Wednesday, January 15, 2014

Guerilla banking versus Gorilla banking: The potential of community-centric bank‏ing

Today the popular legal structure for large commercial entities is “publicly
ownership” along with stock market listing. While there are benefits of this
legal structure, their limitations are increasingly becoming apparent. These
limitations include

1. Agency problems
a. Managers stealing value from owners
b. Managers robbing Peter (one owner) to appease Paul (another owner)

2. Decreasing trust of stock market prices as representative of underlying
value

3. The stock market has allowed investors to "vote with their feet" on key
management decisions. But there is no known mechanism yet to enable
investors to increase their participation in operational decision making.

4. The mass ownership reduces the ability of firms to distinguish them
selves. Masses in human history have rarely understood complex value
propositions and so the stock markets have homogenized firms and made them
very short term focused

With rapid urbanization of the global village, customers want high touch
relationships. Given the level of anonymity and impersonal behaviours germane
to modern urban life, many urban communities are trying to create the
delightful community life common in rural areas. That enables them to
increase the quality and experience of life itself.

In this context, organizing retail financial service providers as
cooperative or mutual societies is better than organizing them as
proprietorship, partnerships or as the typical publicly owned companies.
Organizing this way allows retail customers to access financial services
customized to the community that they choose to be part of. We define call
such entities as community-centric banks. The benefits of knowing each other
help in improving the customers experience and helps in reducing operational
and financial risks, including agency problems. This operating and financial
efficiency is currently not visible in the stock market prices and hence
does not get the related hype associated with typical publicly owned firms’
at least yet. Nevertheless such community store-fronts are becoming
resellers of the financial services originated by the billion dollar gorilla
banks. It is one direction that global BFSI industry is evolving towards -
pushed by IT, customer preferences, financial efficiency and operational
efficiency.

The private/public limited companies or proprietorships/partnerships
nowadays were enabled by the older technological level of the world. Pushed
too far, we now have stock prices unrelated to underlying value, excessive
short term orientation by very short tenure CEOs. The hugely popular stock
market type of corporate ownership gives higher liquidity in exchange for a
short term orientation. The short term orientation creates most of the risk
management problems in financial service providers and complex algorithms
are a poor way of managing these problems. Secondly profits are removed from
the business periodically in this form of ownership.

IT can be leveraged in operations and risk management with higher level of
benefits and less number of drawbacks from the viewpoint of the customers of
community banks.

1. Profits are re-invested into the business. There is not need to pay
dividends.

Community banks can use IT to leverage this inherent cost advantage against
competition.

2. Due to local nature and small scale, risks are lower and easier to manage
through operational relationship-leverage systems and procedures...rather
than over-dependence on abstract statistical models.

a. People usually understand the credit rating of their neighbours better
than those of people 2 cities away.
b. And statistics models can hardly be trusted in a continuously changing
world for any real and/or large scale decision making.

Essentially community banks are less risky and have lower cost of managing
risks, due to the above reasons - a significant competitive advantage.

3. Customer preferences can be aggregated and used to customize offerings
and operational procedures while preserving bank-end choice in the wholesale
markets. To preserve that choice, they have to operate like guerrilla's who
typically leverage their knowledge of their local terrains to fight against
larger adversaries.

This remains the key competitive advantage of community banks

The small and medium scale nature of this market makes it a delicious pie
that IT services companies could easily bite into...and leverage for rapid
growth. In many ways this is an idea whose time has come. In many areas of
modern life, institutions which are leveraging technology in ways sensitive
to the various stakeholders are becoming more and more like co-operative
societies. The NHS is a prime and recent non-banking example that I know of.
The travel industry has been like this for a long time now. In the United
Kingdom, we believe that the building society sector is best equipped to
become community banks and derive competitive advantage by leveraging
information technology to engage their target communities in a mutually
enriching pursuit of shared values going beyond money.
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