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06 July 2015

Digital Banking II: End Game of the Traditional Retail Banking

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The traditional retail banking business is dead. The question is how?

A traditional retail bank takes deposits from the retail clients and pays an interest. The banks lend out the money to take the credit risk. Meanwhile, the banks needs to provide the liquidity to the non-regular cash withdraws and take the liquidity risk. Occasionally, the central bank offers a hand to the banks to help them manage both of the risks, especially when there is a financial crisis happens.

How a digital bank can make a difference from a traditional retail bank? Let’s assume the “Prosper” (2nd largest p2p lending company in US) want to operate a retail banking business. First of all, check some dreadful numbers:

From Dec 2013 to Sep 2014, “Prosper” has executed 87,645 p2p loans with total notional 1.18 billions USD, range from rating AA to HR. The average estimated yield is 12.56% and loss rate is 5.68%. The total estimated return is 6.87%. In general speaking, if we “deposit” 100 USD into the whole assets listed in “Prosper”, you will receive 6.87 USD per year. It is a great yield. However, due to the limitations of the operations, the traditional retail banks cannot provide such services. The p2p lending can do this.

The Power of diversification and transparency

As a retail customer, you are not able to see the stories behind the deposit rate the bank offered to you. As a p2p lending “Bank” customer, you will be able to know exactly the whole portfolio, knowing every single cent goes and how it gains or loses. The p2p lending platform can grant you the completed transparent information. This is the power of the information sharing and huge data flows from the platform.

The traditional deposit yield is equal to: Bank’s fixed cost + interest rate financial markets + quality of bank’s investment process

Now the “deposit” yield of a p2p lending “Bank” is equal to:  quality of bank’s investment process.

The yield you got will be completely determined by how the digital bank operates and supply / demand of the natural credit market. The p2p lending “Bank” business model sets the “banks” free from taking the responsibility not necessary.

It is not just for the retail banking business

If some corporate start to raise their funds through the p2p “Bank” and also attract the institutional customers, then this would be a corporate p2p business. For those corporate operating traditional business, banks are still needed to cover them and provide professional services.

However, those doing business in Amazon or EBay, all their transactions and records are well maintained in the database. Therefore, these customers do not need too much attention to have the credit reports and are able to file themselves online.

In this case, the assets of “retail” and “corporate” clients will be listed for “retail” and “institutional” investors to access. Do those corporate / institutional clients deserve for a better price? Yes, but they are able to choose the prices on-line according to their qualifications. In the light of these services provided, the corporate / institutional customers have no difference with the retail customers.

If some of the corporate might want to just disclose themselves to some specific investors, they are able to do so on-line as all the information are already gathered and in place. Private placement, road show, price bidding and book building process, these services similar to investment banking services now are available to any corporate, institution and even retail clients.

The digital banking does not defeat the traditional banking services by new mobile phone apps, new online services or any faster smart phone. By the dropping of the cost for the information sharing and storage, everyone are now entitled to enjoy the benefits from the digital banking. It is the “sharing” to defeat the traditional banking business.

Yeung Yeung

Corporate and Investment Banking, BBVA Compass

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