Dear,
The main characteristic of the new Financial System is Capital efficiency.
Over-leveraged Financial System and Limited growth make Capital scarce. Additionally, regulators are aware that an over-leveraged Financial System becomes insolvent with limited growth, consequently they increase capital requirements making Free Capital even scarcer.
At the same time technology is making possible new business models that compete with the traditional Financial System with dramatic reductions of the capital consumed.
In the old financial system, accumulating capital was a prerequisite before the capital could be invested or allocated. Regulation forces banks to collect the necessary capital for covering its potential losses, due to its exposure to Credit Risk (Risk Weighted Assets) or Market Risk (Value at Risk).
The more risk the bank is exposed to, the higher its capital requirements become.
Banks issue capital, debt, hybrid securities and deposits for covering their capital and liquidity requirements, these requirements must be covered before they can lend funds to their borrowers, otherwise they will face solvency issues, liquidity tensions and fines.
On the other hand, technology is making possible new models of financial services capable of operate without limiting capital requirements.
I'll explain it with an example from Foreign Exchange services.
Imagine that you’re a EU vendor dealing with a US customer, you must be ready to be paid in USD.
But as you don´t want to take the risk of suffering losses due to USD/EUR currency exchange fluctuations, you will hedge your risk signing a Forex Forward contract with your bank, paying a fee for transferring the risk to it.
As the bank will be exposed to Foreign Exchange Market Risk and potential losses, the bank needs to have Free Capital available in order of offering the service.
Consequently, the bank has to accumulate capital, for covering its potential losses, before it offers the service.
But in the last years we’ve seen new and more efficient alternatives for offering FOREX services in a Peer to Peer model.
https://transferwise.com/
http://kantox.com/en
These companies convert funds to foreign currency, for instance from EUR to USD, with requirements of other customers in the other direction (USD to EUR).
The foreign exposures are assumed by the counter-parties; the P2P platform only connects them and intermediates in the payments, “notarizing” the transaction.
The P2P platforms don´t assume any foreign exchange risk; neither require capital to cover it. Consequently, they can offer their services at a much lower price than traditional banking.
In fact, increasing capital requirements and scarcity are also increasing their competitive advantage.
You can find a more detailed explanation of the P2P model in the following post I wrote three years ago.
http://blogs.sap.com/banking/2011/12/21/new-models-capital-optimization-kantox/
Another example is P2P Lending; in traditional lending, the bank has to accumulate capital for covering its capital requirements, derived from the credit risk that the bank is exposed since the moment it commits to lend funds to a borrower.
But in P2P lending, the platforms connect people (or companies) requiring funds with investors willing to lend them. Again, the P2P platforms don´t have to accumulate capital before starting the process, because they do not assume the credit and market risk. As a consequence, they can offer their services with more competitive fees to the borrowers and investors.
https://www.prosper.com/
And this is just the beginning, new models of disintermediation are going to be more common and efficient with the disruptive technologies supporting bitcoin, blockchain or ethereum.
We’ll talk about them in future posts.
Looking forward to read your opinions.
Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860
K. Regards,
Ferran.
The main characteristic of the new Financial System is Capital efficiency.
Over-leveraged Financial System and Limited growth make Capital scarce. Additionally, regulators are aware that an over-leveraged Financial System becomes insolvent with limited growth, consequently they increase capital requirements making Free Capital even scarcer.
At the same time technology is making possible new business models that compete with the traditional Financial System with dramatic reductions of the capital consumed.
In the old financial system, accumulating capital was a prerequisite before the capital could be invested or allocated. Regulation forces banks to collect the necessary capital for covering its potential losses, due to its exposure to Credit Risk (Risk Weighted Assets) or Market Risk (Value at Risk).
The more risk the bank is exposed to, the higher its capital requirements become.
Banks issue capital, debt, hybrid securities and deposits for covering their capital and liquidity requirements, these requirements must be covered before they can lend funds to their borrowers, otherwise they will face solvency issues, liquidity tensions and fines.
On the other hand, technology is making possible new models of financial services capable of operate without limiting capital requirements.
I'll explain it with an example from Foreign Exchange services.
Imagine that you’re a EU vendor dealing with a US customer, you must be ready to be paid in USD.
But as you don´t want to take the risk of suffering losses due to USD/EUR currency exchange fluctuations, you will hedge your risk signing a Forex Forward contract with your bank, paying a fee for transferring the risk to it.
As the bank will be exposed to Foreign Exchange Market Risk and potential losses, the bank needs to have Free Capital available in order of offering the service.
Consequently, the bank has to accumulate capital, for covering its potential losses, before it offers the service.
But in the last years we’ve seen new and more efficient alternatives for offering FOREX services in a Peer to Peer model.
https://transferwise.com/
http://kantox.com/en
These companies convert funds to foreign currency, for instance from EUR to USD, with requirements of other customers in the other direction (USD to EUR).
The foreign exposures are assumed by the counter-parties; the P2P platform only connects them and intermediates in the payments, “notarizing” the transaction.
The P2P platforms don´t assume any foreign exchange risk; neither require capital to cover it. Consequently, they can offer their services at a much lower price than traditional banking.
In fact, increasing capital requirements and scarcity are also increasing their competitive advantage.
You can find a more detailed explanation of the P2P model in the following post I wrote three years ago.
http://blogs.sap.com/banking/2011/12/21/new-models-capital-optimization-kantox/
Another example is P2P Lending; in traditional lending, the bank has to accumulate capital for covering its capital requirements, derived from the credit risk that the bank is exposed since the moment it commits to lend funds to a borrower.
But in P2P lending, the platforms connect people (or companies) requiring funds with investors willing to lend them. Again, the P2P platforms don´t have to accumulate capital before starting the process, because they do not assume the credit and market risk. As a consequence, they can offer their services with more competitive fees to the borrowers and investors.
https://www.prosper.com/
And this is just the beginning, new models of disintermediation are going to be more common and efficient with the disruptive technologies supporting bitcoin, blockchain or ethereum.
We’ll talk about them in future posts.
Looking forward to read your opinions.
Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860
K. Regards,
Ferran.
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