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Bank on the future

While Mr. Potter may be the proverbial banker who tries to bleed a community for every cent, in the technicolor, real world banking provides great benefit by moving money between people.  Technological changes mean that beneficial banking extends beyond the Bailey Savings and Loan.  There may be only one George Bailey, but these days, benefits are scalable.

Banks move money between people.  By making a deposit, money moves away from the individual in the present for a withdrawal in the future.  People often find it difficult to delay spending and will chose to do so if she can reasonably expect that in the future, she can easily access her assets and the assets will not fall too far in value. Without banks, planing for the future usually means placing money under the mattress and even if the money stays put, its value has likely decreased.

Deposits give the bank funds so that it can make loans: moving money from those who delay spending and those who want to spend now.  My deposits help fund my neighbor’s home and my pizza guy’s second oven.

Banks charge interest on loans partially because making a loan means that money cannot be used elsewhere: the interest rate compensates for a lost opportunity.  Banks with greater sources of deposits can offer lower interest rates because the value of the deposit decreases when there are many deposits.

If a bank gave out a $100 loan when $1000 in deposits just came in and more will likely tomorrow, the loan costs the bank less than if it had loaned $100 with no expectations of deposits.  Here’s hoping that last $100 offers a good return, otherwise, there’s no more bank.  Banks can then provide an excellent alternative to the kind of high-interest rates that arise when an institution, like a loan shark, has very few clients.

But if banks are so great, then why doesn’t everyone have a bank account?  In the US about 12% of all adults do not have a bank account.  Ease of access offers a potential explanation.  For those who primarily deal with cash, their mattress may be a better option than an account if a bank branch or an ATM is far away.  Language can also discourage banking when English is not a person’s primary language.  Finally, there may be a perception that bank accounts are suitable only for the more well-off.

Outside of the United States, distances between a banking branch and the individual are so great they become a barrier rather than a nuisance and banks often require extensive documentation to open an account, all of which contribute to the unbanked 50% worldwide.

Opening any brick and mortar store, including a bank, has high up-front and continuing costs.  Given that bank branches and ATMs are not necessarily ubiquitous when a Starbucks pops up every few blocks in Manhattan, does it surprise that sub-saharan Africa lacks banks?

Successful banking requires that trust between the bank and consumer: that the money will be there, that the loan will be repaid.  Ben Bernanke had the very compelling idea that the Great Depression lasted as long as it did because of a collective loss of faith between bankers and bankees.

Part of the process of “developing” involves developing financial institutions. There is no substitute for time when building a reputation and time is expensive.  A brand recognized in the United States might have some advantage but building local trust is not as simple as saying, “we’re big in America.”  Absent a robust local reputation, the bank will attract fewer deposits, meaning that its standards for customers become more stringent: fewer customers make it harder to offset a bad one.  Stricter requirements then lead to fewer deposits.  With such a cycle, is it any wonder that so many people choose to not bank?

Technology, though, alters the game.  Its actually very easy to transfer money from one person to another, completely electronically, without the bank as the intermediary.

Moving money electronically shows that money can be stored electronically. In the developed world, my individual bank account does not mean that some amount of cash is set aside in the vault with my name on it but that my name is associated with a certain amount of available funds.  If the developed world could start over and build banking around current technology, banks would have the incentive to encourage mobile payments. In such a world, banks would have much lower operating costs with fewer branches and ATMs.

The developing world, though, does not have this costly legacy.  They do have mobile technology and previously unmet demand for banking services.  And so while people in the developed world still debate the costs and benefits of near field communication, people in the developing world bank by phone.

While some might cry paradox that developing countries lead mobile implementation, it shows that high costs force resource optimization.  Technology is more than cool new ways to do old things; it provides new resources that allow people to overcome old barriers.  And while sharing photos of a rickshaw ride with people on Tumblr is cool, providing the tools for someone to invest in a rickshaw to expand a business is nothing short of awesome.



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