Breaking the Big Four banks

Silicon Valley’s payments war is bad news for Australia’s cosy corporate sector and our banks may have to reap a bitter harvest.

Apple’s announcement of its entry into the payments industry has further shaken up a once cosy business with serious consequences for Australia’s big four banks.

The last three decades have been good for Australia’s bankers; a recession proof economy has made residential lending an easy bet while business banking underwritten by proprietors’ home equity has been almost risk free and high transaction fees have ensured deep and steady cash flows.

In recent times those payment cash flows have started to come under pressure with the arrival of new services like Mint Wireless, PayPal Here and one of the fastest growing companies in the field, San Francisco-based Stripe.

One of the co-founders of Stripe, 24 year old John Collison, spoke to Business Spectator last month about how the company is looking at changing the payment industry by making it easier for businesses to accept electronic payments.

“We came to Stripe because we had built apps and web services before and it was phenomenally difficult to take a product you had built and turn it into a business,” Collison recalls. “At the time you had two options; you could turn your business over to PayPal, which was problematic for a whole bunch of reasons, or you’d build something from scratch.”

“It was clear to us that neither of the options was very good so we went about building something better.”

PayPal’s grand plans

While Collison is dismissive about PayPal, describing the company as having a desktop computing business model in a world that’s gone mobile, the incumbent payments giant has a grand strategy of its own.

In a tour of PayPal’s San Jose innovation centre, the company showed Business Spectator its range of payment products for small and big businesses ranging from mobile commerce services that automate point of sale systems through to the PayPal Here service that allows small traders to accept chip and pin card payments through their smartphones.

Not so long ago it was difficult to set up a merchant account with an Australian bank. A local shop or budding entrepreneur had to jump through numerous hoops with their bank to earn the privilege of accepting credit cards.

The service was cumbersome, slow and expensive.

Today it’s possible just to visit your local office supplies store, buy a PayPal Here terminal and start accepting credit cards within hours – at a fraction of the rates offered by the banks.  Accounting software vendor MYOB offers a similar service in partnership with Mint Wireless that directly integrates payments into a business’ accounts.

Along with providing services that are easy and quick to set up, the new providers are cheaper with simpler and more transparent fee structures.

Apple Pay gets the treatment

Given PayPal’s heavy investment in the various technologies it was barely surprising the company launched a vicious attack on Apple’s payment services this week with a campaign stating “we want our money safer than our selfies”, referring to Apple’s recent iCloud privacy troubles.

It seems though that embarrassment hasn’t hurt Apple in the marketplace with the company indicating it has entered into agreements with most of the major US banks and payment services along with a range of retail stores and other providers, including Collison’s Stripe.

A worrying development for the banks in these stories are reports Apple are negotiating with the credit card companies to reduce and possible even eliminate merchant fees. To make matters worse, The Financial Times reports this week that Apple are demanding the banks pay for the privilege of being involved in the Pay service.

If nothing else, Apple’s reported demands illustrate how the balance of financial power is shifting from the banking industry to the technology sector; a development that will trouble many of the world’s high paid bankers.

Another aspect of these developments is how the technology companies are using their deep pockets and healthy cashflows to move into other traditional banking areas that modern financial institutions have neglected.

PayPal has been a pioneer in this with its Working Capital program offering US and German businesses up to $60,000 in unsecured loans to clients. Globally, the capital starvation of small business since the 2008 financial crisis has been a problem and PayPal is looking at extending the service to the UK and Australia by the end of the year.

For the technology based payment provider, their analytics allows them to make better decisions about lending to small business. Having real time access to the financial performance of businesses gives them far deeper insights into the ability of companies to service their lines of credit.

The banks’ bitter harvest

Australia’s big four banks dismantled their competitive advantage in the local small business market by largely dispensing with traditional suburban business bankers over twenty years ago – now the algorithms are doing that job and it may well be that multinationals are better at this than the local financial institutions.

In many respects, the banks are reaping what they’ve sown with their obsession with home loans and abandoning small business relationships over the last three decades. It’s also somewhat ironic that the very technologies that have allowed banks to slash their costs and shrink their workforces are now eroding the financial sector’s own business models.

The banking industry is like many other service industry sectors that thought they were immune from global competition but are now finding out that technology is overcoming what incumbent executives and investors thought were insurmountable market barriers.

A wave of global competition is bad news for Australia’s banks, their shareholders and the nation’s superannuation funds that are grossly overweight in the Big Four bank stocks. For Australia’s smaller businesses they now have alternatives to the local oligopoly and the ability to demand a far better deal from the nation’s cosy financiers

For the bankers, competition has arrived. That’s great news for Australia’s small businesses, except maybe for the café owners in the bankers’ enclaves of Mosman and Brighton.