Between them, Wall Street veterans Richard Berner and Gary Gensler share a few decades of experience in private banking, government, and now academia.
Armed with that perspective, the pair sat down recently to assess the current state of finance and speculate where the industry might be headed.
Berner, a Morgan Stanley alum and first director of the U.S. Office of Financial Research, and Gensler, formerly of Goldman Sachs and the Treasury Department under Barack Obama, see an industry in disruption, with technology and data integrating every level of financial services. The next decade’s dominant financial technology firms are incubating now, with both new and traditional companies competing to maximize the value of their data and create the most satisfying mobile customer experience.
Here are the developments the pair are watching most closely in finance.
Data as king — and cash cow
High tech has been monetizing data for years; now finance is getting in on the act.To be sure, the symbiosis of technology and finance is not new. “We used to have paper stock certificates, now we have cloud computing, the internet and mobile banking,” said Gensler, currently senior lecturer at the MIT Sloan School of Management. Voice recognition and the continued move to mobile will have a near-term impact on the industry, with advances in machine learning and artificial intelligence poised to “deeply change how we price insurance and underwrite risk,” he said.
A key element to all of this progress is how firms are harnessing data, said Berner, executive-in-residence at the Center for Global Economy and Business at the NYU Stern School of Business, citing former Federal Reserve chair Arthur Levitt’s adage that “information has always been the lifeblood of finance.”
Financial services firms are beginning to emulate the technology business model of giving away services for free while selling the data. As Berner said, “Google has always been in the data business. Finance has only now realized they are in the information services business.”
With enormous stores of data now cheap and accessible, the interesting question becomes how financial organizations optimize and monetize that data.
One example is fintech startup Robinhood, which lets its five million clients trade stocks and bonds for zero commission. The company makes money selling details about its order flow to market makers, explained Gensler. These third-party dealers aim to profit from the bid/ask spread of a security, buying at the bid price and selling at the ask price. In other words, they’re willing to pay Robinhood for the ability to have visibility into the other side of its clients’ trades.
The fate of brick-and-mortar banks
Gensler and Berner agreed that traditional branch banks may be in decline, but they won’t completely disappear anytime soon.
Thirty years ago there were 14,000 physical commercial bank branches in the U.S. Today there are 5,600, Berner said. “If you go to rural parts of the U.S., you still see single-branch banks. These exist because they have strong personal relationships with their customers.” But while they may serve as a physical destination for their customers, these banks often outsource most of the traditional and back-office functions of a bank.
Gensler believes commercial banks will persist because they do a couple of things well.
First, they offer a maturity transformation that customers want. Consumers like to save while still maintaining immediate access to their money. Companies prefer to borrow with a term of five years or longer. Banks are good at taking consumers’ short-term deposits and turning them into long-term commercial loans, Gensler said.
Second, banks prove the value of pooling risk assets when extending credit. Their ability to diversify idiosyncratic credit risk across a large number of borrowers lowers the cost of borrowing for all. For most small-scale companies looking for capital, banks are still the best option.
The next challenge for banks is the client interface. Two billion people have gained access to financial services through their mobile phones over the last 20 years, Berner said. There will be “a continued blurring between commercial banks and other financial intermediaries,” Berner predicted. In 10 years, “banks will likely still be part of the payments mechanism, but they may retreat into the background.” The front-end consumer experience, often provided by fintechs, will be much more diverse.
Regulation (or not) for fintechs
If, how, when, and by whom should nontraditional financial tech startups be regulated? Gensler opined, “it’s best to show some flexibility.” While activity of any significant size has to be contained within the current regulatory framework, he said, small operations should be put in “a regulatory sandbox” so as not to smother innovation before it has the chance to breathe.
As finance and technology merge more fully, systematic risk increases, Gensler and Berner agreed. While Berner is worried in particular about operational risk and cybersecurity, Gensler takes a more moderate stance, saying “We must preserve the freedom for firms to fail.” If the U.S. overregulates emerging fintechs in an attempt to protect consumers from all possible risks, it will likely stifle innovation. A more relaxed regulatory approach when startups are very small fosters creativity.
At the same time, Gensler acknowledged that systematic tech risk is a new form of risk to finance. Traditional banks have always had the risk that their computers or systems might go down or that they may be hacked. Today, however, a single incident on AWS, Amazon’s cloud computing platform, could potentially bring down hundreds of fintech companies reliant on its network of servers.
Unlike the consumer retail or travel markets, it took some time for tech disruption to hit the financial services industry. But it’s clearly here now. Berner and Gensler see evidence of this disruption across both fintech startups and traditional banks. The ultimate winners will be those finance companies that can integrate data and technology to provide the best possible consumer experience.