Comments for Innovation and regulation in the retail banking industry Dirk Auer 9 March 2016 Banks are complex institutions that operate in various markets. Though, historically, they started by taking deposits and changing currencies, they quickly branched into further activities such as lending, risk management activities, etc.  More recently, banks have played an important role in the dematerialization of money through their participation in payment systems and wallet services. Marianne and Carlotta’s paper…Read moreBanks are complex institutions that operate in various markets. Though, historically, they started by taking deposits and changing currencies, they quickly branched into further activities such as lending, risk management activities, etc.  More recently, banks have played an important role in the dematerialization of money through their participation in payment systems and wallet services. Marianne and Carlotta’s paper offers a rich overview of the barriers that might prevent the entry of innovative players in the various markets/sectors in which banks operate. In this comment, I would like to focus on Decentralized Public-Ledger Currency Platforms  , such as Bitcoin . Bitcoin is an internet-based ledger which tracks the exchange of virtual coins between users . Crucially, Bitcoin is decentralized and open-source (it can and has been forked). It is also a multi-sided platform which brings together two groups of users: general users who conclude transactions with the coins, and miners who provide the computing power necessary to record transactions and mine coins (in exchange for coins). Though it has sometimes been viewed as a currency, Bitcoin’s biggest potential seems to be as a payment system . In that regard, Bitcoin claims to offer a number of advantages. First, transactions are processed rapidly. Second, international transfers can be made at no extra cost, delay or difficulty. Third, transaction fees are much lower than those of traditional payment networks. Bitcoin also has its downsides. It does not have a system of interchange fees to subsidize cardholders (consumers often receive rewards for using payment cards; these include delayed payment when they use credit cards, various perks such as air miles, and various legal guarantees in cases of loss and/or fraud). As a result, consumers have few incentives to use the Bitcoin network rather than traditional card networks – even though Bictoin might be a cheaper network overall. There are other drawbacks. Most notably, Bitcoin has been accused of being a vector for criminal activity, of being vulnerable to fraud and theft, and of offering insufficient security to its users. Setting aside these pros and cons, it might interesting to question whether there are any barriers which might hinder Bitcoin’s uptake. In their paper, Marianne and Carlotta highlight three broad types of barriers to entry: regulatory, structural and strategic. I will focus on one structural barrier which could limit the uptake of Bitcoin: indirect network effects. Bitcoin faces a classic chicken-and-egg problem . Merchants’ demand for the platform will depend on the number of consumers and vice versa. Left to itself, Bitcoin is badly equipped to deal with this type of problem. It is a decentralized system whose lack of central authority might make it difficult to reach strategic decisions – say subsidizing merchants or consumers – in a timely fashion. As things stand, Bitcoin treats all users equally and does not have any acquiring activities (acquiring refers to payment networks’ efforts to attract merchants). A number of players have attempted to fill this void. The most notable example is Coinbase , a company which relies on the Bitcoin network to offer wallet services (similar to Paypal). Unlike the Bitcoin network, Coinbase is a more classic platform which has both acquiring and issuing activities (though, for the moment, it does not seem to subsidize either merchants or consumers ). It notably provides an API (i.e. an interface in layman’s terms) for online vendors. Coinbase notably secured a high-profile deal with Expedia . Despite this, its uptake has remained relatively weak. This might notably due to the fact that it does not offer any significant rewards to consumers. Instead, Coinbase’s strategy seems to be geared towards niche markets, including that of international payments where the speed and costs of the Bitcoin network give it a significant advantage. This might be a good way to gain an initial user base. However, if Coinbase wants to gain a critical mass of users, it will probably have to crack the chicken & egg problem which many multi-sided platforms face. As things stand, it does not seem to have found a viable strategy to do so.  See Xavier Freixas & JC Rochet, Microeconomics of Banking §2 (MIT press Cambridge, MA. 1997).  See David S Evans, Economic aspects of Bitcoin and other decentralized public-ledger currency platforms, UNIVERSITY OF CHICAGO COASE-SANDOR INSTITUTE FOR LAW & ECONOMICS RESEARCH PAPER (2014).  Bitcoin is the most high-profile Decentralized Public-Ledger Currency Platform.  See Satoshi Nakamoto, Bitcoin: A peer-to-peer electronic cash system (2008). As I understand it, each coin comprises a chain of digital signatures which guarantee its provenance.  See David Evans, supra. Evans argues that Bitcoin offers little promise as a currency because its value fluctuates rapidly, whereas successful currencies must offer stability if they are to be widely adopted. The Bitcoin community seems to recognize this. For example, one of the largest Bitcoin sites advertises Bitcoin as a payment network rather than a currency. See https://bitcoin.org/en/.  Bernard Caillaud & Bruno Jullien, Chicken & egg: Competition among intermediation service providers, RAND JOURNAL OF ECONOMICS (2003).  See https://www.coinbase.com/  See https://support.coinbase.com/customer/en/portal/articles/585625-what-is-coinbase-and-how-much-does-it-cost-to-use-  See http://www.expedia.com/Checkout/BitcoinTermsAndConditions Show less Reply Tiphaine Vanderstokt 7 March 2016 Even if the presence of non-banks in retail payment is not new, we have seen an increase in their presence recently. Non-banks have generally limited and specific functions, some can have larger role but the real change is the emergence of non-banks as end-to-end payment service providers (end-to-end providers have a direct relationship with customers, usually maintaining an account with…Read moreEven if the presence of non-banks in retail payment is not new, we have seen an increase in their presence recently. Non-banks have generally limited and specific functions, some can have larger role but the real change is the emergence of non-banks as end-to-end payment service providers (end-to-end providers have a direct relationship with customers, usually maintaining an account with them). Why are they more present? Some characteristics of the bank market influence whether incumbents and new entrants provide retail payment. On the supply-side, one factor is that non-banks want to take advantage of economies of scales or scope coming from the provision payment services. But on the demand-side, they find hard to find a critical mass of new end users to benefit from network effects. Non-banks that are driving by the possibility to benefit from economies of scales or scope or with an existing network will be inclined to enter the market. We can also point out that the main drivers for the increasing presence of non-banks are: – The outsourcing of back-end services by banks to non-banks: increased competition and new technology push the banks to outsource back-end services to non-banks and those may thus have a comparative advantage in this services. Non-banks will specialize in those services and take advantage of economies of scale. Banks will certainly continue to outsource services to non-banks as long as they are saving money with those practices. – Changing payment needs and innovations in payment consumption: new possibilities in payment as electronic payments, the possibility to use mobile phone and personal computing devices as transaction channels, and the rise of social networks support the emergence of non-banks on the market. According to a study by Infosys and Efma, a majority of banks believe that the impact of non-banks on innovation can be huge but 60% of them are not ready to work with non-banks. Those can thus enter the market where banks are lagging behind. – Regulatory environment: Regulation is not there yet in some countries and, some restricted the access of non-banks on the market but other push non-banks to integrate the retail market. In Europe, for example, there are only regulations about activities that involve the consumers’ funds but not the other activities along the payment chain. Impact of their presence? Non-banks can improve efficiency by increasing competition, providing new payments options or even improve them, or reach new consumers. They can also cooperate with banks because they have an expertise in services where banks lack and together, they can provide innovative services. The price will, thus according to me, lower but the quality of the services may change due to the degree of specialization of the non-banks. Let’s also note that non-banks increase the risk on the market because banks and non-banks will seek innovative services and this search can be risky for the business. http://www.bis.org/cpmi/publ/d118.pdf http://www.frbsf.org/banking/publications/asia-focus/2015/january/non-banks-and-retail-payments-innovations-in-china-and-the-united-states/ http://www.bankingtech.com/397852/non-bank-competitors-prompt-banks-to-invest-finds-survey/ Show less Reply Xoan-roi Gomez Marti 6 March 2016 To answer to the following question: what are the players’ incentives to innovate in the current regulatory context. I will base my pitch on a Spanish interview done by an IE Business School professor Enrique Dans (see link bellow) Non-bank payers (like Apple) are entering into the payment market without the willingness of providing (at the moment) the same services than…Read moreTo answer to the following question: what are the players’ incentives to innovate in the current regulatory context. I will base my pitch on a Spanish interview done by an IE Business School professor Enrique Dans (see link bellow) Non-bank payers (like Apple) are entering into the payment market without the willingness of providing (at the moment) the same services than a bank as the sector seems to be too regulated for them. Let’s take the example Apple and their mobile payments. It was launched few years ago in the US and is currently reach Europe starting by the countries where the penetration rate of Apple is higher. By providing a new way of payments Apple is entering in a market where banks and credit cards issuers still are the bigger players. But this irruption is done in order to avoid as many entering barriers as possible. Those barriers are been avoided by “lending” their technology to banks that do not have the technical capacities or willingness to develop their own new ways of mobile payment. Apple pay just takes a percentage of each transaction that is done by the consumer. This percentage is not payed by the consumer or by the shopkeeper but by the bank. Banks are ready to pay this fee as they seem to be capturing payments that were not done with their ways of payments, as small amount are mostly paid in cash. They do want to provide this technology to their clients, as it’s a question of competition between banks too. They all want to provide the possibility to their customers to pay by phone, watch, etc. As if they do not they could lose a part of their beloved clients. Nevertheless, Apple is not the only company that is entering in this new market. Samsung, Square… are showing the willingness to be present in this market too. The entering technique could be seen as similar to the one used by apple a few years ago in the music industry. Presenting themselves as a channel where at first companies could sell their tunes by the intermediary of their platforms. But at the end of the day, Apple having the opportunity to grab a bigger share of the market decides to jump over the records labels and sign with the artist directly. To summarize, introducing players as powerful as Apple or Samsung in the payment market could be a future possible threat by all the present actors. http://www.rtve.es/alacarta/videos/la-noche-en-24-horas/noche-24-horas-25-02-16/3501078/ From 1h30 to 1h46 Show less Reply Leave a Reply Cancel reply Your email address will not be published. Required fields are marked *Comment You may use simple HTML tags to add links or lists to your comment:<a href="url">link</a> <ul><li>list item 1</li><li>list item2</li></ul> <em>italic</em> <strong>bold</strong>Name * Email * Notify me by email when the comment gets approved.