Why Do We Need Bitcoin? What Is So Problematic With Today’s Financial Institutions? — Part One
In short: Our financial and monetary institutions systemically deepen economic inequality.
In Short: Our Financial And Monetary Institutions Systemically Deepen Economic Inequality
What if you were told that we are approaching another global financial crisis that will be worse and more prolonged than the global financial crisis of 2008? Would you want to know more? What if you were told that for a number of decades now, our financial and monetary institutions have been some of the greatest contributors to economic inequality all over the globe? Would you be interested in understanding why?
What if you were told that for decades now, many regulations that are intended to strengthen our financial systems, or interest rate decisions that are intended to stimulate the economy also had a silent but harmful impact on your future wealth? And that in the process it effectively enforces the reduction of government debt by silently eroding the wealth of everyday savers like you and me? Would this seem implausible to you?
The Inconvenient Truth
The unfortunate truth is that the above statements can be factually substantiated. Yes, many of us who are privileged enough, experience the positive aspects of strong regulations, sound banking practices, and solid financial markets. Our money is safe, payments work, and financial institutions offer value to us in an attempt to win or retain us as customers.
But…
There are other negative but largely unknown aspects of financial systems that need to be unmasked. Without an appreciation for how even well-functioning economies can (and usually will) succumb to unsound monetary practices, we will not be able to appreciate the power of Bitcoin. We will tend to relegate Bitcoin to the fringes and see it as an alternative payment system or currency that is relevant for troubled/underbanked economies only.
Here we will explore the background financial processes that result in wealth-erosion that scales across entire economies of millions of people, and over a period of time. This is why the gradual reduction of your individual wealth is not immediately noticeable, and it usually will not be sudden or dramatic. For each individual, the amounts will typically not be enough to incite uproar, but when summed over millions of individuals in an economy, the numbers start adding up.
It’s Not Just About The Fees
It is not only the more commonly-experienced irritations such as bank fees, remittance fees or investment fees that affect our pockets. In a number of countries, there is a silent and subtle redistribution of wealth away from everyday savers like you and I, towards profligate governments and financial institutions. This hidden redistribution of wealth becomes more pronounced as inflation rates increase. And inflation need not be high (relative to historical rates). It is not only the highly-publicized hyperinflation scenarios of Venezuela or Zimbabwe that demonstrate how wasteful government expenditure and unsound monetary decisions can harm people economically.
Even in well-developed economies that are characterized by moderate economic growth, low-interest rates, and seemingly harmless inflation rates, the wealth and savings of people are being systemically redistributed towards paying off government debt. And it happens so stealthily, without voters being aware of it, that there is a minimal political consequence for careless government spending.
In most countries, people entrust their money, savings and economic well-being to large financial institutions and central banks. People have faith that a strong regulatory environment in their country will support their endeavors to survive (or even thrive) financially. Yet the regulations that are intended to protect the integrity of the banking system also create the very money supply, inflation, and interest rates conditions that stealthily move wealth from private sector savers to public sector debtors. So the next time you think that topics of inflation and government debt/wastage are boring and shouldn’t concern you, think again.
How Deep Does The Rabbit Hole Go?
Instinctively, many of us are aware that something is wrong with the status quo. We feel the discomfort and inequity when we experience:
- Exorbitant remittance fees for sending money to our home country,
- High interest rates on our personal or business loans,
- Exorbitant payment fees, whether it is accepting a card payment or making a cross-border corporate payment,
- Limitations on how much money we can invest offshore, and
- When we experience reductions in the value of our portfolios while asset managers, brokers or exchanges continue to thrive.
However, the rabbit hole goes way beyond this. Our financial systems and regulatory frameworks have been architected in such a way that money and the wealth generated from it, insidiously moves through the banking system, away from savers towards financial institutions and government debt repayments. More importantly, the scale at which this takes place is mind-blowing. This article is the first of a series that will provide a fact-based overview of how all of this takes place. Hopefully, it will ‘open your eyes’ to these realities and push you to think of better alternatives to what has always been considered as normal.
In this and the following article, the following major themes will be explored:
- Consumers bear the brunt of the heavy cost structures of today’s financial institutions.
- Financial institutions benefit more from their clients’ money than what clients do.
- Even in well-functioning, developed economies, wealth is redistributed from the poor to the rich.
The article will start with the more commonly-experienced financial services ‘irritations’ that we have become accustomed and desensitized to. In the next article (Part Two), we’ll venture into how the monetary institutions and systems that we trust every day facilitates the insidious and hidden transfer of wealth from the poor to the rich. All of these issues and challenges will then provide the basis for why we need to be open to a better system of money (Part Three).
Financial Institutions Are Cost-Heavy Machines
There are many reasons why it has become so costly to provide people and businesses with financial services. Let’s touch on a few.
Financial Processes Are Fragmented And Involve Many Intermediaries
Many of us are typically unaware of the extent of the difficulties and challenges that companies offering some kind of financial service have to deal with. Everywhere across the globe, the actual financial markets, technology platforms, and systems within those markets are fragmented and disconnected to varying degrees, even in developed economies. As a result, the many different service providers often come together and collaborate in order to provide us with a particular service.
For example, in order for you to make a simple card payment at your favorite store, there are companies that provide the point-of-sale devices to accept your card payment, the bank with which your store has a bank account — called the acquiring bank — a card network such as Visa, Mastercard or Amex, to transmit your payment authorisation request to your issuing bank, your own bank — called the issuing bank — who eventually will transfer funds from your account, and a central bank that will ensure that acquiring and issuing banks’ payment obligations to each other are cleared and settled.
This is not an exhaustive list, but it becomes easy to how all of these parties and their own costs will contribute to the overall cost of just processing a simple payment.
Inevitably though, we feel the effects of those challenges in our everyday lives in the form of banking fees, insurance premiums, and reduced savings or investment returns. However, besides having multiple players, each adding their costs/fees for their portion of the service offering, many other factors add to the cost burdens that inevitably is borne by the consumer.
Financial Institutions Have To Maintain Costly Infrastructure
Large banks, insurance companies, and other financial institutions usually carry massive costs for things like:
- The regional network of branches, with each branch incurring the costs of its staff, the premises, management of cash, and so forth;
- The regional network of ATMs, which incur the costs of maintenance, cash replenishment, cash transport and security to name a few;
- The majority of banks have ageing legacy IT systems with many IT professionals, dedicated to its maintenance and ongoing enhancements;
- Tens or even hundreds of thousands of well-paid employees;
- Financial Services executive salaries that typically are very high;
- Etc.
In short, traditional financial institutions are extremely costly to run, and these costs need to be recovered through fees, premiums, interest and so forth.
In addition to financial institutions being costly to run, the fact that their systems are not well integrated adds to their costs. This lack of standardized and integrated systems is the reason why for example:
- It can take a few days for a payment to your recipient to reflect in their bank account;
- You are not able to get one view of all of your investments and insurance policies held by different institutions, without an intermediary or broker that manually needs to collate this for you. And of course, this intermediary will require a fee for the service.
Global Payment Systems Are As Fragmented As Domestic Ones
The lack of integration becomes more pronounced when you take a global perspective. Individual countries’ domestic payment system are not integrated and geared to handle streamlined cross-border payments. As a result, additional intermediaries such as the SWIFT network and correspondent banks, each charging a fee, are required to facilitate cross-border payments.
Cross-border payments are just some of the use-cases where Bitcoin technology comes into its own. Global remittance payments reached $689 billion in 2018. The global average cost for remitting $200 remains high at about 7%, with the banks on average being the most expensive at 11%. More detail about remittance costs can be found here.
Cross-border corporate payments are significantly higher in value. In 2018, cross-border corporate payments exceeded $21 trillion. Fees that average between $30 — $40 per payment, along with an average currency spread of 2% make cross-border corporate/B2B payments very lucrative for financial institutions. In cases where corporate treasurers rely on the receiving bank to handle currency conversions, visibility into exchange rates and conversion fees can be limited for both the sender and receiver of a B2B transaction. Cross-border payments do not settle real-time — settlement times of up to 5 days is not uncommon. However, the inability for both the sender and receiver to effectively track the progress of funds as it moves through the correspondent banking system is generally a bigger concern for corporate treasurers.
Fragmented Systems In The Investment Industry
Other ways in which fragmented systems impact consumers can be seen in the investment space. Multiple parties collaborate in the management of your investments, all of whom charge fees that ultimately reduce your investment returns.
Consider the investment returns you expect from your retirement funds. Behind the scenes there are quite a few participants involved in the process of managing your retirement funds, each of them charging fees for their services:
- A Retirement Fund Administrator — the administrator assists with channeling portions of your monthly salary deductions to the different asset managers that will manage (and hopefully grow) your funds, manage your claim payouts, etc.
- Asset Managers — they will invest your monthly contributions into specific shares and other instruments, usually based on some form of life-stage investment strategy. In addition to their normal asset management fee, they may charge a performance fee if the portfolio performance exceeds some benchmark (which investors rarely understand).
- Multi-Managers — multi-managers may sometimes be involved in the management of your investments by managing the underlying investment managers who each manage certain portions of your investments. An additional multi-manager is then levied for this service.
- Platform Providers — these providers have the systems and operations to give more savvy retirement fund members more choice in terms of where to invest their contributions. Platform fees are levied for this as well.
- Employee Benefits Brokers — their responsibility is to help your employer with the structuring of your retirement benefits, be the interface with the administrator, assist with educating you (the employee) about how to better grow your retirement savings, and so forth.
- Asset Consultants — these consultants typically advise stand-alone retirement funds with regard to investment strategies and levy a fee for this advisory service.
And of course, there are other entities such as the exchanges where the actual buying and selling of securities take place. These exchange and trading-related costs are all passed on to the investor as well. Today still, in the 21st century, the issue of opaque and exorbitant investment fees is still one of tremendous frustration.
Institutions Benefit More From Clients’ Money Than Clients Themselves
There are many other tacit ‘issues’ with our current financial system. Financial institutions profit significantly from their customers’ fees. Naturally, it is important for these institutions to remain profitable for the services they offer. But our society has become so desensitized to the skewed income distribution between the average consumer and the finance professionals, that we no longer question the extent of the profiteering. For example:
Banks Benefit More From Their Customers’ Money Than What Customers Do
People pay banks a monthly fee for a bank account. Yet these bank account customers do not get the benefit of interest on their bank/cheque/current accounts. Meanwhile, banks use customers’ money to provide high-interest loans on which they make even more profit. And as will be discussed in Part Two, banks are able to use their customers’ funds to extend loans to governments at below market-related interest rates.
Investment-Related Institutions Earn Revenue Regardless Of Market Movements
The average investor that invests in a unit trust or buys listed shares via a broker will bear the risk of market/price movements. The broker and the exchange involved in the investment process will gain volume-based transaction fees even when markets plunge.
Asset managers who manage investment portfolios for individuals or even retirement funds will earn a fee of say 1% of the assets they manage, regardless of whether their customers’ portfolios reduce in value. This is another example of how the average investor’s benefit is tied to market movements, but the asset manager’s income is not (at least not in the short-term, because continuous under-performance will result in the asset manager losing business).
Unintended Consequences Of These High-Cost Structures
Unequal Access To Banking Services
One of the unintended consequences of the above costs is that it is not feasible for everyone to be banked. Banks need to maintain profitability, and low-cost accounts for low-income earners are almost always unprofitable for them. It is estimated that nearly 2 billion adults across the globe are unbanked.
Unequal Access To Investment Opportunities
Another unintended consequence is that not everyone can afford the same investment opportunities. For example, in order to access investment opportunities abroad through your local broker, there are usually minimum investment amounts that less affluent people are not able to afford. Or even more simply, some people are not able to access the services of certain money managers unless they have some minimum amount of money available to invest. Less affluent people, therefore, have limited investment choices that do not offer the same advantages that are afforded to wealthier individuals. They typically would only have access to simple products such as:
- Investing in a collective investment scheme — Despite the fact that funds are pooled, the various fee items still greatly impact on investment returns.
- Investing in a notice account at a bank — Unfortunately, these accounts offer interest that barely (if at all) keeps up with inflation.
