The Fat Lady Ain't Singing To The Banks

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American Banker ran an article titled Time to Face the Music On Disintermediation in which the author stated:

“In spite of all the regulation that helps prop up legacy business models and protect established companies, much of banking is ripe for digital disintermediation-and it’s starting to happen already. Fundamentally, banks connect those with money to those who need it. By limiting access to the systems that handle the transactions, banks have been able to charge big fees. But the walls are breaking down now, just like they did in the music business.”

My take: The banking and music industries aren’t analogous.

In response to the article, @dmgerbino tweeted “I disagree. Banks/CUs are embracing change. The music industry tried to stop it.”

David’s right, but there are a number of other reasons why the viewpoints in the article are off-base, and why the music industry suffered what it did:

1. The product form changed… Although the music industry saw plenty of change in product form from 1950 to 2000 (from vinyl to cassettes to CDs), one thing was constant: The product was a physical product. It wasn’t until music became a predominantly virtual product that the industry began to suffer.

2. …which caused the cost of production to plunge…. In and of itself, the digitization of music doesn’t explain that industry’s woes. Another contributor is that, as a result of this digitization, the cost of producing the product dropped. Virtually any musician could produce a high-quality mp3 file.

3. …and caused the cost  of distribution the plummet… In addition to making it easy to produce the product, musicians could easily do an end-run around the traditional distribution channels and go direct to their fans.

4….which exacerbated intellectual property rights….The fly in the ointment — illegal file sharing — became more like a mothra in the ointment thanks to Napster and subsequently other sites. This created a need for new approaches and new firms with the capability of protecting and enforcing these rights.

5….and resulted in new business models. iTunes and other companies emerged to fill the need. Today, people subscribe to music online. And it’s even getting worse for traditional players in the industry. Recently, I watched Bob Weir’s band Ratdog broadcast a live concert from his new TRI Studios in Marin County. It was free, and attracted about 100,000 viewers. They could have easily charged $5 and with even just 20,000 views grossed $100,000. The variable costs of touring from city to city can be avoided.

Now let’s look at the banking industry:

1. The product form hasn’t changed. I find it interesting that the author of the article says that banks “fundamentally connect those with money to those who need it.” That’s one part of the business. But payments — think of this as the “transfer of funds” — make up a pretty big portion of what a bank does, no?  When you write a check, or use your debit card against your bank account, you are fundamentally triggering a transfer of funds from your account to someone else’s. It’s certainly true that access mechanisms — how we check our balances, transfer funds between our own accounts, etc. — has changed, and become more electronic.  But the underlying form of the product has been electronic for some time now.

2. The need for security drives up costs. As far as I know, no one has tried to steal the music off my hard drive (it’s mostly Grateful Dead music, which is widely available on the Internet, anyway). But protecting the funds in my account is a pretty big deal. And as most banks know, it requires a lot of investment to ensure that accounts are protected from fraudulent activity. So-called disintermediators to the banking industry often seriously underestimate the cost of doing this.

3. Risk management is a requirement. Security and fraud are one thing, risk management is another. When a bank makes a payment it often assumes the risk of non-payment (something Dick Durbin can’t seem to understand). Any potential newcomer can design a fancy front-end website to disintermediate the banks. But that doesn’t alleviate the need for risk management.

4. Regulations create barriers to entry. While the bank haters love to point to regulations as something that keeps the barriers to entry erected, most bankers know that there are scores of regulations that drive up costs and eat into profitability (FYI: I’ve estimated — with the help of Continuity Control — that the largest 100 banks in the US spend $1 billion on compliance each year). Potential disintermediators looking to get into the industry must adapt to the regulatory environment.


All of this is not to say that we won’t see new entrants into the industry. But what we’re not seeing — at least not right now — is the disintermediation of banks. New entrants are not creating radically new business models that are threatening the legacy players.

In fact, one of the author’s examples shows how banks’ role is strengthened, not disintermediated: Square. Today, many micro-merchants are forced to accept cash or checks from their customers because they haven’t been able to accept credit cards. By outfitting these merchants with card readers, more payments can actually flow through the banks that issue credit cards.

Another of the author’s examples — Simple — does create a new interface to banks, but doesn’t eliminate banks from the financial services equation.

Bottom line: There’s no doubt that the financial services will dramatically change in the next 10 years. But because of the complexity of moving money — including technological complexity, security concerns, risk management needs, and regulatory compliance — banks aren’t going to be disintermediated a la the music industry. The fat lady may be singing to the big music companies, but she ain’t singing to the banks. 

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