Davos 2016 – The Transformation of Finance


Hello everybody,
and good afternoon, and welcome to the session
called “The Transformation of Finance.” It promises to be a very
interesting discussion. In fact, so interesting
that there’s almost a riot outside the
door right now of people queueing up to listen to
the bankers, which is great. Great start. But we are indeed at a very,
very interesting moment in finance. I’ve been coming to
Davos since 2007, and I think there have
been three phases in terms of the Davos debate
about finance. Back in 2007, the
first time I came, bankers were on
top of the world. Everyone was in love
with credit derivatives, financial innovation
was celebrated, bankers threw great parties
and held their heads high, and it was certainly a time
when finance was booming. Then, of course,
we had the crash, and for the past few years,
most of the panels at Davos have been dominated by endless
discussions about regulation, what went wrong, essentially
bankers saying sorry or not saying sorry, and lots
of discussion about what could be done in the future
to make things safer. A very backward looking,
very inward looking debate. What’s interesting about
this year’s agenda in Davos, if you haven’t pawed
through the program yet is that there is barely
a discussion about regulation at all. Thankfully, we
don’t have to worry about those wretched
acronyms anymore. Instead, it’s a much more
forward looking discussion about FinTech, about
the big changes that are sweeping through finance,
and potentially transforming finance in ways that are
both positive and negative. Now, as someone
who’s a journalist and paid to be
cynical, my day job is I oversee the Financial
Times in North America. There’s part of me that
thinks, well, maybe this is just a new way
to distract people from some of the underlying
problems that still haven’t been solved in the
core of banking. Certainly, if you
talk to bankers, their entries are still
bulging with regulatory issues. Or you can say actually
this is the real story and while we’ve all been
worrying about the backward looking crisis in
the last two years, we’ve been fighting
the last war. In fact, the biggest
challenge to incumbent bankers today is not the
crisis and regulation, but the new players. Or you could say
actually this is going to be what revitalizes
banking and allows the bankers to suddenly
become beloved by everybody and maybe, just maybe,
makes the bankers suddenly very fond of the regulators,
because guess what? Maybe they’re going
to protect them from the new disruptive forces. Lots of changes, lots of very
interesting issues, and we have a terrific panel
here to discuss it. We have three
incumbent financial, two incumbent bankers,
one incumbent insurance sector representative. At the very end, known to most
of who is Tom de Swaan who runs Zurich Insurance Group. We have in the middle,
you can see, John Cryan from Deutsche Bank, co-CEO. And next to me on my
immediate left, you’re right, is James Gorman
from Morgan Stanley. But we also have an
incumbent or a semi-incumbent who may– sorry,
disruptor– not incumbent. A disruptor, semi-disruptor. I’m glad you didn’t flounce at
the panel in a fit of– Yes, well, compared to some
of the real start-ups, they may think of you
as an incumbent now. Anyway, a disruptor, Dan
Schulman from Paypal. And of course, we
have Christine Lagarde who runs the IMF, who takes an
overview of what’s going on. So I’d like to start with a
quick overview from Madame Lagarde. The IMF has spent a lot of
time in the last few years looking at the financial crisis
and what’s wrong with banking. But today, you have something
slightly different to unveil, don’t you? Because the IMF has taken
a slightly different role, a slightly different direction
in terms of looking at finance. Can you tell us a bit about
that and tell us briefly where you see finance going
in the next few years? Thank you, Gillian,
for setting the agenda and a tough question. First of all, I think your
point about regulations is well taken it, yet the entire
regulatory environment is not completely settled yet,
and there is still work to be done in various areas. I think the
cross-border resolution is one of them, which has not
yet been completely settled. And I think there are issues
to be resolved between the US and Europe in terms of
over-the-counter derivatives and clearing systems which
are not really exchanging information on this
stage at the level and at the speed
where they should. So in those two areas,
at least, more regulation is still to be defined
and agreed upon. Two points. There are new ways of doing the
regular traditional business and for those of
us who have kids or young adults
in the family you know that they
don’t go to a bank. Probably many of
them have not stepped into the branch of
any particular bank, yet they do banking. But they do it in a different
way, using different channels, using different
modus operandi, which has nothing to do with
interfacing with a person or with an account
manager, and that’s for the retail basic banking,
which is certainly disrupting the business of many
traditional institutions, including some
possibly in the room. There’s is a the
second point that I wanted to make which
is one where we have done a little bit of homework. And I’m saying on purpose
a little bit of homework because it’s the
beginning of process. And that touches on virtual
currencies and the ways in which block chains
technology ledgers can actually disrupt the business in a much
deeper way and another way of doing the same business. And frankly, I’m saying
that this is the beginning because we know
relatively little about the virtual currencies. What we know is that they’re
not yet a major component. I want to give you the numbers,
because I think they matter. The current total market
value of virtual currencies is about $7 billion
US at the moment, and if you compare that with
US currencies in circulation– I mean, banknotes, coins–
it’s about $1.4 trillion. And if you include US money
supply, otherwise known as M2, you are talking
about $12 trillion. So what we’re talking
about these VCs is really a very
small compartment of the total currencies
around the world and the total creation of
money using different means. So it’s still a small
component, small item, maybe nothing to worry about. But just like so
many things, it’s a bit like The
Tale of Two Cities. “It was the best of times,
it was the worst of times.” Well, virtual currencies
you could argue is extremely beneficial,
beneficial for the customers. It brings better value,
it reduces costs, it provides financial inclusion,
it provides versatility, it reaches out to places
where people were not bankable in some very far and
remote places where technology is beginning to
make huge entries. That’s the best of time. Worst of time, it’s a
great instrument for crime. Because a lot of it has nothing
to do with central control, with the central banks,
with supervision, with regulatory
environment, and it’s a very nice way– and people
who look into how terrorism is financed will tell you
a lot more than I would– but I’ve heard them. But it’s certainly a
potential instrument for illicit transactions,
for money laundering, for terrorist financing. Equally, if it was to
develop significantly, it would be also a potential
threat to financial stability, because it’s completely outside
the realm of regulated activity and there are some tell
risk scenario that you could actually think of. Third, and we don’t see
that as a risk going forward for the moment, it could
disrupt monetary policy. Too small to really be
a concern at the moment. Our bottom line– and that’s
very preliminary because we believe that this scene is
going to change massively going forward– but bottom line,
just as we heard in 2008, the investment
bankers who were just coming into the net of
supervision and regulation didn’t like it very much. But had to resort to
it, saying to all of us, please look at
the funds, and see what the hedge funds are
doing, and why they shouldn’t be included in the net. It might very well be the
case that going forward a lot of those that are
regulated and supervised by virtue of what is defined as
the banking activity, whatever form it takes–
retail, investment, or more innovative– might very
well say please include them as well, and these go beyond
the shadow banking, which is a bit more into the net of
regulators and supervisors. You’ve asked me to be
short, so I’ll stop here. Thank you. For those of you who’d like
to read the entire report I’m sure the IMF has got
plenty of copies to hand out. It’s available on
the net as well. Exactly. Or you can download it on
your cell phones right now. But so from Basel III
to the block chain, that’s quite a
big thing to span. But I’m curious,
James and John, when you look at your inbox
about what you are actually dealing with day in, day out
in running big banks today do you care about any of
this electronic stuff, virtual currencies, or are you
still fighting the last war in dealing with the regulatory
onslaught from the last crisis? And what do you think are going
to be the big forces shaping finance going forward? James, would you
like to go first because your nearest to me. I can jump on you easiest. Thank you, Gillian. Yeah, we care a lot. We’re in an industry that
is driven by technology. And whether it was the
advent of the ATM machine or the advent the credit
card or any of the evolutions and innovations of the
last 50 years in finance, it’s part and parcel
of what we do. In fact, we had our
earnings call yesterday. We focused a lot on what we’re
doing with our core businesses. The first email I got from
one of our board of directors was about an article relating to
FinTech in the paper that day. And it was a healthy
reminder that while we’re talking to investors about
what is in front of us, we have to have enough of
a share of our mind looking forward to what might
challenge us in the future or what might be opportunities. But if you go back
to the simple inbox, I’d love to say that the banking
sector is done with regulation. We know what the regulatory
world looks like. We have a fully integrated
global regulatory system. As Madame Lagarde
just said, we clearly don’t, that all of
the rule changes that have been put in place
over the last several years have finished, and I don’t
think anybody could say that that’s actually the case. So in terms of
inbox, we spent a lot of time worrying
about regulation. The GSIT buffer as an example,
for the globally systemically important banks is
a major new step that’s coming down the track. TLAC, one of those acronyms
that we’re trying to avoid, has been something all the
banks have been adjusting to. So if you’re not focused on how
the regulatory environment can shape the kinds of
businesses that you’re in and dictate the kinds of
returns you can expect from them you’re not doing your job. At the same time, if
you’re not focused on how some of these
innovations are disrupting different parts of
the financial system, and how you can embrace them,
and use them to win business, not just defensively then
you’re not doing your job. In our space, I think into
the world of disruption, we’ve got, obviously, Dan
from the payment sector. There’s the credit sector, and
then there’s investment sector. We’ll come back to this,
I’m sure, in the discussion. But I think there are very
distinct challenges for each of those sectors, and in very
different stages of maturation, and that’s largely driven by
what the economic proposition is to the client
by going entirely digital through
payments, through credit, or through wealth management. John, how do you see it? When you look forward
to say, five years how do you think the
banking sector will look? Do you think you’ll have
a different set of rivals? Well, I think we’ve always
had to cope with new entrants into the various
aspects of finance which we as a bank
at least prosecute. We’ve essentially
three businesses. We’re a traditional
banking business where we take deposits. It’s the reason why
banks are regulated is the taking of deposits and
people sometimes forget that. We have a stockbroking
business which has borne the brunt of much
of the regulation oddly because the source of
the crisis was actually just an extension of credit. And then we have a
fiduciary business which so far has been
the business that has benefited interestingly
from most of the legislation and rules that have
been introduced since the financial crisis. They’ve generally benefited
funds under management and fund managers which is an
unusual beneficiary when you think about what went wrong. In banking, there
is clearly some risk that we would be
disintermediated or made irrelevant because
we’ve been slow to move in technology terms. There is a degree
though to which we are still protected by,
for example, clearing rules. Although Paypal can move
a lot of money around, ultimately, clearing,
particularly in US dollars is tightly controlled. And very often the
payments are made from one bank to another bank
by means of something other than a bank. So banks still involved. I think on the
stockbroking side, we’re really just
trading electrons anyway. Everything’s been
dematerialized and I think we cope with that relatively well. On the question of whether
cash will exist in future, I think we do actually spend
quite a bit of time on that because cash, I think, in 10
years time probably won’t. There’s no need for it. It’s terribly inefficient
and expensive. But if you think about
money, and there is actually a lexicon today, so I’m
not plagiarizing it. If you think, there are really
three functions of cash– Feel free to read out
the FT to the audience. There are three
functions of cash. And if you look at it,
block chain technology itself is quite interesting. Bitcoin I don’t think is. Block chain I’m
much more interested in what will come later. I’m much more interested in
data than I am in process. I think where we’re
really struggling is with data, and the
rules around data, and the new regulations on data,
and the obligations on banks to report on data much
more so than process. But if you look at
block chain technology, I think it can be used for
digital identity purposes. If that’s acceptable to
the G20, because this is going to be a super
national initiative and the US is going to have to take
a leading role in this. But if we look at money, it’s
used as a medium of exchange. But we barter in lots of
things that aren’t money at the moment,
including bitcoin. It’s just another
medium of barter. It’s a bit opaque, so it’s
used for buying pornography and potentially for
other illicit purposes. It hasn’t gained
too much traction. It’s a bit complicated so I
think people will be put off by that complication. Money is used as a store
of value and bitcoin hasn’t proven to
be a very good one. I think it’s gone from
about $200 a bitcoin to $300 to $1,000 or something. And it hasn’t been
reliable at the moment. It’s not very liquid. There are only 21
million of them, so you divide them up into
very, very small chunks if you need to use them. So as a store of value it
hasn’t been terribly reliable, and they’re better stores of
value sometimes than cash. And it’s interesting
whether if the oil price has fallen, has the dollar
just gone up or has it fallen? And everything’s relative. The other the measure, the other
aspect of cash that’s important is as a unit of measure. We account in cash terms. We express our accounts
in dollars or euros or however we account. And I don’t think
there’s much threat there because it’s just convenient,
it’s decimal, it’s easy to use. But we do worry about
cash, because I think that should be dematerialized. I think the world has
enough robust technology. And I think governments
would be interested in that. Because it’s the old adage that
the money launderer’s greatest friend is the 500 euro
note because it’s anonymous and it’s a relatively
large denomination. It would be better if
everything were traceable. So can I just jump
in there quickly and say is either Morgan
Stanley or Deutsche Bank, are you developing a block
chain technology right now? The technology’s developed. It’s the use of
that technology– Are you using it? –and we wouldn’t presume
to do it ourselves. We working with lots
of other companies, and we’re planning on
useful ways of using it. And one of the issues
I have is people are too prone to get excited
by a technology rather than its useful application. And we have to be practical. We’re never going to
develop technologies of that nature that thoroughly. They’re very complicated. But there could be
uses way beyond bitcoin because they essentially are
a protected unique identifier. And that could be useful. James, are you about
to launch a block chain function at Morgan Stanley? I’m going to ask
Tom that as well. No. But others have and we’ll
access the technology. We partner with a lot of people. I’m more focused
honestly on things that take away human interaction. Our business is
built around– we’re a service business–
we’re built around people. People making intelligent
decisions, guiding clients whether it’s allocating
assets, whether it’s trading in different currencies. And what parts of
our business model are susceptible to being
disintermediated in that way. And whether it’s
through robo advice, can you build an expert
advice model for all people, or only for people with
very simple portfolios? Whether it’s through
electronic trading. Do you really need traders
sitting on desks and to what extent do you need them? Whether it’s through developing
expert systems to model M&A transactions and due
diligence on those? There are lots of ways where we
have historically added value. We obviously believe we’ll
continue to add value on those, but where are the pieces
that we can adopt and embrace technology that give our
clients more certainty with what they’re doing? So we’re adding
value at the higher end, the true advisory
end of the spectrum. So this is a– and
by the way, there’s a little bit of, I think,
near hysteria about FinTech. It’s real. It’s here. It’s disruptive,
but it’s not going to change everybody’s
life tomorrow. This is going to unfold
over many, many years in different ways so
as large corporations, nobody’s got the wisdom to
see how every product is going to unfold perfectly. So you have to make bets, you
have to form partnerships, you have to have
alliances, to have to hire talent to come from
outside of the banking system. A lot of things that
we’re doing is basically building optionality. Right. Out of curiosity,
before we come to Tom, looking at you in the audience,
how many of you in the audience use online banking? So almost everybody does. How many of you have
ever used a robo-advisor? OK, three of you, four of you. Interesting. And how many of you have
faith that block chain is a viable product or
process that will actually form part of financing in the
next say four, five years? Someone’s put two hands up. They’re such an enthusiast. Probably a CEO from [INAUDIBLE]. Exactly. Well, I must say, bad news. That’s only a third. The other two thirds
of the audience is looking a bit
suspicious about this. Anyway, Tom, how is this
playing out in insurance? Because I can’t imagine
you’re about to jump on the block chain bandwagon. No, no, no. But let me start by
saying that the insurance industry, especially
in Europe, is just gaining some breath after the
introduction of Solvency II. So when we talk about
regulatory impact on the way we do business it
has been phenomenal. Some of my colleagues
are still trying to stand up after the
implementation of Solvency II. As far as FinTech
is concerned, I think that McKinsey reports
show that the insurance industry will be the most affected,
one of the most affected parts of the economy as
far as technology in financial services
industry is concerned. And one of the main reasons
being obviously that risk pools are being affected. The possibility to use big
data, to make risk more granular is enormous. And you can even have a debate
on the basis of insurance, which is based on solidarity
that somebody wants to insure something that might happen. If he knows that
it’s going to happen, we don’t want to
insure it anymore, and he won’t take out insurance
unless actually the house is on fire. So that is a major
fundamental discussion that takes place in
the insurance industry. The only problem is,
and I think that is a point that was
made by John as well, is the timing of the thing. We know that cars
become more intelligent. We know that accidents
will decrease tremendously when we all have
sensors in our cars that avoid head-on collisions. Unfortunately, at
this point of time given the level of oil
prices, people have more cars, use more cars, drive more,
and we have more accidents. So it’s very difficult in
the present environment too. We can have a theoretical
debate about risk pools. You can have a theoretical
debate about the solidarity element in insurance. But the day-to-day
management of the company is, to put it bluntly, it’s
much, much more important. I think that you have
to life at the top of a financial
institution was not easy, is not easy, and will
not become easier because there’s unpredictability
of how fast technology will influence our work. It’s very difficult. You
know that it’s coming. On the other hand, we still
have to manage the business we have at this point of time. So we have to find
the right balance. You have to find
alliances with disruptors. I’m a firm believer
that disruptors need us, the incumbents. I have not spoken
to one disruptor who actually wants to take
insurance risk on his balance sheet. He wants to sell the products. He wants to sell
us products, but he doesn’t want to take the
insurance risk on the balance sheet. In that respect, I think
that the incumbents, at least the insurance side
of the incumbents, have a strong argument to create
alliances with disruptors, take them in, and use
them, and they use us to the benefit of both in
order to create new products, create new distribution
systems, and enhance the value of both the
disruptor and the incumbent. Right. Well, thank you. Well, Dan, as somebody who is
the non-incumbent on the panel, when you hear the incumbents
saying that they think the disruptors are dying
to do alliances with them, and they need the
incumbents, when you hear this talk about the incumbents
embracing technology and things, do you think
that this is simply a case of the
incumbents becoming a bit savvier, a bit sexy
with their electronic stuff? Or do you think
actually what we’re going to see is disruptors,
outsiders come into finance, and change it in a much more
radical way in the years ahead? I don’t think it’s
either/or and I think partnerships are going
to be important for everybody. But I will say when I was
at American Express, what I used to say all the
time is that the biggest impediment to our future
success was our past success. And I really think a
lot of big companies extrapolate from what was, and
don’t reimagine what could be. And that’s a danger for
a lot of big companies. I think there are five key
trends, in my view, that are going on right
now that I think we all need to keep in mind. First of all,
money is absolutely digitizing in front
of us right now. Checks are disappearing. Cash we talked about. All over the world,
money is digitizing. However, let’s not forget, 85%
of the world’s transactions are still in cash right now. So we’ve got a long
way to go on that, but it is just inexorable. It is going to happen. Money is digitizing
and will continue to do so going forward. Second thing is mobile is
exploding across the world right now. And it’s not just mobile. Everyone knows
that, but the bill of materials for a
smartphone is now under $30. So everybody is going
to have a smartphone. It’s as simple as that. When you have a
smartphone, you’ve got all the power
of a bank branch in the palm of your hand. And to me this combination
of money digitizing and the explosion of
smartphones enables us to think about basic consumer
transactions in a fundamentally different way. Imagine thinking about
banking and starting it in a world of
software and mobile. It would be fundamentally
different for basic consumer financial services. Not for mortgages or some of
the other wealth management, but for that. And I believe that
affords an opportunity to bring in the
billions of people across the world that are
outside the system right now. And that is a thing that
we are very focused on. Third, the amount of data
is exploding everywhere. And it’s not going to stop. People are like let’s hold it
back, we’re worried about it. It’s exploding
and algorithms are the weapon of the
digital company, and if they’re the weapon and
the ammunition is data then the more data you have, the
better quality, the better you can create value
propositions that allow you to target various
segments of the market, and serve them in better ways. Of course, there’s
the flip side. You’ve got security
and privacy issues that you need to think about. You got discrimination that
you have to worry about. But data’s exploding and it
is going to fundamentally change value
propositions out there in lending, in numerous areas. Fourth thing, industry
lines are blurring right now and product lines are blurring. So you have got circling around
digital payments right now, you’ve got technology
companies, whether it be Google or Facebook
or Amazon, Microsoft. So you’ve got tech companies. You’ve got carriers– mobile
carriers– circling around it. You’ve got OEMs
handset manufacturers. You have merchants
circling around it, because merchants fundamentally
see mobile and digital payments as a redefinition of commerce. How do they create
new value propositions to use mobile and software to
get closer to their customers. That’s going to
happen, and we’re not going to get in the way of
it, and it’s already starting. And so how do we create
platforms and API sets and software
to enable merchants get closer to their consumers. And then finally, the
fifth trend is security. It’s something I think about
literally every single day. We have a tremendous amount
of data and information. Authentication is very,
very tough these days. Everybody’s password
has been compromised. That is the truth of the matter. So it isn’t protecting
somebody from logging in. They’re going to log in
with real identification into account. Real ones. It’s yours. We know exactly
which ones you have. We know what your username is. We know your password. We know stuff about you
and the bad guys have it. So you got to have a
huge amount of data, and I think scale
really matters here, because what you have to do is
take that data and information, and create walls
as best you can. But then make sure you have
information and data that spots abnormal behavior,
and prevents it from leaving the system. And so I think those
five things are happening and FinTech is in
the middle of that. But this is going to be a
combination of regulators, incumbents, new people
pushing in to this market, and I think it
will fundamentally redefine basic financial
services more in the next five years than what’s
occurred in the last 30. Wow. That puts the 2008
crisis in perspective. Can I ask, how many
people in the room agree with John’s prediction
that cash will no longer exist in 10 years time? OK, that’s a pretty
striking statement given that 85% of the
world’s transactions are done in cash right now. There’s no way. Not in volume, in number. It’s 85% in number,
not in volume. That’s right. Of the transactions. There is a big difference
between the two. While I’m on that
question how many of you think that the current
big lineup of big name banks, some of which are
represented on the panel, will continue to dominate
banking in the next 10 years. In 10 years time, do
you think we’ll still have the same big name
banks dominating banking? OK. One. One person has
stuck his neck out and said the future belongs
to the big name banks. I guess the key
question I wonder about this is to what degree
are the regulators prepared for this? Because it strikes me right now,
and I firmly believe the 2008 crisis was partly caused
by tremendous levels of fragmentation in the
regulation community and central banking world
which prevented them from seeing what was going on. But once again we have
a lot of fragmentation. We have people looking at tech
in one regulatory department and people looking at
finance as another. Who wants to jump in
on the regulators? Tom. I think that the
regulators first have to question what are we
going to regulate before they actually start regulating. You or Dan was referring to
the incredible amount of data that is being generated, and
that the financial industry will use to service
their customers, develop products,
analyze the risk perspective of their customers,
et cetera, et cetera. One of the biggest issues there
is that the financial world is still rebuilding trust. We not there rebuilding trust. And the question is how can we
while we’re rebuilding trust also convince our
customers that we should be allowed to use their
data in order to service them better and create new products? And I think one of the problems
from the regulatory side– I used to be a
regulator, I’m not a regulator anymore– is
that they have to define what they’re going to regulate. Are they going to
regulate privacy further? Are they going to regulate
the transfer of that data across borders? And how do you then
see too that you have a regulatory
environment that is globally applicable otherwise
you can’t use it at all. So I think that is a
much bigger problem, that before you start
regulating that you have to know what to regulate. Dan, and then I know John’s
got something he wants to say. But Dan first then. Let’s start off
by saying I think that most of us in this
panel would agree that in general what
regulators want and what we want is very, very similar. We want protection
for consumers. We want it to be a
transparent type of system. We want security for that. I don’t think anybody
can argue with that. It’s hard to argue with it. You could, but you’d get kicked
out of the system immediately. But I think the issue really is
what are we trying to regulate and how are we
trying to do that? For instance, again, when
I at AMEX and we were doing stress testing. We were stress testing what if
the housing market collapsed this much and what
would happen, et cetera. I’m like you know what? Honestly, that’s not the next
stress that’s going to happen. The big next stress is
the financial system’s going to be hacked
for one or two days, and there’s going to
be a pandemonium that’s going to happen, and that’s
going to be the stress. It’s not what happened,
it is probably what is likely to
happen going forward. And that wasn’t part of the
stress test, for instance. I think it’s a big
oversight because I think, not to be pessimistic,
I think it’s likely that something like that
could happen in our system. I hope it doesn’t, but we
face pretty serious opponents out there. Right. Number two is I
think we need to be able to innovate responsibly. There needs to be
some sort of sandbox where you can try things and
not run the risk of running afoul of regulation. Because there are
so many cool things that we could do that
are very different today in terms of using data and
information to increase lending, to think about
financial health, and inclusion in different ways. But you want to be careful you
don’t run afoul of regulation, but there needs to be some sort
of sandbox to go and do that. As I think about it, we’re
moving into a new world. I believe that. I’m not saying it’s going to
happen tomorrow whatsoever. I’m a pragmatic
person around this. But we are moving
into a new world. That’s going to happen. And new worlds demand
new ways of thinking about our regulatory
environment as well. John, I know it’s
something that’s close to your heart, the
issue of regulation and data. Well, I’d just like to
go on the record saying I like regulators very much. Are there any regulators
in the audience? If there is, take notes. One. There’s one regulator
who wants to admit to it. Sometimes we refer to regulators
and what we really mean is policymakers. And regulators’ jobs
really are to ensure, they supervise in normally
a constructive way, and they enforce
policy and rules. But the rules are set by
generally other people with feedback from the industry,
but also from regulators. I think some people,
my observation is that much of the
debate in finance that’s focused on regulation
has focused on quite a numeric aspect of regulation. We’ve looked at
prudential regulation, we looked at adequacy of
capital and liquidity. And there’s been a lot
of debate about that. And banks have generally gone
from being under-capitalized 10 years ago to being
now relatively safe. There’s still a lot of tinkering
going on because the rules have become complicated and when
rules become complicated they get arbitraged
by people who are cleverer than
the people who set the rules in the first
place or think they are. And that’s been the case
since regulation was invented. The much more complex regulation
is almost a stealth regulation. And that’s when,
for example, banks but other institutions
within the finance world are asked to take on roles
that are societal roles, they are utility roles. And one– and this is not
specifically a Deutsche Bank point– but I think we’ve
been slow to recognize that we are an extension
of law enforcement. And the obligation
goes beyond clients because it reaches
potential clients. And our obligations,
for example, to report to crime agencies
suspicious activity where the demand on the
determination of what constitutes suspicious
activity is very, very onerous and is not single
transaction related or single client related. It’s pattern related, so we need
to develop pattern recognition systems to help ourselves. Where conduct of sale for
financial institutions sets huddles that
are much higher than for many other industries. And many other
industries are presumed to be effectively competitive
and financial services presumed not to be. So if you want to
sell a kilo of sugar at an egregiously high price
as part of your business model, you probably won’t
sell very much and so the market will
put you out of business and that’s fine. If you want to sell an
insurance product for a better margin than the market,
you can actually be prosecuted for not
treating customers fairly. A lot of that goes to
management of data and that’s my point about
hardware these days. If you buy some new
hardware, you normally save costs because
the old hardware just costs you more to run
even in electricity terms. Software doesn’t cost that
much these days to develop, and you can partner with people
who can do it very effectively. Cleaning data, managing data,
organizing data, storing data, maintaining data, reporting
on data is incredibly complex. And those are the
standards to which I feel we are at the
highest we are held. And we’ve not got a good legacy. We haven’t done well. We’ve had fragmented systems. We’ve never had standardized
data even when we’ve had standardized processes. And our inheritance as an
industry is pretty lousy. Now, if you talk to Tom, he’ll
say, well, wait a minute, presumably I’ve got
pension policies that were written in the
1940s or ’50s potentially still in force. The world has changed
100 times since then. How am I meant to manage
that sort of information? We’re in the odd
position of having to go back to people who’ve
been clients for 20, 30, saying can you now prove to us
you are who you say you are? And they say, well,
surely by now you know. And of course we do, but we’re
held to a different standard. And I’m finding,
personally, that we’re thinking too much about data. We should have
thought more about it. And we need to
get smarter, and I think that’s where
we need to get really smart on new technologies. That’s a fascinating point. I wanted to try and bring
the audience in for questions in a few moments, but I
quickly want to ask, James or Christine, do you
have any strong views to add to this about? Yes. Yes, I’m sure you do. I’ll give you a chance. Thank you, Gillian. I’d like to add three points. One is the point made by Dan
about having a sandbox where you can experiment, where
you can test without running too high risks, I think is a
really interesting proposition. And I think it’s important
to keep it as a sandbox, and not to make it the courtyard
where everybody is actually playing. Because essentially, what
you’re doing– all of you, many of us– is actually
dealing with public good. And when you’re dealing with
public good, when you’re dealing with trust to do it in
a sandbox to make sure that you limit the damage that you do
when you experiment I think is exactly the
right thing to do. And part of the regulations that
we’ve put in place since 2008 has been about precisely
protecting the public good, and making sure that taxpayers’
money is actually not on the line when too many
mistakes have been made or when the tools that have
been experimented in the sandbox have been elevated
to a higher level. So that’s point number one. Point number two, I was
actually a little bit challenged by the point that
I think you made, John, when you said that
regulations in the banking and finance business is actually
decided by policymakers as if governments were in charge
or parliaments were in charge. And I have my slight
doubt about it, because when you are
inside the system, and when you see how
regulations get negotiated, yes, governments participate. But most of the hard work
which eventually defines the capital adequacy ratios, the
liquidity ratios, the leverage ratio, TLAC, as
debated as it was, it’s very much in
the Basel committee. It’s very much in the FSB. That all of that is worked
out and eventually channeled into the regulatory
system as defined by virtue of it being
decided by parliament. So I would say for
bad or for good– and I’m not taking a
view here because there is a lot of good about it– but
the profession itself has a lot to do with how
supervision is defined and how regulations
are determined. And there’s a lot
of negotiations to be had in that respect. We have seen it since 2008. I would add that on
the accounting front, it has been very much
delegated to professionals. And when you look at the
international accounting standards, many of
them are actually decided by the profession
itself, rightly or wrongly. But I would contend
that parliaments and sovereign representatives
are part of the process, but they’re a small
part of the process relative to other industries. Final point that I
would like to make. I was fascinated by what
you said about data, and the abundance of data,
and the fact that cleaning up of data, and
management of data is going to be the
thing of the future and critically important. And I was wondering– and
that’s a question, Gillian, if I may ask– whether the
[INAUDIBLE] of de-risking, which is big for some countries
around the world, and many more than we think, which consists
for those who are not in the know on that, which consists of
some banks deciding to cut off links and ties
with correspondent banks in those
countries that are not capable to provide the data. Know your clients, know
your client’s clients that is expected from
some authorities, particularly in the US. Whether that de-risking,
which is bad news really for some countries, which
otherwise can operate legitimate businesses, and
legitimate households banking, whether that abundance of data,
and the improvement of managing those data can actually
help limit this de-risking or avoid it altogether. Do you want to
answer that briefly and then I’m going to ask James. Or you can chuck it to
James if you want to. I think the answer today
is no, because the issue with correspondent
banking, and we just stopped onboarding clients
in 109 countries, which we agreed with our regulators
were high stress countries. And the ask in
correspondent banking is to know your
correspondent bank’s clients. And data protection
rules prevent you from knowing your
correspondent bank’s clients. So the question is which
law do you want to break? And instead of
breaking either, we exited correspondent banking. And all that leads to is
marginalization and social exclusion for the
109, in our case, riskiest and therefore
least developed countries in the world. Wow. That’s a sobering point. James? There’s a lot of ground
to cover there, Gillian. OK, you have two
minutes, and then we’ll bring the audience in. Or you can take a pause,
I’ll ask the audience first. No. I’ll give you two minutes worth. Two topics. One is regulation, one is ROE. On regulation, the
regulators will and should get involved in the shadow
banking sector, which obviously they’re involved in the core
regulated banking sector, already in the shadow
banking sector to the extent that there are cyber issues. Because I agree with the point
that is the big enchilada. To the extent that there
are systemic issues created through concentration of
risk and risk of contagion, and to the extent that there
are issues that affect consumer confidence, because at the heart
of the banking system is trust. It’s the Jimmy Stewart movie
about It’s a Wonderful Life. When trust goes, people
want their money back. Banks don’t have their money. They’ve given it
to somebody else, and that is sitting in
somebody else’s house. And that’s actually what
started the financial crisis was a lack of trust when individuals
and corporations saw banks taking credit hits. As a result, they
pulled their money out thinking those hits
would wipe out the equity. When they pulled their money,
it created a liquidity run. And with a liquidity
run eventually everybody dies unless the
all-time great steps in, which is the governments and
bail it out, which is what happened. So on this whole
FinTech shadows system, regulators can and should get
involved where it’s cyber, where it’s systemic on
credit, risk of contagion, and where there’s
real consumer issues. I think just broadly,
two quick broad comments. One, we can’t talk about banks
or financial institutions. Are you correspondent banking
or is it project finance? Is it consumer lending? Is it student card lending? Is it credit card lending? Is it use of debit cards? Is it wealth management? Is it trust services? There are too many things
going on under this, so we’d need many
hours to do that, but that’s for another day. The important issue is the core
banking industry pre-crisis had an ROE of about 25%. And that was because it
was running balance sheets on capital with a ratio
of about 40 times. As a result of
regulatory action, sensibly, the
banking industry has a capital ratio
of about 11 times and an ROE, unfortunately,
of less than 10%. So in terms of scale
of change, you’ve taken one of the most important
industries in the world, and taken the ROE from
25% to call it 5%. FinTech and these changes that
are happening in and around that, they’re not
rounding errors, but they’re not transformative
at that scale yet. Within certain
products, certain parts of payment system,
peer-to-peer lending, they’re becoming
much more than that. But it’s system wide. Regulation remains the
number one game at least the here and now. Right. Right. Thank you. That’s a very, very
good point indeed. I’d like to bring the
audience in for questions. We’ve only got about 10 minutes. There a lot of you. I can see a lot of you
have strong feelings about these issues. I should say I was in a session
earlier discussing FinTech and there was a very
strong division in people’s about whether they thought
it was good or bad. But I think there
are some microphones. Please keep your comments
or questions extremely short or I will cut you off. And it will courteous
but not compulsory to identify yourself. So who would like
to ask a question? OK. I can see Mr. Block
Chain at the front. George Bachiashvili,
Georgian Co-Investment Fund. So basically, your
bread and butter is storing other people’s
money, making transactions with other people’s money,
doing the same for the stocks, and issuing credit. All of that is done much more
efficiently by block chain even today in a
decentralized way. Why are you so
ignorant, I may say so, because it’s a big train coming
right towards your direction, and I don’t see much
concerns from your side. I’m very glad that Ms.
Lagarde is much more positive about block chain. So James and John,
are you the rabbits in the headlights of the
train coming down the track? I don’t think so. Not in the next
four or five years. I can’t see block chain
being adopted that rapidly. At the moment we’re
regulated to take a dematerialized form of cash. That’s what we do. So we borrow money from
people A at one rate. We lend it to people,
group B, at a high rate, and try not to lose it. You could argue that
deposits, the deposit product, is no longer relevant
in today’s society. And James’ business is
geared around, much more around not specifically wanting
to take so much deposits. He’s got a much more developed
wealth management business. And his client base,
presumably, is better served by offering a broader range
of potential investment opportunities than a simple
deposit rate of return. Banks have been regulated
to take deposits, and a good use of
those deposits was to lend them to other people
for a positive margin. And that’s traditionally
how banking’s built up. There’s no compulsory
reason, but banks had a competitive advantage
conferred on them because they also dealt in people’s money. And when you deal
in people’s money, you generally have a direct
indicator of the health and therefore
creditworthiness of the person to whom you’re lending money. And so if you can bank,
i.e. manage the cash flow of your debt then you can
manage that, arguably, over a cycle better
than someone who’s blind to the cash flow
performance of a borrower. I’m old enough and
probably cynical enough– and you can suggest that
I’m complacent enough– to know that there have been
various cycles of disruptors in credit who’ve come
along, and they’ve grown incredibly quickly. And they’ve worried banks. I’m old enough to remember
the centralized mortgage lenders in the UK. I’m a Brit. In the late 1980s, early
1990s, they took market share from building
societies by lending to people who either in
the end couldn’t pay back, didn’t have a house
of the value that was sufficient to
cover the debt, or didn’t want to pay it back. And they did disrupt for awhile. But on the credit side,
I wouldn’t be complacent. But I would not be so
worried about crowd funding, for example, where the ultimate
aim is to lend to people. Banks, I think, just have
a competitive advantage because they have
insight into cash flows. OK. So banks have a
competitive advantage. James, do you agree? I don’t think
anybody on the panel said that block chain
was not relevant, and I don’t think
anybody suggested that it’s not something
that we’re looking at. In fact, it is, so I would
take your characterization of ignorance and turn
it around as pragmatism. If you look at how we
actually make money, you have to look at
what the block chain technology would do to disrupt
that source of revenue. Is block chain going to stop
us from bringing Alibaba to market? So you have to look
at how we make money before you make the assertion
that our business is in a state of inexorable demise. There are parts of the financial
sector, and the payment system, and the storage of data,
and the use of that data which are clearly
affected by it. But there are large
parts that are not. They’re affected
actually by other forms of financial technology. Dan, as the disruptor
on the panel, do you think block
chain is over-hyped? Well, we just brought
on a board member who is one of the experts in
crypto currency in the world, so we’re obviously thinking
about it quite a bit. I think people have a
rightly disaggregated bitcoin the currency versus
the underlying technology. Part of the promise of
the underlying technology is a reduction in
transaction costs, which Christine rightly mentioned
helps with perhaps financial inclusion, et cetera. The problem is you have a
currency that’s bouncing around so much that you have to
immediately translate it into fiat currency, and
there’s a 1% fee to go do that, so you take away some
of that efficiency right now because of the volatility
of the currency associated with it. I do think that
it’s very possible that the rails in which we
move money evolve into more of internet based
rails as opposed to proprietary rails
that are run now by some of the networks. But I feel– and this is going
to be weird for a disruptor– but I feel the same way. I think there’s a lot to think
about yet with crypto currency, not the least of which is what
is the regulatory final say going to be on that. You have multiple governments
with multiple different views on it right now. But we allow bitcoin into
Paypal as a payment mechanism right now through Coinbase
because there are some people who want to do that. But I’m not going to repeat
the host of issues with it, but it’s very interesting. Well, sadly, very
sadly– and we could talk about this for another
couple hours I think– we are pretty much out of time. I do apologize. It’s been a
fascinating discussion. I’ve taken away
several key points. One is that clearly there are
some extraordinary changes going on right now, which
probably haven’t had the attention they deserve
until recently because the media investing public and the
public have been focused so much on the financial crisis. Secondly, there’s
clearly an urgent need for regulators to think about
this and policy makers too. And certainly papers
like the IMF’s paper are going to help
spur that debate. And thirdly, to
me it’s still very unclear about who’s
actually going to be the winner here or not. Clearly, the
incumbents are still dealing with the
legacy of regulation and distracted by that. And yet they do still have
a pretty incumbent position in many areas. So it’s going to be a very
interesting fight going on. The one thing I am
pretty clear about is that whatever bank notes you
got in your wallet right now, frame them. Because eventually they’ll
be a collectible item. So thank you all
very much indeed.

Danny Hutson

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