over there. So don't put the control in, the people will simply bypass it. There is a useful corollary to this law: the money belongs to the people, not to the bureaucrat. It helps to consider this carefully when thinking of putting in controls.

On the other hand, it is easy to see how to give the AML people what they can usefully use, without hurting the poor. Again, Dave nails it:

One phrase that caught my ear, in a very positive way, was "risk-based approach to know-your-customer". In other words, I think, it's time to begin to resolve the implicit tension between financial exclusion and financial inclusion agenda in a common sense way. It's one thing to recognise the legitimate law enforcement and regulatory requirements for identification and authenticaton and another to insist that these requirements are met in the tightest possible way in all circumstances. The truth is that bringing people inside the tent, given the data exhaust from electronic payments, delivers far greater overall benefits to society than trying to keep people out of the tent. In other words, stringent rules about terrorist financing and so forth mean that the poorest people stay excluded because it becomes complicated and expensive to deliver services to them. I think that we should start looking at a global exclusion for pre-paid accounts below a certain level (say 500 euros) in return for increased monitoring to patterns, transfer and behaviour.

It is massively important to follow this path, but who will understand it? Even though Dave considers it now reasonable to challenge the ivory tower of the FATF, the problem is, nobody in the AML world is going to stand up and say "we were wrong. Now what do we do?" It is far too easy to accuse detractors of supporting money laundering (!) and continue to draw salary than to learn real economics and add value to society.

I think on this point Dave is economically correct and will be eventually be totally exonerated, but this time he has gone too far, and will have to explain himself to the secret committee for economic purity. Nobody challenges the fat cats in Paris without being labelled a sympathiser of jihadists, an eater of babies, and a downright nasty chap. Meanwhile, the poor are going to have to wait at least another decade before the anti-money laundering disaster is fixed, and are invited into the world of secure payments run by deftly-regulated institutions.

Not to mention, it just isn't their decade, as the rich are a bit busy right now.

Posted by iang at February 16, 2009 06:42 AM | TrackBack

In the mid and late 90s ... there was some expectation that telcos would take over the payment industry.

The scenario was that they had highly efficient technology developed for call record processing. They were supposedly going to leverage this high performance technology to take-over the micropayment arena and then leverage those volumes to take-over the rest of the payment business.

Some number of telcos made forays into this arena ... basically payment charges showing up as line-items in phone bill. It then seemed to fall apart and the telcos participation seem to disappear.

Afterwards the explanation was that telcos hadn't the infrastructure to handle the financial risk (and defaults). Telcos had a fairly high default rate on bills ... but were able to absorb a lot of it ... since it was for services ... but didn't actually represent "real money". The (defaulted) payments actually represented money that telcos provided to merchants.

Its been a decade and some number of proposed cellphone payment activities seemed to have lost that institutional experience (this is analogous to lost institutional memory about difficulty in supporting PC serial port devices ... between the time home banking moved from dedicated dialup to the internet ... and the attempt to introduce PC serial port smartcard readers in the consumer market).

In last couple yrs ... there have been announcements by some of the payment processing infrastructures about installing some of the higher-efficient database technologies (that had evolved for telco call-records). This presumably should help further drive down processing overhead costs and possibly help enable new generation move into micropayments.

In parallel with this is the significant fees that are part of the current infrastructure. A couple yrs ago there was an article that the payment transaction fees represented nearly 40% of the bottom line for US institutions (although less than 10% of the bottom line for EU institutions). For some operations like C-stores ... payment transaction fees are claimed to be their largest expense. The existing fee structure is motivation behind some amount of search for alternatives.

Posted by: Lynn Wheeler at February 16, 2009 12:49 PM

One thing that isn't clear to me is ... where does all of this leave fiat currency?

Posted by: gyg3s at February 17, 2009 12:07 PM


Central Banks have many roles, but in banking, they only have one economically strong role, that of the "lender of last resort." In the above, I am referring to the Central Bank in that role (because banks got out of banking, we no longer need the "lender of last resort" or at least we can't justify it any more using any modern economic theory).

Fiat currency is a different role, of course, and fiat currency can be issued by any agency. That said, the fiat currencies we have now are in for a big bunch of over-issuance and inflation. Also, as other get more into the future, there will be more competition from other issues. However this effect is practically immeasurable; for various reasons, government-issued fiat currency will remain the dominant force for the next century.

Posted by: Iang at February 17, 2009 03:04 PM

From Tom's post:

This story suggests the enormous possibilities inherent in the new mobile phone technologies and networks. - t.h.g.

How mobile phone banking is empowering the poor

13 Feb 2009 15:11:00 GMT

Written by: Natasha Elkington

Six years ago on a whim, I was lucky enough to buy a farm with two friends in my native Kenya. The farm borders the Shimba Hills National Reserve, high above the coastal plain. It's an enchanting other world, but also very remote. As I live in Britain at the moment we've hired a caretaker, Samuel, to protect the land from squatters and wild game that occasionally breaks through the fence looking for food.

The problem is how to pay Samuel when the nearest bank is 50 km (30 miles) away in Mombasa. The answer - as improbable as it sounds - is by mobile phone. Two years ago, a new phenomenon hit Kenya that allows money to be transferred between people using text messaging called M-PESA (pesa means money in Swahili).

This system, known as "branchless banking", lets people set up remote bank accounts that are accessed through their mobile phone or other technology.

It's a financial revolution that has taken Kenya by storm and will probably do the same across the rest of the continent by giving Africa's poor access to financial services for the first time. Africa has seen phenomenal growth in mobile phone subscribers - with 278 million users by the end of 2007, according to Britain's Department for International Development (DFID).


Posted by: Thomas Greco's blog: "How mobile phone banking is empowering the poor" at February 23, 2009 04:19 PM

Just in,


Hawala system legal in England and Wales. Hope this is of interest.

Posted by: gyg3s at February 26, 2009 02:46 PM

"I think on this point Dave is economically correct and will be eventually be totally exonerated, but this time he has gone too far, and will have to explain himself to the secret committee for economic purity. Nobody challenges the fat cats in Paris"

Given this paragraph, I couldn't resist pointing that I have been invited to an meeting at the OECD in April!!

You are much too kind in your comments Ian, but thanks.

Posted by: Dave Birch at March 6, 2009 01:53 PM
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