Costs, Increasing Transaction Frequency
Every day most Americans swipe their credit cards for groceries, utility bills, or a night out on the town. Charges are applied – merchants pay roughly 30 cents plus 3 % of the value of the transaction – and while expensive, merchants oblige because of the convenience credit cards offer to their customers. Given that most retailers have 5–10 % net margins, taking credit card payments often wipes out half or more of their profits! Furthermore, imagine that you are a merchant who is also a part of the three billion people (50 % of the world’s population) living on less than $2.50 a day. The 30-cent credit card fixed fee just does not add up. Who would pay a third of their income (plus taxes, which often do not get collected on cash transactions) just to swipe a card?
In this case, bitcoin – the internet of money – holds promising potential to bring transaction costs down. Anyone can send thousands of bitcoins across the world just as easily as sending one hundredth of a bitcoin, without incurring transaction or remittance fees. Moreover, unlike cash, full information details on the transaction can be attached to it, and be programmed to disburse only after whatever condition has been agreed upon is met – all without any extra cost. Talk about reducing the costs of moving money around!
Most of the costs of holding and moving small balances will be stripped out of such a system (eventually including deposit insurance). Electronic delivery and instant disbursement of funds will take place via mobile phone. Daily amortization would be possible for microloans. Pay as you go financial services are on the horizon. As the frequency of transactions increases, across all financial services, the ability for all participants (both customers and lenders) to better react and prevent financial shocks will improve dramatically.
Non-banks, all while still turning a profit and serving more clients, will perform many of the banks’ functions better. It is natural that service providers that interact more frequently with clients (mobile phone, retailers, internet providers) perform many of the consumer relationship functions. In many scenarios, banks will need to partner with such lower cost providers in order to remain competitive and relevant to the consumers who are experiencing financial services for the first time. One really wonders what banks will use their branches for 20 years from now!
Change is Coming, Past a Bank Near You
The current banking system is not equipped to carry out the challenging task of adapting to the new digital landscape. Banks use mostly centralized legacy technology infrastructure, and rely heavily on expensive branches and manual processes. Moreover, given their role in the recent financial crisis, they will keep facing increasing capital and regulatory constraints. Banks will continue to pull away from lending to “risky” clients. Given their high cost base, banks cannot afford to underwrite and lend money in small amounts, as would be convenient for clients.
Under this cost structure, banks rely heavily on fees and tricky penalties to make money – no need to hold capital reserves to earn those. Take the overdraft, which generates $30bn+ in fees per year,32 on automatic overdraft loans of less than $30bn+ annually. One FDIC study found that the average consumer would pay an implied APR of 3520 % on a $24 ATM overdraft (at the median overdraft fee of $34) – if the overdraft loan were paid back in two weeks.33 By the way, in 2007, total overdraft charges were $17.5bn, so this line item has grown at a “healthy” 9 % CAGR since.
Marketplace lending platforms hold the key to making finance as significant and well-distributed as it should be. Embracing new data sources and underwriting techniques, as well as using cost-reducing and feature-enabling technologies like bitcoin and the blockchain, is where the next mass-scale opportunities will be unlocked. Lending in the 21st century comes with the promise of transforming the world. The addressable market is immense – five billion people strong. There are plenty of loans yet to be made, and one trillion of them might just be the beginning.
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