Once upon a time, a bank was a place where you kept your money, where you went if you needed a house or business loan, where neighbors’ funds were used to benefit the community. There’s a scene in the Christmas movie, It’s A Wonderful Life, which describes this perfectly. But things have changed.
Over the years, banks have diversified their business and found opportunities to make money in a number of different areas. They charge interest on credit cards, loans and mortgages, a monthly account fee and various punitive fees such as late fees, returned payment fees and even inactive fees. From a commercial perspective, this is a truly beautiful business model. However, not all customers feel the same way.
This customer-level dissatisfaction has soured our opinions of banks but it is also leading to radical changes in the way we bank.
Where do banks get their money?
Before I head into how banking is changing, I’m going to go over a little background information. I’d like to point out, that banks lend money they don’t have. Money in banking and society in general, is largely an abstract notion.
In It’s a Wonderful Life, when there’s a run on the bank and the cash isn’t there it’s said to be in the neighbors’ homes and businesses, bricks and mortar etc. In this example the message is clear — the money exists — somewhere. But in reality, in today’s banking, the money isn’t anywhere. In fact, a bank only needs to legally have a 10% reserve of the money it lends. And I don’t mean physical money, I mean electronically.
Every day at the end of business if a bank does not have this 10% it needs to obtain it. It can borrow this from another bank, or it can borrow from the Federal Reserve.
An unequal partnership
This means the customer and supplier model in banking is not a level playing field. Where the earlier model says the bank needs us in order to lend money to other customers to make a profit off the interest, this model says our deposits are neither here nor there. Essentially, thanks to this system, we need them more than they need us. And this state of being has led to some very unfavorable conditions for the customer.
But it’s not all bad news for us as this has opened up opportunities for suppliers who recognize the breach. As businesses step up to provide these functions and services banks are slowly seeing their business seep away. And this is seriously shaking up the financial world.
Start-ups changing the way we bank
For most customers today, a bank’s function revolves around the lending and transferring of funds. Current bank interest rates are laughable and although we may have savings accounts, we use these keep money safe and to help us reach savings goals. No one puts money in the bank expecting it to grow.
So already, a bank’s functions are reduced and yet, there are still businesses looking to do what a bank does, only better. Let’s take a look.
I hardly need to explain this. From Paypal to Remitly, there is a wealth of choice when it comes to transferring money. Whether you’re splitting a bill with a neighbor, buying shoes online or sending money home to family abroad, these companies are redefining money transfers. These companies are causing the banks major headaches as they not only provide the service cheaper and quicker but they also outmaneuver the big banks in terms of service too.
As I mentioned above, no one looks to the bank to grow money anymore. Today most banks offer zero interest on day to day banking. Some big-name US banks do offer fixed term saving with 4–7% interest but these are 5 to 10 year deals. Instead established names such as Goldman Sachs are reaching into the traditional banking customer base with online products such as Marcus, which pays 2% on a savings account. Discover now offers a similar rate via its online savings offering.
There’s much debate around the viability of account fees in banking. Some banks charge fees justifying the payment saying it gives them the funds to offer a better customer experience. However, few customers really feel the benefit of paying $10 dollars a month. The most noticeable factor affecting the level of customer service is your bank balance. Whether you have an account specifically designed for high worth individuals or a regular savings account with a high balance, customers report noticing better customer service. Charging an account fee helps banks maintain highly expensive, physical city center properties. Naturally, online banks can waive this fee.
In the US, your bank acts as the agent brokering the deal between you, the customer and Visa, MasterCard and American Express card in your wallet. Credit cards make money from both sides of the transaction — from the merchant and the lender. If you pay in full every month without interest, they still make money on the transaction. However, online credit cards are slowly shouldering their way into the credit card market.
Likewise, customers can shop for loans relatively easily online. They can also comparison shop, driving down the interest rates the banks are able to exact.
How can banks remain relevant today?
In short, banks have to start thinking differently and they have to become more flexible. Many big-name banks focus on what they can offer the customer that online options can’t, such as the physical space. However, just like money, banking is become a more intangible thing.
What customers want is the banking service — we want to transfer money, invest money, have credit and take out loans. But we also want a return to the social philosophy behind community banking.
This is the model in It’s A Wonderful Life. In the movie, the bank is the backbone of the community, it works in the best interest of the people and acts like a shared income allowing citizens to invest, build and grow.
The question banks need to ask themselves is, can they offer this principle of shared income again? If they can I think they’ll be able to find their place in the changing world of banking.