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Tuesday
Nov272012

Prising apart lending and deposit taking

An important theme on this blog is the disaggregation of the value chain in financial services. Usually what I mean by this is the separation of payments from the core banking services of deposit taking and lending. But perhaps even more interesting is the separation of deposit taking and lending themselves. 

Taking deposits and then on-lending them appear inseparable, but we don’t have to look very far for examples to show that they aren’t. In the developed world, a galaxy of specialized lenders such as credit card issuers and mortgage lenders focus squarely on the asset side of their balance sheets; in developing countries, many microfinance institutions work the same way. Without deposits, these entities fund their operations from equity or by borrowing wholesale in the capital markets. Conversely, there are banks like ING Direct that accept deposits but don’t make retail loans, and of course an increasing number of non-banks like Safaricom accept what walk and talk like deposits from customers. (If it weren’t for poorly thought through rules, some of these would even pay interest.) These entities aren’t allowed to on-lend those funds (for that would make them banks) or invest them in risk assets, so they park them in a regulated bank account instead.

In all these cases, financial intermediation—that is, the transformation of savings into capital that can be used by others for investment or consumption—doesn’t stop; rather, it occurs through new channels, facilitated by multiple institutions rather than one.

The separation of deposit taking and lending is good for consumers in part because it permits specialization. Surely one of the reasons that credit-card issuers like American Express and Capital One are good at what they do (and I mean good both in the sense that they offer products and services that customers like and in the sense that they do so quite profitably) is that they are focused on just on side of their balance sheet, whereas to excel as a bank, you have to win in two very different product lines.

If this is true for giant companies, it is especially so for startups, which can typically only hope to do one thing properly at a time. As such, the growing separation between lending and deposit taking is helping to make financial services more attractive to entrepreneurs. This in turn creates further value for consumers by exposing the retail banking sector to the kind of competition that more nimble upstarts bring to bear.

Technology (including but not limited to mobile technology) is an important catalyst for this divorce of lending and deposit taking. First, technology is making product innovation in both areas easier. In the UK, payday lender Wonga offers an ingenious design-your-own loan facility online; Zidisha is working on something conceptually related, but optimized for poor countries. On the deposit-taking side, M-PESA and its progeny are made possible by widespread mobile connectivity.

Second, technology makes it easier for customers to pick and choose financial services from different providers. A major enabler of the big retail banks’ “financial supermarket” strategy was the degree to which it was annoying for customers to open and maintain accounts at multiple institutions. Electronic channels (e.g., online and mobile banking) means that such “multi-homing” is much easier than it used to be. This in turn allows customers to use a wider range of financial instruments, offered by a larger number of institutions, to manage their financial lives.

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