The world of payment technology may be a boring one for most people, but it’s difficult to avoid exposure to it. Whether paying for your morning coffee with contactless card, buying a new TV on eBay using PayPal or paying your rent through a mobile app payment systems are an ubiquitous part of modern life.
And they’re quietly undergoing a revolution.
In the old days almost all payment systems were managed through your bank. Whether by issuing a cheque or paying with your debit card, in effect every transaction you made was settled through a single institution that managed your current account.
Those days are already coming to an end. With the advent of prepay cards, online payment systems such as PayPal or Africa’s mobile payment system M-Pesa, gambling websites such as Betfair, or even Oyster cards people are holding money across multiple platforms. This is a question of ease (you don’t need to type in your credit or debit card details every time); security (all of your money is not in the same place); convenience (you don’t need to open a bank account or worry about going into a branch); and, of course, cost (you don’t pay transaction fees if you use a platform’s own payment system).
Why does this matter?
The business model of retail banks require them to be at the centre of the financial lives of their clients in order to make money. When you need an overdraft, they provide it at a price. When you need a loan, ditto. And when you want to send money abroad, well there’s a fee for that.
This is not just so that they intercept your every transaction with a fee, however. The value is also knowledge. A bank can see what you buy, whether you have a lot of savings and would be interested in investment opportunities, or are struggling with your finances and could use a loan.
And while every service has a price and that price can be protected as long as other companies aren’t willing to offer the same service for next to nothing these companies can flourish.
Then came the crisis. In its aftermath regulators are increasingly clamping down on banks selling additional services to their customers such as insurance products where they were making their highest margins. This reduces the potential value of customer information that the banks can collect — just as traditional margins from payments charges and loan spreads are being squeezed.
Unlike most of the banks, the new players in payments are breaking the gentleman’s agreement that has prevented a race to the bottom on fees.
They’re already working at scale. Alipay, the payment arm of Chinese e-commerce behemoth Alibaba, reportedly has over 300 million registered users and handles around 80 million transactions a day, according to the Wall Street Journal. These include everything from purchases on Alibaba, to paying household bills or restaurant bills.
Apple Pay, though far smaller in scale so far, no doubt has similar aspirations.
A tried, tested and failed model
Yet while these large companies have been able to offer basic payment services, there has been one area in which traditional banks retain their exorbitant privilege — money issuance.
When a bank issues a mortgage loan, for instance, it deposits that sum into the seller’s account and then must find funding either from its own savers or from other banks in the market to plug the gap the loan has left on its books. The interbank market, the channel by which banks lend to each other, means that even if the mortgage money is deposited with another institution a bank can theoretically borrow the same money back at minimal cost to cover the loan.
That is, the loan has in effect created a new liability — the deposit — and a debt asset that the buyer has to repay over a set period of time with interest. The only cost is the amount of interest the bank has to pay to either its depositors or other banks for the funds to balance its books.
The model has worked for generations, but it has also increasingly focused economic vulnerabilities onto the housing markets of developed economies, since property is the most commonly held asset for people to borrow against. This entails a huge risk that the fortunes of the financial sector becomes tied to the health of the housing market — a toxic connection that was made all-too-apparent in the financial crash of 2008.
As the Financial Times’ Izabella Kaminska points out, these flaws might well be an inherent part of the system:
What banks really do, after all, is control capital distribution. In that sense they get to dictate who gets to consume today’s available stuff and who doesn’t. If they do that job well, we all get richer, because capital flows to the sort of people who use stuff productively to make even more useful stuff for everyone in the long run.
If they do that job badly, we all get poorer because it turns out they they’ve provided the wrong sort of people with consumption rights — the sort who don’t just fail to add to the system but fail to replace what they’ve consumed, and now, oops, it turns the system is short of stuff to distribute.
The death of banking (as we know it)
So how might the new payment players overcome this problem? One possibility would be to create new money by issuing equity rather than debt.
At a corporate level we are already seeing this happen with companies issuing shares in order to part-fund their takeovers of rival firms.
There is also a precedent for this at a retail level, however. If you think about supermarket clubcard points, for example, customers effectively save in tokens created by the company that they trust can later be redeemed for goods. In most cases, supermarkets use these schemes to get rid of excess inventories that would otherwise go unsold. But there is no reason why, if they extended the system down the supply-chain to their suppliers that they couldn’t be used as “inside” money across the network.
These are, in effect, IOUs held against future purchases or future goods and services much like debt-linked currency is held against the borrower’s future income. Their value is derived from trust in the system between suppliers, the company and its customers.
Most interestingly, while debt contracts are enforced by law and bank deposits up to certain limits enjoy a state guarantee so that the risk of default is at least partially carried by the state these IOUs would be held exclusively against the company. Their value would depend on suppliers believing that there will be sufficient demand for their goods and services in the network and consumers having the confidence that the IOUs will retain value over the short to medium term so that they don’t have an incentive to immediately attempt to dump them.
In other words, the risk (and rewards) of equity-backed currency is held by the network. The stronger the network gets, the more valuable the IOUs become but if trust in the network is lost, then so too is the value of the IOUs. Since the value of companies like Apple, Alibaba, Amazon etc. is the network this could be seen as a way to enhance loyalty as well as more equitably distributing the resultant gains.
And now the hitch…
What is holding these tokens back from becoming more widely used alongside national currencies is that at present there are limits on their transferability. Whether it’s air miles, clubcard points, or loyalty cards at your local cafe businesses tend to be reluctant to allow people to pass on their IOUs or, where it’s allowed, have tried to take a cut of the transactions.
That’s a mistake. Lack of transferability acts as a limit to the value of equity-backed currencies. Think, for example, of a company that could only trade its stock among employees but never with the outside world.
However, with these businesses increasingly operating across national borders new payment systems could offer an answer to this problem. If people are willing to trade tokens between networks, or outside them altogether, then this newly created money can circulate much more freely and be accepted much more readily by those not directly within them.
One way in which you could manage this is by allowing the IOUs to be convertible into company shares at a fixed exchange rate (preferably somewhat lower than their value on the network so that $ /£/€1-worth of IOUs = less than $ /£/€1-worth of shares). This would allow them to be priced more easily and therefore traded, but disincline people from cashing out as soon as the share price rises.
With interest rates stuck around zero in large parts of the developed world and little prospect of a return to pre-crisis “normal” levels, margins look set to remain tight and it is perfectly possible that retail banking as we know it will slowly die. Whatever the answer to what fills the gap ultimately is, we need to start talking about it now.
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