Yes, it is all about Brexit these days. Beyond doubt, it will shape international politics for the years to come. But silently, another revolution took place in the UK that did not get the attention it deserves.
The Bank of England announced that it will allow non-bank payment service providers access to the real-time gross settlement system. After centuries of exclusive access to central bank reserves, commercial banks will now share this access with the growing Fintech community. We are really excited about this regime change, and here is why:
Everyone who has worked in the IT department of a large commercial bank knows that banking infrastructure is in a terrible shape. It is highly inefficient, based on outdated technology, and very expensive. But until today, banks were the only ones with access to the real-time gross settlement system (RTGS), the central payment ledger of the British economy. Every electronic transaction – paying for dinner, buying a house, or selling stocks in the aftermath of Brexit – eventually has to go through RTGS. So no matter how poorly banks operated, everything, even payments operated by non-bank payment service providers, had to pass through their hands and generated revenues for them.
Breaking the Banking Cartel
Allowing access to non-bank payment service providers has the potential to break the banking cartel on payment services. Fintech companies will now be able to completely bypass the commercial banks. They wil do so with an infrastructure created from scratch. This will enable them to offer more convenient and efficient payment services at very low costs. They will also not operate an expensive branch network like banks do. It is difficult to conceive how the old banking dinosaurs will successfully compete against agile and lean technology companies on providing a utility like payment services.
Enabling fintech companies to completely bypass the banking system will create a second, potentially lethal problem, for commercial banks. Assume another financial crisis as the one in 2007-08 materializes. In the UK, Northern Rock suffered a genuine bank run when depositors arrived in droves at the Northern Rock branches to get their money back. Within just a couple of days, depositors withdrew two billion pounds. Northern Rock was unable to weather the storm, and the government nationalized it shortly thereafter.
Remember that the depositors of Northern Rock had to either walk to the branch and take out their money in cash, or wire it to another bank. Back then, trust in banking was evaporating, but it was not possible to transfer money out of the banking system quickly. If you really wanted to circumvent banking, you needed to hold cash, which was both costly and cumbersome.
Now imagine that non-bank payment-service-providers had already existed when the run on Northern Rock took place. Instead of physically going to the branch, withdrawing the money, and stuff it under the mattress, they could just have opened their smartphone app and transferred all their savings to one of these new non-bank payment service providers. It would have taken depositors less than a minute to bring their savings completely out of the danger zone.
Breaking the Banks?
The thing about bank runs is that you never want to be the last one running your bank. Banks have much less cash reserves than the amount of deposits they promised to pay out on demand. The first ones running their bank will always get their money back, while the last ones will not. By allowing non-bank payment service providers do directly access central bank reserves, everyone can run the banking system with their smartphone while sitting on the couch, without having to consider where to store the physical cash. So take some free advice: In the next financial crisis hitting the British islands, you better be quick…
The step taken by the Bank of England likely will, intentionally or unintentionally, alter the way another banking panic unfolds. It will give the people another option to the banking system than holding physical cash. Letting non-bank payment service providers handle their accounts that offer more convenience than deposits and more safety than physical cash. The political pressure to save banking one more time may then not be large enough to motivate another bailout. The way may be paved towards a modern financial system without banks being a protected species, and creative destruction could finally unfold its power.
Today, no one talks about this decision of the Bank of England. All eyes are focused on the Brexit referendum and its consequences. But this move could be the most important and promising shift in the regulatory framework of the British financial system of the past decades. We are excited to see how this one will play out.
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