Strong words from Finance 2.0 gurus at SXSW

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Permalink Reply by John Kemp on March 19, 2009 at 10:36pm

At last, what we've all been waiting for, an understandable explanation of derivative markets ...
Heidi is the proprietor of a bar in Detroit. In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).
Word gets around about Heidi's drink now pay later marketing strategy and as a result, increasing numbers of customers flood into Heidi's bar and soon she has the largest sale volume for any bar in Detroit. By providing her customers' freedom from immediate payment demands, Heidi gets no resistence when she substantially increases her prices for wine and beer, the most consumed beverages. Her sales volume increases massively.
A young and dynamic vice-president at the local bank recognizes these customer debts as valuable future assets and increases Heidi's borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral. At the bank's corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then traded on security markets worldwide. Niave investors don't really understand the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics.Nevertheless, their prices continuously climb, and the securities become the top-selling items for some of the nation's leading brokerage houses who collect enormous fees on their sales, pay extravagant bonuses to their sales force, and who in turn purchase exotic sports cars and multimillion dollar condominiums.
One day, although the bond prices are still climbing, a risk manager at the bank (subsequently fired due his negativity), decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar. Heidi demands payment from her alcoholic patrons, but being unemployed they they cannot pay back their drinking debts. Therefore, Heidi cannot fulfill her loan obligations and claims bankruptcy. DRINKBOND and ALKIBOND drop in price by 90 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %. The decreased bond asset value destroys the banks liquidity and prevents it from issuing new loans.
The suppliers of Heidi's bar, having granted her generous payment extentions and having invested in the securities are faced with writing off her debt and losing over 80% on her bonds. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 50 workers. The bank and brokerage houses are saved by the Government following dramatic round-the-clock negotiations by leaders from both political parties. The funds required for this bailout are obtained by a tax levied on employed middle-class non-drinkers.
Finally an explanation I understand ...

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Permalink Reply by Luke Owen on March 20, 2009 at 9:57am

John, great analogy. I think this deserves its own discussion.

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Permalink Reply by Gary Schurman on March 21, 2009 at 5:24pm

Are banks slow...Yes. Are the websites crap...Maybe. Are banks no fun.....This couldn't be more wrong! I was always part of the finance/treasury/M&A group and I always wondered what it would be like in the "real world" so I left to view the world from the other side of the fence. Let me tell you, that side of the world is extremely boring when compared to banking. In banks Treasury/finance runs the show. In the "real world" Treasury/finance is admin and therefore a necessary evil. Where but in banking to you get exposure to such cool things such as derivatives and higher level math? In my opinion a bank is equivalent to a hedge fund. You invest (go long) in risky assets, borrow a ton at near risk-free rates (short deposits), and you have a tiny sliver of capital there to cover risk. I'm sorry but considering the alternatives, banking is downright thrilling!

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Permalink Reply by Kelly Rusk on March 23, 2009 at 12:11pm

I was at this panel at SXSW and they way you've portrayed what was said was very much taken out of context. And the rest of the panelists were all saying the same thing

The point being made is when it comes to innovation, banks lag behind startups like MInt.com, SmartyPig, Billeo etc. because they are large organizations with lots of red tape. Because of this--young engineers and web developers do not want to work for banks because they do not have the option to innovate--it's often about following templates, lengthy approvals, basically going through all the red tape.

I don't think anyone can argue this is NOT an issue. The Internet is changing the way the world works, and large organizations (like banks) are not moving quickly enough to adapt. This will continue to cause problems and widen the gap between Gen Yers (who are generally already anti-bank because banks do not cater to their needs and preferences).

So YES banks should definitely be in this discussion, but instead of turning this into financial startups vs banks, it should be a learning exercise. How can we change this attitude that many--beyond just the startups--share.

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Permalink Reply by Luke Owen on March 23, 2009 at 12:27pm

Kelly, good to hear from someone who was there. Just for the record, the attached article was not written by me or the company I represent. I agree that banks can learn from the innovators at finance 2.0 companies. My posting of this article was an effort to keep the dialog going cause I do feel banks are dipping into this arena. An arena that recognizes the power of the consumer in this web 2.0 world we live in.

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Permalink Reply by Kelly Rusk on March 23, 2009 at 12:54pm

Sorry, I totally understood you didn't actually write it, but I still addressed my comment that way.

It's a little irritating because the original article "sensationalized" the comments which took away from the main point. But I agree the conversation needs to keep going. and banks need to be a part of it.

I'm currently authoring a short guide to social media for banks & brokers--and as I roll into the final stages I find myself trimming it back to target the smaller institutions like credit unions and community banks because I'm not optimistic it'll be useful for larger banks.

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Permalink Reply by dmgerbino on March 23, 2009 at 8:25pm

Let me be clear. I was not SXSW. I did not want to post here until someone did who was there. Thank you Kelly. Now I can disagree (a bit) to keep, as you say, "the conversation...going."

I have issue with the following quote from Kelly in regards to what was said at SXSW: "The point being made is when it comes to innovation, banks lag behind startups like MInt.com, SmartyPig, Billeo etc. because they are large organizations with lots of red tape. Because of this--young engineers and web developers do not want to work for banks because they do not have the option to innovate--it's often about following templates, lengthy approvals, basically going through all the red tape."

How many banks actually write their own web software applications. I think it is safe to assume that most do not. So where does innovation come from then when it comes to internet banking? The core providers and the Internet Banking module providers. Let's talk about Intuit.

Here are some basic facts (some from memory so I apologize in advance is a make a mistake with a date). Intuit, the most famous consumer and business financial software company, started in 1983 and 23 years later they signed an agreement to buy Digital Insight, an Internet Banking solutions provider to banks and credit unions, on November 30, 2006. The press release mentioned, "With the acquisition, Intuit will be able to combine work flows in its financial
management tools with online banking capability offered by Digital Insight to create
new, easier, and better-value offerings for consumers and small businesses." Then on March 13, 2007 they released a press release that led with the following: "Intuit is Changing the Face of Online Banking, Recent Acquisition of Digital Insight Already Producing Next-Generation Solutions -- MOUNTAIN VIEW, Calif. – March 13, 2007 – Digital Insight®, an Intuit
company, today announced the upcoming release of Personal FinanceWorks and Small
Business FinanceWorks, two products expected to lead the next generation of online
banking. The product announcement comes just five weeks after Intuit Inc. (Nasdaq:
INTU) completed the acquisition of Digital Insight.

To me, that is innovation coming from the bank software infrastructure. The vision has been set and while everybody was saying how great Wesebe, Mint, Geezeo and others are in this space, Intuit was there again. And, they have a Small Business version too. Where is that innovation from the Web 2.0 financial software startups.

So, it really is about banks vs financial startups. The financial startups are selling us that the "banks" are not innovating. I disagree. CheckFree, a competitior to Digital Insight, was purchased by Fiserv and they have a PFM solution. For Community Banks, the innovation comes from their core tool providers, for big banks, they need to develop their own software. PNC Bank's Virtual Wallet is the perfect example of bank innovation. There is even Bank of America's My Portfolio and their Online Business Suite.

Over the last couple of years I have been tracking these developments in the banking industry and it has been exciting to watch. For me, the bottom line is the core provider and ancillary companies, big banks, and financial startups all started this latest round of innovation around the same time.

Just my 2 cents to keep the debate moving along.

@dmgerbino

Resources:

Intuit's Digital Insight

Fiserv's Check Free

PNC Bank Virtual Wallet

Bank of America

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Permalink Reply by Kelly Rusk on March 24, 2009 at 5:27pm

I see your point about banks innovating--they definitely are *within* the industry, but compared to other industries they are generally miles behind. (For the most part, there's good reason, for example--data security issues). And when you're talking about big banks vs. small startups, it's definitely easier to solve these challenges.

Also worth clarifying, Patzer said in the Raw Story comments (and in the panel) that he did not say *all* banks are evil, but rather the big guys. They gave lots of love to community banks and credit unions.

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Permalink Reply by dmgerbino on March 24, 2009 at 6:48pm

The security and regulatory issues stifle one kind of innovation and foster another. Either way, Patzer's comments made for some good discussion here. I just wish there was more.

@dmgerbino

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Permalink Reply by Matthew Wright on April 13, 2010 at 8:56pm

My 10 cents...
Lots of banks ARE delivering new online banking functions to enhance existing ones, new security capabilities, new marketing methods etc.
Think how big banks actually are, and how much technology is involved in running them. Then think of industries of comparable size - and ask yourself how much consumer-focused 'innovation' these guys release to their markets on a daily basis.

The lens that mint.com etc are looking through when they make statements like this are very narrow - they're commenting only on the thin, online presentation layer world that they operate in. And they know this, because they also know that it's the only thing that consumers care about... until something breaks - which is very unlikely due to the huge amount of work that banks have done to ensure we have a reliable, secure payments platform to operate on.

Retail banking plays in the consumer space, so we absolutely need to get better at the presentation layer for fear of being relegated to commoditised infrastructure - but we shouldn't throw out our most valuable assets - trust, reliability, consistency, control of the payments platform - just to play in an 'online bleeding edge' environment we're not equipped to win.

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