• Thomas Pintelon, Co-founder at Capilever


• 24.09.2019 09:45 am
Banking

Banks are technology companies with a banking license ! This claim and similar claims can be read more and more in articles on trends in the financial services sector and is often used as an argument that banks will soon be replaced by Fintechs and Silicon Valley tech giants. It is certainly true that IT is crucial for a bank and its importance can hardly be underestimated, but risk management is equally important as a bank’s core business.

While the mastery of financial risk management should be used by incumbent banks as the main competitive advantage compared to FinTech companies (tech companies rarely master this expertise), banks seem to insufficiently play out this advantage. Both the management of internal bank risks and the support towards customers to manage their risks are underexploited. Dozens of articles have been published about the failure of internal bank risk management during the financial crisis and more recent crises, so we don’t want to get into this topic here. Instead in this blog we will focus on the lack of support towards bank customers in their risk management.

Too often certain banks have used the customer’s lack of financial knowledge and lack of proper risk and liquidity management, as a business opportunity to sell more products and more profitable products. While this may generate easy short-term profits, in the long-term this type of selling doesn’t really generate a deep customer relation, which gives a much higher risk of losing the customer to another bank (incumbent bank or neo-bank).

The main financial risks a customer can face are market risk, interest rate risk and liquidity risk. Ideally a bank should help its customers manage those risks in the best possible way. This means reducing the risk as much as possible, at the cheapest possible price in the most transparent way.

For market risk, this means assisting customers in diversifying their portfolios, recommending investments in line with the customer’s risk profile and investment horizon and with a low correlation to other assets already in the customer’s portfolio. Very few banks advise their customers properly on this. Robo-advisors can bring a solution, but also new products and services need to be considered, e.g. allow options also for retail customers, but limited to a hedging strategy, not for speculative purposes (e.g. covered call writing); allow customers to do risk simulations on their portfolio; provide individualized risk factors for instruments a customer wants to buy (e.g. correlation to current portfolio, value at risk (VaR)…); automatic creation of a stop-loss order when buying a new instrument (to sell automatically when loss becomes too large). These new services and products should be presented to the customer not in the typical financial vocabulary (options, VaR, stop-loss orders…), but by using words explaining what the bank can do for the customer to reduce their risk. And ultimately increasing the customer's financial literacy.

For interest rate risk, banks should provide more products in which customer can invest that are interest-rate linked or inflation-linked. For example very few banks provide term deposits with interest payments based on variable interest rates, most online banking tools don’t give simulations on returns or interest rates compensated for inflation, nor do they show in a user-friendly way how the current yield curve relates to different interest-bearing products with different maturities.

Finally, for liquidity risk, we believe the biggest opportunities exist for banks. Ideally customers would prefer to invest a maximum of their assets targeting their investment horizon, while keeping a minimum of assets liquid to pay common expenses. PFM tools can help customers predict this balance, but even the best PFMs are currently not giving very good views, due to the variable nature of expenses. Some banks gain a lot of money on this difficulty to manage liquidity, e.g. costs charged for missed direct debits, large interest rates for usage of overdrafts, credit card bills being automatically repaid by revolving credits, even if customer has enough assets on their account, etc. With banks having access to almost unlimited amounts of cash nearly for free, it is strange that customers need to avoid these extra costs, by either continuously managing their accounts or by keeping large reserves of cash on their current account. Democratizing asset-based-lending (i.e. lending against your investments) can provide the solution for this. By providing cheap, flexible and STP credits, using customer assets (which the customer can’t or doesn’t want to immediately liquidate) as collateral, the bank can automatically manage the liquidity for the customer. This way customers can invest a maximum of their assets in medium- to long-term investments, without having to bother to continuously manage their accounts for enough liquidity. Furthermore it allows customers to better plan expenses for the future, for example it helps avoid freeing up cash upfront for a large expense to be made in X months, it allows paying all invoices at due date (without having to worry if sufficient liquidity will be available at due date), etc.

Banks that can maximally reduce financial risks in a user-friendly, easy and cheap way can compete without any issue with any future tech player.