It’s a very familiar story: at various times through the year, the big banks take turns in announcing another round of record-breaking profits. Last year the big four earned a combined $31 billion in profit. That’s $58,980 a minute. Unsurprisingly, the people that run these behemoth moneymakers do quite nicely for themselves as well. Australia’s highest paid banking CEO, Nicholas Moore, made a whopping $18.2 million last year. We can only hope that he at least shouted his mates a round.
Understandably, this annual event often causes its fair share of controversy. Are these companies and the people that run them too profitable? If private companies exist to make money, is there even such a thing as ‘too profitable’?
One of the surprising aspects of all this is that it seems to fly in the face of what we learnt in high school economics class. If super large profits are being made, then new companies should rush into the industry, igniting competition and forcing the existing players to drop their prices. After a while this should result in lower profits for the banks and lower prices for their customers. Although it’s not that simple.
The problem is that there are large barriers to entry in banking. You can’t just open a shop, stick a ‘bank’ sign on the door, and start doing business. Banks are really important to the economy so the government is incredibly strict about them. For a start, there are rules about who can even call themselves a bank. To legally put those four letters in your job description, you’re up for about $50 million in fees to get a banking licence. Even if you can get this non-trivial amount of money together, it’s going to be incredibly hard to get a loan when you explain that your business model involves taking on some of the most profitable financial institutions in the world. Besides, who’s going to lend you the money? The banks you intend to compete against?
But thankfully the regulator responsible for the financial system has recognised this and intends to take steps to inject some long overdue competition into the sector. Just like Uber with the taxi industry and Airbnb in the accommodation sector, disruptors have begun to eye off a slice of the action in banking. As the use of physical payment methods have declined, the need to maintain a network of bank branches has shrunk. Fewer branches mean lower overhead costs and the potential to undercut the competition. A wholly online bank without an expensive branch network to maintain could lure customers away from the big players by charging them lower interest rates on their loans and paying higher interest rates on their deposits. And so the neobank was born.
Neobanking emerged about five years ago, particularly in the UK with players such as Monzo and Atom Bank. Part of their message was building a bank with and for their customers, and part of this was the crowdfunding campaigns they ran alongside traditional fundraising, allowing their customers to contribute and own a small piece of the bank they were creating. In parallel, the regulators loosened the reins on becoming a bank by introducing the equivalent of L or P plates. This is now happening in Australia, with not only equity crowdfunding being introduced, but also legislation being put forward that reduces the restrictions on an organisation calling itself a 'bank', and the amount of money they need to have before they become an L or a P plater.
But what does any of this matter to you? Competition benefits consumers. If companies think that their position is unchallengeable and that nobody will compete to poach their customers, they’ll treat you accordingly.
Back in the day, the government used to regulate the airline industry to make ensure that only two carriers existed. Fares were high, service was poor, and the airlines made stellar profits. Competition has forced airlines to lower their prices and enabled a much greater range of options – those than want a premium service can pay for it and a trip to Japan can happen on a shoestring. Everybody wins, almost.
The same applies to banking. Neobanks, highly agile and with low cost overheads, can offer high interest rates for deposits and low rates for borrowers. At the same time, competition will also push players to improve their service.
Financial technology is improving the self-service nature of banking apps. You know that friend who manages to keep detailed records of all their spending and who is always on top of where it goes? Thanks to Artificial Intelligence we could all be that person without having to trawl through our statements or keep a box of receipts. AI can track your spending habits for you by recognising the businesses where you swipe your card. At the end of each fortnight, it can prepare a report showing where you spent money and how this compared to your last pay cycle.
The same technology also enables neobanks to action long and complicated processes much more quickly than their traditional competitors. Rather than have people fill out lengthy applications to apply for loans, AI can assess creditworthiness through your banking history. It can determine your income, assess your spending habits, and determine creditworthiness by learning about you via your bank records. This can cut waiting times and mean that loans can be approved in a matter of seconds via an app. Shorter wait times and automation also mean lower costs—in a truly competitive market this should also mean lower fees and interest rates.
“We’ve seen maybe 5% of what’s possible with technology, banking, money, and even how we make decisions. Technology will make banking less relevant, and decisions about how we spend our time and resources more relevant, in human terms, as well as in terms of the impact on our world and the universe,” Van Le, Director of Strategy and Innovation at Xinja, tells VICE.
She believes that the rise of neobanks will actually make us feel better about spending money. “Technologies will move us towards a world of abundance rather than a world of scarcity, where one dollar can create multiple positive outcomes. We may have algorithms that will tell us the impact of where we spend our money—including social impact—which can change our individual and collective decision-making around money and what it’s for. Add to that things like blockchain and the ability to transparently ‘follow’ the money and we could have a new world of accountability, as well as a new world of fulfilment in seeing our money making a positive difference.”
Competition is undoubtedly good. It drives efficiency, reduces costs, and improves service. For too long the banks have been able to hide behind a regulatory shield that has enabled them to act more like monopolists rather than competitive companies, but this is changing. If the government can update regulation to better reflect technological realities there could be big gains in it for everyday customers like us.
This article is supported by Xinja, who are building the first Australian 100 percent digital bank designed for mobile. You can join the waitlist here.