Bankers know all about disintermediation.
For one thing, it's easily measured. When the industry's assets and liabilities run off to more specialized, nonbank institutions, it's reflected in publicly disclosed balance sheets and regulators' reports.
But disintermediation, or disaggregation, has a close relative that's much harder to figure out. This trend, called functional disaggregation, occurs when the business, operational, and technological steps needed to create bank products and services are handled by nonbanks.
It's caused primarily by the continued evolution of information technology and the need to create more efficient ways to manage technology and related investments.
The two types of disaggregation are somewhat linked. For example, many balance sheet disaggregators - such as a phone company or automaker - take advantage of the functional disaggregators when they issue credit cards. These nonbanks can go straight to a third-party processor and get exactly the same functional capability as a bank gets.
But while, say, the cash flowing into equity funds is tracked and published, measures of functional disaggregation are difficult to come by. Banking regulatory agencies do not publish any data on where or how banks actually produce their products.
This is surprising given the high degree of dependence that banks have on their suppliers. Moreover, thousands of individual banking production functions are not standardized and can be complex. What data there are usually cry out for interpretation and explanation.
For example, automated processing of consumer loan applications is an important industry trend, but the activity itself is not precisely defined.
Does it mean the "loan machine" that prints a check for an unsecured loan in 10 minutes at a kiosk in a shopping mall? Does it mean the consumer calling a computer at a toll-free number to get a nonbinding prequalification on a mortgage?
Does it refer to a wide area network that connects auto dealers with their indirect lenders' credit scoring and document preparation software? Or does it mean batch processing of a million names prior to a preapproved credit card solicitation?
All these methods (and others) are used today. But the exact rate at which they are employed, the market share each has for each type of consumer loan, and their cost-effectiveness are, generally speaking, unknown. Each method is being driven by new technology, but banks are usually in the dark as to how they will ultimately affect lending volumes and competitive postures.
There are some signs of the extent that bank products are handled by nonbanks:
About 11% of the nation's 63 billion checks are now processed by a third party, excluding the Fed or transportation companies.
About 68% of all credit card accounts are processed by nonbank third parties.
About 45% of all merchant acquiring activity is done by nonbank third parties.
About 10% of all automated teller machines are now owned and operated not by a bank, but by a third party.
There are many marketing and sales front-end specialists that include independent mortgage originators or leasing firms that sell the debt to a bank and the equity to an investor.
The largest deposit account processors in the country are no longer banks, but firms like Fiserv, Electronic Data Systems, Bisys, or Alltel.
As alternate retail delivery channels develop, the key players jockeying for position are nonbanks like Intuit Services, Checkfree, and Visa Interactive. In fact, NationsBank and its partners are investing in proprietary home banking software to counter the disaggregative trend and maintain control of retail home delivery channels.
Disaggregation appears elsewhere, too. For years, the Federal Reserve, Visa and MasterCard, the ATM networks, Chips, Swift, and the ACH have helped banks offer needed products and services.
But as technology automates new banking channels, new "utilities" are often required. Some examples:
The London stock market has a new system, called Crest, for settling stock transactions between trading parties and maintaining the central records of stock ownership.
Depository Trust Company's institutional delivery system dominates the U.S. marketplace for electronic trade confirmation systems. However, new systems such as Oasys Global, Sequal, or Trax, are being used extensively within the United Kingdom and, to a lesser extent, in continental Europe, Asia, and the Americas.
International Business Machines is working on two new utilities - an indirect auto loan origination network with Chase Manhattan, and INet, a proposed Internet banking network with a consortium of major U.S. banks.
Fannie Mae operates MornetPlus, a network that supports loan delivery to Fannie Mae and includes its loan origination software and others'. Any lender using the network can also access the secondary marketing system.
SEI Corp. is now offering a service called FundWeb to its trust provider customers that automates the steps from trade initiation through settlement.
Mondex is spinning itself out from a one-bank effort to a multibank consortium.
Of course, vendors have been heavily involved from the start - all of these new utilities involve technology companies in one way or another. Many of these firms have the needed integration skills and are willing to invest in required technology. Again, this is an example of how technology is tightly linked to the far-reaching nature of the functional disaggregative trend.
How far might this trend go? And what are the implications of this trend to the industry?
Within the next 10 years, we may see as many as 200,000 jobs transfer from U.S. banks to functional disaggregators. Because the volume of transactions and accounts will grow over that period, and the banking products produced by these disaggregators will have additional features and functions, it can be argued that overall bank and nonbank productivity will be higher.
As this occurs, we might expect the share of all bank technology dollars that are directed outside the bank to grow from 50% now to 65% or 70%.
Disaggregation affects banks of all sizes. Community banks, for example, could be viewed as the sales, servicing, and distribution agency for products that are made far away. The service bureau or technology company, in essence, is the "factory," and the local bank is the "store." This approach will only accelerate as "branded" financial products, such as well-known mutual funds, are piped through bank channels.
But it is unreasonable to expect that financial institutions will lose all their functions to technology companies. Banks will continue to create and manage the balance sheet, absorb risk, and manage the customer. Indeed, banks manage hundreds of millions of retail relationships - a task that technology suppliers are unlikely to take over.
What are some implications of the disaggregative trend?
First, the customer is generally not affected, and is unaware of who actually produces bank products and services. To the extent disaggregation improves services, which it generally does, the customer is better off.
Second, the natural inefficiencies in the boundary between the bank and its technology suppliers must be managed. As the number of potential suppliers continues to grow, each bank must make efforts to control and limit its total number of relationships to a number it can handle.
Third, many sources of banking product innovation now come from both technology suppliers and banks. Witness the rapid pace this year of public offerings from banking technology companies, ranging from Affinity Technology to E-Trade. The high valuations of these firms, while reflecting a bull market (at least through July), also show that disaggregated technology firms are viewed as industry catalysts with high growth potential.
Fourth, there is more to follow and it is harder to keep up. All banks need to recognize that precisely because technology is such a swiftly moving target, the sheer volume of options, choices, and solutions continues to spiral upward. Keeping informed is a nontrivial task.
Last, we could argue that the technology firms - those who are disaggregating the industry - have themselves a responsibility to the industry. Their forte is technology, but as they gradually play a larger role in the industry they must learn more about the business of banking.
Specifics include how bank product economics work, how banks differentiate themselves and seek competitive advantage, and, most important, what bank customers need.
In the long run, "banking" has to be redefined as an industry that includes, but is not limited to, banks. Some portion of the information services industry, which of course serves other industries, needs to be included in banking industry estimates.
Disaggregation is here to stay. The complete definition of the industry includes any type of firm that contributes to the creation of bank products and services.
