Patricia Meredith and James L. Darroch are the authors of Stumbling Giants: Transforming Canada’s Banks for the Information Age, the winner of the 2017/18 Donner Prize.
Most businesses fail to respond to the challenge of disruptive technology. But disruptive technologies, including mobile devices, cloud computing, artificial intelligence, blockchain and social networking, are transforming financial services.
So it is perhaps not surprising that, far from embracing creative destruction, the protected oligopoly of Canadian banks and their counterparts in many other parts of the world have chosen to lobby in favour of the status quo. The response of global financial regulators, in the form of Basel II and III, has reinforced the old business model, making it more difficult for banks to adapt. Unfortunately, as we describe in our book, Stumbling Giants: Transforming Canada’s Banks for the Information Age, the forces of change are far more powerful than the bankers and regulators are.
As Bill Gates said more than 20 years ago: “We will always need banking, we won’t always need banks.” The functions of banking – lending, investing and paying – are necessary in the information age. But how these functions are performed looks very different. Financial-technology companies (fintechs) – such as Amazon, PayPal, Alibaba, Apple, Google and myriad small players including robo-advisers, lenders and payments providers – are using technology to create new and better financial services for both consumers and businesses. They operate in all parts of financial management, whether that is tracking overall spending, applying for a loan or optimizing investment strategies. These technology companies compete directly with traditional banks and, in many respects, have taken them by surprise.
Ant Financial Services (part of the Alibaba Group) uses information from its payment-processing platform to develop cash flow forecasts and assess the riskiness of micro, small and medium-sized businesses. It tracks performance in real time and increases credit lines if the business is increasing faster than expected and accelerates collections if it is not. Ant’s loan losses are significantly lower than those of traditional banks. It’s “Just Spend” securitized consumer loan product helps consumers take that vacation they have been dreaming about. Amazon One Click let’s me buy that item I have been eyeing up online without having to perform a payment transaction. PayPal for Business offers web payments, online invoicing and other services to help me run my online business better.
To support the growth of fintech companies in Canada, the federal government must encourage innovation and increase competition. As Payments Canada rolls out our new real-time payments system, the government should accept the Competition Bureau’s recommendation and enact legislation to open access to qualified non-bank participants. It must implement legislation similar to laws already in place in Britain, the European Union and Australia, making it clear who owns the data stored in warehouses (the customer) and who has access to it (all competitors with the owners’ permission). This would make information – the raw materials for modern financial services – available to all competitors.
To support the growth of micro, small and medium-sized enterprises (SMEs) the government should consider giving the Business Development Bank of Canada the mandate to develop securitized lending. Using artificial intelligence and sophisticated risk-pricing algorithms to adjudicate loans based on real-time transaction data and future cash flow forecasting has proven much more reliable than traditional bank lending, based on historical returns and secured assets.
In the early 2000s, Canadian Mortgage and Housing Corp. led the development of the residential mortgage-backed securities and mortgage-backed bond markets. The Canadian approach to securitization not only made home ownership more affordable, it also helped Canada’s banks to withstand the affect of the global financial crisis. Securitized lending gave new entrants access to funding on similar terms to incumbents and opened the door for significant (more than 40) new competitors to enter the residential mortgage arena. Consumers benefited from lower prices, easier access and more choice. This type of innovation is necessary to expand Canada’s economy in the information age. There is another benefit to securitizing SME loans: They could become an exciting new investment category for individual savings that offer both higher risk and higher returns.
Innovation in financial services is urgent. Canada is falling further and further behind. Countries such as China, India and the United States are moving rapidly to establish e-commerce platforms with integrated financial technology companies. Fintechs are key drivers of the financial ecosystem of the future. Instead of wasting time revising the Bank Act to preserve the status quo, our policy makers should focus on legislation to ensure access to infrastructure and data for innovative new entrants and access to financing for the SMEs that represent Canada’s entry into the 21st century information economy.