Dominik Zynis

Candidate - MSc, Industrial Management & Economics

Prepared for Prof. Martin Andersson

Blekinge Tekniska Högskola

August 15, 2013

dominik.zynis@gmail.com

Topic: Mobile and Peer-to-Peer Banking

The methods by which societies exchange money for goods and services have begun to evolve and accelerate since the advent of telecommunications.  The latter half of the 20th century brought the rise of an international, global network of electronic payment systems which eventually consolidated under the control of a few large multinationals (predominantly, Visa and MasterCard). Merchants no longer keep lines of credit for their retail customers, and less frequently take payment in the form of cash or bank checks. Since the advent of the Internet there has been further innovations which have resulted in new entrants offering innovative services to allow consumers to easy spend money for for goods or services (Paypal, Bitcoin and similar services).  However, many of these entrants have faced nearly insurmountable regulatory hurdles.

Currently, two key trends may play an important role in the money transfer services sector.  First the ever growing presence of “mobile” technologies (phones, tablets, soon internet connected glasses, etc) and second, the development of peer-to-peer (p2p) networking technologies such as Bitcoin for transmission of virtual currency.

The paper will first examine briefly literature on theory of disruption, proceed to a review of recent literature on mobile banking, and virtual p2p currency, which will be followed by a synthesis to provide implications for incumbents and new entrants in the banking sector, primarily whether banking incumbents should innovate internally, spin out internal projects that involve disruptive technologies, and engage in partnerships and corporate venture capital.

Theory of Disruption

Christensen et al.  (2002) find that “‘disruptive technologies’—simpler, more convenient products that initially do not perform well enough to be used in mainstream markets—can take root in undemanding tiers of the market and then improve at such a rapid rate that they can squarely address mainstream market needs in the future” (pg. 961).^[1] Raynor (2011) conducted an experiment using Christensen’s disruption theory and found that when MBA students were exposed to four rules^[2] their predictive ability increased 50%.^[3]

For the industry covered in this paper Alt and Puschman (2012) find that four drivers are leading transformation in the banking industry: the recent "financial crises, the changing behavior of banking customers, the pace of diffusing innovative downstream IT-solutions, and the emergence of non-banks" (204).^[4]  Anderson claims that six areas that will impact banking where there are regulatory concerns, including: a six-fold increase in fraud for online vs. in-person, "high costs of the existing core cartel," circumvention of protections for consumers due to costs, "small risk of a large-scale technical failure", and loss of confidence in banking by consumers due to fraud (pg. 15 - 16).^[5] 

Mobile Banking: A case of Sustaining Innovation?

Whether mobile banking is a case of sustaining innovation or radical innovation depends on the context.  Anong and Kunovskaya (2013)  note the difference between “Additive models” that would be applicable in more mature banking markets and “Transformational models” serving the unbanked in lesser developed markets. (pg 454)^[6]  However, Alt and Puschman  (2012) find "third party social web applications, such as online investment communities and peer-to-peer business models, are emerging which include the possibility to compare bank products and to obtain neutral advice. These banking innovations are mostly provided by new actors for a realm of financial customer processes" (205).^[7]

Looking at the transformational case first Anong and Kunovskaya (2013) note a huge business opportunity for serving the unbanked in lower income developing countries (2.7 billion), and that there appears to be a correlation between use of mobile banking and prevention of families falling back into poverty - "Secure, low-cost, convenient and fast mobile financial services are able to increase productivity, income, and education of the rural poor, helping prevent them from falling back into poverty" (pg. 454).^[8]  Currently, the most popular case study regarding mobile banking is that of M-Pesa a mobile banking system used in Kenya.  Introduced in 2007, the M-pesa system which as of 2012 employs 50,000 people, has 15 million users^[9] (current population over the age of 14 is approximately 25 million)^[10]  It is important to note that the parent company of M-pesa, Safaricom, is not a bank, it is a mobile network operator.^[11]  The scenario in Kenya appears to be in line with Christensen et al. conclusion that “ vertically integrated firms will often dominate in the most demanding tiers of markets that have grown to substantial size,while a horizontally stratified, or disintegrated, industry structure will often be the dominant business model in the tiers of the market that are less demanding of functionality” (pg. 956).^[12]

The additive case, is presented in a case study of Nordea’s developments in e-banking where Ender et al. (2006) apply Christensen’s Disruptive Innovation Theory and find that the “Internet has been a sustaining innovation at Nordea and... that pure e-banks are unlikely to create a disruptive innovation in the retail banking industry” (pg. 67).^[13]  The case study is somewhat dated and prior to the emergence and wide adoption of smart phones and tablets, however their conclusions stand. In a more recent study Alt and Puschman (2012) cite numerous examples of telecommunications and IT-oriented companies entering the banking space to  “provide innovative IT solutions. While online banking systems are still limited to payment transactions and security order management systems” (pg 205) whereas they find that Google has acquired banking licences in over 100 countries and Apple has well over 16,000 financial services apps.  It appears that mobile banking is not merely a sustaining innovation but that it may well be a radical innovation as exemplified by the horizontal integration of new mobile banking applications.

Virtual & P2P Currency: A case of Radical Innovation?

Dodd (2012) notes that two opposing forces have developed in the monetary system over the last couple decades that of centralization "driven by dollarization and monetary union" and decentralization driven by "alternative monetary forms" (pg. 161).^[14] The current most popular alternative monetary form to come to existence was created in 2009 takes the form of a p2p distributed ledger which allows its users to transfer monetary value across international boundaries with a level of anonymity that appears to skirt regulatory requirements for money transfer as dictated by the UN Convention against Transnational Organized Crime 2000 (“Palermo Convention”), namely “Customer Due Diligence (CDD) and Suspicious Activity Reporting.”^[15] 

Despite this, Ramos (2013) claims that “peer banking” is an alternative that “rather than simply strengthening market actors via trans-territorial opportunities and investment, p2p enterprises may displace or make obsolete some market actors, in particular those extracting value through the imposition of artificial immaterial scarcities” (pg. 75).^[16]  Currently, currencies such as Bitcoin are already being used for crowd-sourced funding of projects, trading on “virtual” stock exchanges, virtual currency derivatives, loans, and of course purchasing of legal and illicit goods and services. Applications have been developed that provide among other services escrow services, reputation services, and secure storage services.  

Beyond Bitcoin there already exists a plethora of virtual currencies, they currently can be segregated into five categories according to Selldahl (2013) : “Prepaid value, Loyalty points, Monetization currencies, Gaming currencies and Value encoded currencies” (pg. 89).^[17]  In any case these virtual currencies allow consumers and businesses to interact without the need of a bank as an intermediary.

Conclusion

With regard to mobile banking it is appears that the banking sector is facing a transformation where customers in both developing and developed markets are utilizing services coming from non-banks.  Mobile banking does not appear to be merely a sustaining innovation. That has several implications, while some customers may still value facetime with a banker, they are more likely to get financial information from non-banks, thus resulting in a weakening of the customer-banker relationship.  If banks wish to remain a dominant presence they will either need to form partnerships or focus their strategy on corporate venture capital as it is unlikely based on  for them to drive internal innovations in the area of mobile banking.  Mobile banking related projects should be spun-out to increase the probability of success and shareholder value.  

P2P banking while completely different in some ways to the traditional banking model may present a unique opportunity for banks.  Banks are specialists in security, risk,  fraud and adapting to regulatory regimes.  However the current p2p banking technologies appear to skirt regulations designed to thwart and detect money laundering, tax evasion, and threat and drug finance. regulators are typically slow to move and there is a risk that these technologies (like p2p file sharing) reach a critical mass where consumers no longer see the value in traditional banking.  In this case banks will need to innovate to provide new products and services centered around their core (security, fraud, regulatory demands on consumers and businesses) around this new form of banking.  Again as in the case of mobile banking they will likely need to pursue a verticalized strategy where they offer their services to a partner ecosystem whether it be providing security to p2p digital wallet holders, acting as escrow agents, evaluating risk for crowd-funding investors, or providing services which enable consumers and businesses to meet regulatory requirements.