Difference between a bank and the grocery shop around the corner — Part 1
More and more, we see seemingly unnatural players starting to enter the financial services scene. One recent example is WhatsApp getting prepared to launch online lending in India following its mobile payments services. Below, I explain how I see banking and its differences from the neighborhood convenience store, and also why each bank is a grocery shop, and each grocery shop is a bank in some sense.
As in almost any shop, you aim to sell the right product for the right price, and you aim to sell it as much as possible. The right product will get you demand, the right price will get you profit, and quantity will multiply your profits.
At a very basic level, a bank is a shop selling credit, selling today’s money for future money. So, the bank also aims to sell the right product (can be a mortgage, credit card, commercial loan, etc.) for the right price (start with the risk-free base rate, then add risk premium and some profits considering the competition), and it aims to sell it as much as possible to multiply profits.
Unlike the grocery shop, a bank doesn’t give the product and get the money right away. Bank may or may not get the money for its product at some point in the future. Possibility of default (i.e., time and uncertainty associated with time)changes the game. That’s why a bank cares about whom to sell and prices its products differently for each customer to incorporate their default risk. This adds two additional points to the equation above: “The bank aims to sell the right product to the right person at the right price for that person, and it aims to sell it as much as possible to multiply profits.”
Considering these two additional points above — selling to the right person and charging personal prices — your grocery shop around the corner actually does these from time to time. Once you go to the shop short on money and the shopkeeper says, “No worries, you can pay once you get the paycheck.” (and it’s not very uncommon in Turkey), he’s actually giving you a micro-credit attached to his own products. Also, personal discounts are not uncommon in local grocery stores proving the fact that price varies among the neighbors. Hence, to a certain point, the shopkeeper also has to sell to the right person at the right price for that person.
A couple of differences exist. First, the shopkeeper sells credit attached to her own products while the bank is providing cash with which you can buy anything. Second, the shopkeeper has to know you at a personal level or has to observe you well for a long time to be able to calculate your default risk, her reach is limited to her own network and eyesight while the bank has its eyes everywhere thanks to what we call data. That’s why a bank can scale selling credits while the shopkeeper lends to its closed circle. So, there’s some banking involved in shop-keeping, but it’s a tiny bit of banking.
It’s not to say that that a bank is no different than the grocery shop around the corner; but once you see that each bank is a grocery shop and each grocery shop is a bank in some sense, you’re less surprised reacting to “seemingly” unnatural players of financial services scene.