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Mediterranean methods

As events over the last few weeks demonstrate, the European banking crisis has remained bubbling away in the background. The rescue of Banco Popular Español by fellow Spanish institution Banco Santander sent sighs of relief around Madrid. The seemingly never-ending Italian drama continues apace while yet another Greek rescue package is under discussion: clearly Southern Europe remains weak. Nor is elsewhere in Europe immune: yesterday brought the news that Barclays (bankrolled by the Qataris) is being charged by the UK's serious fraud office in relation to number of offences. The failure of Banco Popular Español must be a cause for concern. The Spanish lender's demise was not flagged by the European Banking Authority's stress tests in mid-2016, which must call into question the validity of these exercises. The nominal sale price of €1 tells a tale of its own, with Santander riding to the rescue. Spain This rescue is also significant as it was the first time that the EU's new Bank Recovery and Resolution Directive (BRRD) was called into action. Shareholders and junior bondholders felt the brunt of the new regime, while senior bondholders survived unscathed. The BRRD was put into place with the goal of eliminating the need for a state-led bail-out of a failed institution, thereby saving taxpayers hefty sums. While this has been achieved, the circumstances involved in this rescue mean that the boundaries of the new regime have not yet been fully explored. Santander was willing to take over Banco Popular, restructure the bank and raise approximately €7 billion in additional capital. However, if Santander or other potential investors had been unwilling to acquire the failed lender, then it would have been likely that the authorities would have had to impose losses on senior bondholders and unsecured creditors (ie, depositors). The former would have surely caused anxiety on the bond markets, while the latter would have certainly unleashed a political storm. So, while the intervention by the European authorities passed off without a hitch and barely a murmur, a couple of caveats must be borne in mind. Firstly, neither senior bondholders nor unsecured creditors were affected, which means that the most far-reaching elements of the new regime have yet to be implemented — and thus the reaction from the markets and from the public remains unknown. Secondly, Santander had very little time to carry out due diligence on its new acquisition. Banco Popular Español's loan book includes a relatively high percentage of non-performing loans: one hopes that this acquisition does not backfire on Santander. Italy In Rome, meanwhile, attempts to rescue banks continue apace. Both Veneto Banca and Banca Popolare di Vicenza are the subject of rescue efforts, as both lenders suffer from capital shortfalls. However, the approach adopted in Spain will not work in the case of the Veneto banks. This is because neither of Italy's banking champions — UniCredit or Intesa Sanpaolo — are willing to take over either of the ailing institutions on their own (in contrast to Santander's decision to acquire Banco Popular). This leaves the Italian and European authorities in a bind. If either of the ailing banks fail, then — as per the conditions of the BRRD — shares would be converted to equity while losses would be imposed on junior bondholders. However, due to the prevalence of ordinary retail investors among junior bondholders in Italy, any such action would almost certainly cause a political backlash. However (unlike in Spain), this does not take into account the likely non-intervention of a national banking champion. Under this scenario, any bank failure could easily trigger losses for senior bondholders or a haircut for unsecured creditors (in addition to shareholders and junior bondholders suffering losses). As this scenario has yet to come to pass, it is difficult to predict how it would play out. However, it is likely that investor confidence would be shaken while there would almost certainly be a public backlash. This means that in the case of a failure, the scope for a bail-in is limited. However, the entire point of the BRRD is to protect the taxpayer from expensive bank bail-outs — even when the state would prefer to rescue institutions, as is the case in Italy. This leaves the Italian authorities in a difficult position: The BRRD prohibits state bail-outs (except under exceptional circumstances); Imposing a bail-in would almost certainly result in a public backlash and precipitate a political storm; A private investor such as Santander has been (thus far) unwilling to step forward and take-over any ailing institution. This is most likely due to undercapitalised banks, over-banked markets and the general lack of incentives to invest in these institutions. Europe European authorities too find themselves at a tricky pass. The mountain of NPLs on the books of Italian lenders is not going away and has to be dealt with somehow. The country's economy is stagnant and has been since it joined the common currency. While this has been caused by several factors, membership of the euro prevents Italy from resorting to its tried and trusted pre-euro strategy of depreciating the lira. This weakened the domestic currency and boosted exports, giving the industrial north a chance to grow (at the expense of higher inflation). Now Italy cannot grow its way out of stagnation, meaning that it is difficult to see how a significant dent can be made in the pile of NPLs. This situation has forced European authorities to acquiesce to long-running requests from Rome for state intervention to shore up Monte dei Paschi di Siena. This effectively amounts to a state bail-out, with initial reports of an injection of some €6.6 billion (the latest of a series of attempted injections of state-aid). Leaving aside the inconsistent application of a one-size-fits all European directive to troubled lenders, the most important takeaway from the last few weeks is that crisis continues to haunt the European banking system, especially in Southern Europe. The Spanish solution may not be possible in many cases, while state intervention along the Italian lines would first have to meet European regulatory approval, which is difficult to achieve. The full implementation of the BRRD is the known unknown: how will markets and the public react to losses imposed on investors and depositors?

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The Atlantic Conundrum

Europe and America are home to the most entrenched banking systems in the world — and must make their peace with fintech realities When the next definitive history of banking is written, the chapter on the Global Financial Crisis will surely be followed by one detailing the dialectical encounter of traditional financial institutions with digital technology. It may be that the second of these two chapters will be longer: universal banking may have been chastened by the events of 2008, but the impact of the digital is revolutionary. However, a sceptic might argue that banking entered the digital age long before many industries, half a century ago now in some cases. That is true. And yet retail banking as it is largely practiced in 2017 is like the compact disc era in music: digitalism on the terms dictated by the incumbent. This can only last so long. The long-term resolution of the banking plus fintech equation will mean to the banking industry much as Spotify and Napster meant to the music industry: consumer expectation and savvy will zoom upwards. The result will be that, when it comes to the mass market, intuitive and powerful platforms will be a basic requirement. With the implementation of PSD2 on the way in Europe, it may be that banking, despite trade worries over the propulsion of third-party payment service providers into their space, is in fact getting a head start on the race into the future. Europe The shift is global, but there are revealing parallels at work on either side of the pond when it comes to fintech's relationship with banks. In the European Union, the most recent flashpoint has been the screen-scraping tussle that arose when the proposed Regulatory Technical Standards were released four months ago by the European Banking Authority (EBA), an EU agency. Here is the key passage: ...the EBA has decided to maintain the obligation for [banks] to offer at least one interface for [third-party providers] for access to payment account information. The...existing practice of third-party access without identification referred to by a few respondents as 'screen scraping'...will no longer be allowed once the [Regulatory Technical Standards] apply. In other words, the new players can't come in the hall door, but will have to use a service entrance — from November 2018, which is the earliest date at which they can apply. This proposal, advanced on the grounds of security and yet to be ratified by the EU, was interpreted by many in the fintech sector as a defensive wall being thrown up to block their progress. It remains to be seen how radical PSD2 will actually turn out to be. As one tech executive (Ralf Ohlhausen of PPRO Group) put it in a recent Reuters article: "We have serious concerns that if banks are given a choice, they will try to limit the access and make our life difficult. We can't have access blocked by an underperforming API". America In the United States, a Fintech Charter being crafted by the regulator seems to posit fintechs as depository institutions — with appropriate regulations in train. This is still a work in progress and already under fire. Again the tech start-ups are unhappy, feeling that a wall is being erected to protect the industry's collective lunch. But the convergence now in process calls for disciplined and dispassionate thinking: at the vanguard are those banks that are profoundly rethinking their role. One such is Suresh Ramamurthi's oft-profiled CBW Bank. CBW's thinking is to transform the bank into the purveyor of a Platform-as-a-Service (PaaS). Visionary models like this not only upgrade services for customers through the pooling of innovations but can also fortify the bank's position in the market as the quality-guarantor of a new ecosystem. Amazon is the most breathtaking case of a company (originally an online bookseller) transforming itself itself into a market-interactive platform of this kind. As perennial fount of wisdom, Seth Godin, observed recently: "in interactions that lead to connection, to shared knowledge, to possibility, it's pretty clear that there isn't a zero-sum game being played. In fact, the more enthusiasm and optimism people bring to the interaction, the more there is for everyone else." The conundrum on either side of the Atlantic boils down to not letting the banking industry be, in effect, destroyed by digital technology, to not let Citibank or Lloyds, to take two random examples, not go the way of Kodak or EMI. That will take courage, at all levels of banking, not just in the c-suite. In China meanwhile, the powers-that-be have created a fintech committee that will soon produce recommendations which, as is the way in one-party states, should soon become law. Any Incumbent v Challenger, or indeed Regulator v Regulator, battles will be settled — if they have not been already — far from public view.

Payments & the Coming Wave: Pt 1

It is a common observation that there are four stages in the development of an economy. Long forgotten in the developed world, there is the requirement simply to stay alive; hence the primary stage in economic development that becomes the agricultural economy . Once that fundamental need is satisfied, the focus turns to production; initially the tools of production and then, as the eye turns towards lifestyle, there are the tangible 'things' that improve everyday experience: this is the manufacturing economy . As lifestyle needs and aspirations grow, there comes a degree of satiation with mere 'things', and production of those things is outsourced to less developed, cheaper locations: against this background arrives the services economy to serve peoples' 'wants'. Then the focus shifts to the sources and application of capital that facilitates and powers this ever more sophisticated economy. This is the final stage: the financial economy . The increasing presence of finance in all our lives is not just an economic phenomenon, it is cultural. Finance had already reached unprecedented levels of visibility when it crashed into ordinary people's lives with disastrous consequences as a result of the crisis that began in 2007. It was at this point that the financialisation of the developed world became all too apparent and, in the dire circumstances of the time, the term 'financialisation' implied not so much economic sophistication as something to be viewed with a jaundiced eye. This is unfortunate, although understandable. It is ironic that the first financial derivatives were developed specifically from the need of farmers to secure forward prices for their products: to provide some revenue certainty in a capricious business operating in a capricious climate. Over time, a vast amount of trading in derivatives came to be undertaken for speculative purposes and with no reference to the actual quality of the underlying assets. The introduction of Europe's revised Markets in Financial Instruments Directive (MiFID II), which has, as a specific objective, the introduction of limits on speculation on commodity derivatives, is recognition that financialisation can be a monster with insatiable appetites, potentially divorced from intended purposes — such as risk management. No one suggests that the invention and deployment of high-risk financial instruments for wholly speculative purposes — so-called 'financial weapons of mass destruction' — is defensible. These have the capability to harm individuals and economies far beyond their principals. But such focus on relatively rare (though widely toxic) phenomena deflects attention from the enduring capacity of financial innovation to contribute meaningfully to the overall economy. From a Developed World-perspective, we tend to take financial system sophistication as a given and tacitly assume that if the end-point in this process has not yet been reached then it is certainly within sight. This is mistaken. In fact, even in the developed world, and in spite of the enduring fallout from the financial crisis, any 'saturation point' remains a long way off. The challenge is to redirect and modify efforts to unlock the massive latent demand that exists for financial services but which lies behind a wall of ignorance, suspicion and poor communication. And a new wave of financial innovation has surely begun. Digitalisation + Regulation This wave's momentum is being propelled by the dual forces of digitalisation of payments in tandem with enabling regulation. In examining the phenomena responsible for the new age of digital banking, Europe is a good place to start, and specifically the impact of the revised Payments Services Directive (PSD2), including the Access to Account (XS2A) rule that obliges banks or other payment services providers (PSPs) to facilitate access via APIs to their customer accounts and data where the account holder gives consent. This is the new world of Open Banking. The loss of traditional card-based fees from EU legislation is well understood but perhaps even more fundamentally, within Europe at least, PSD2 and XS2A are set to finally dissolve any sense of customer ownership banks might once have had as accounts information and payment initiation services are opened up to third parties via APIs. The reason for this is simple: while banks might once have imagined that there was resonance in the customer relationship through supply of trusted services, facilitation of a payment transaction cannot compete with the customer experience around the possession or use of the associated good or service. It is the difference between a payment experience and a shopping experience. This new world threatens to polarise the world of banking. As banks lose their grip on customer ownership, so the attraction of monetising data and becoming massive utilities for new third party providers (TPPs) becomes greater. Meanwhile, a rump of smaller players are working harder within the new environment to create a digital ecosystem that attempts to link the bank-customer-merchant triangle through open APIs the better to provide contextual, timely and relevant advice, products (financial and non-financial) and experience to their customers. In Part Two of this article, Peter Kinahan will examine recent moves in the area from BBVA, as well as the possibilities of a '360° view' of the customer For more insights from this Lafferty thinker, read the just-published Payments Power: How digital payments will unlock massive latent demand in consumer banking , available at If you have yet to obtain your copy (for example, as part of your Lafferty Councils membership), use promo code WP17PCW to avail of a ten percent saving at checkout . We would like to invite you to join global leaders in cards, payments and banking at The International Cards and Payments Conference 2017: Thriving in the new world disorder , a two-day conference in association with ClearBank, the UK's first new clearing bank in 250 years, taking place on 19-20 September 2017 at One Whitehall Place in London. Visit to view the agenda and a list of speakers. Use the exclusive promo code LAFFERTY 10% for a ten percent saving on registration.

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