Are Banks Destined To Become The Next “Dumb Pipes”?

It seems like there are a lot of folks in the popular media talking about the future of financial services these days. In particular, the growing competition banks face from a new crop of technology companies who are meticulously chipping away at their business by “unbundling” many of their bread-and-butter banking services.

Some writers breathlessly proclaim that unbundling spells demise for big banks. I don’t think so. The “unbundling” of financial services is not going to drive banks out of business. Banks have massive structural investments (literally, many billions of dollars of accumulated balance sheets) and positional advantage gained from decades of relationship-building with regulatory and law-making bodies. Those assets won’t evaporate overnight, even if a bank loses control over the primary user interface with customers through unbundling.

If you take a step back and compare across industries, you’ll find other sectors where huge entrenched companies have made large investments in infrastructure and built regulatory expertise. Large telecom networks like Verizon and AT&T have positional advantage because they’ve laid down millions of the miles of copper wire and built the hundreds of thousands of cell towers that make modern communications possible. They’ll be relevant and important players in the U.S. economy for a long time. However, they’ve lost market power because they are no longer in control of the primary user interface to American consumers — they’ve lost it to technology giants like Apple and Google.

Carriers used to play a dominant role in telecommunications because they controlled the infrastructure (copper wires and cell towers), customer devices (phone handsets), the operating system (dial tone) and the popular applications (phone dialer and text messages). The unbundling of telecommunication infrastructure, devices, OS and apps has led to an all-out power struggle for primary relationship with the consumer.

Between popular application publishers like Facebook, OS vendors like Google and computing equipment companies like Apple, there has never been more choices for consumers. While it’s not yet clear who exactly will win this battle in the end, it probably won’t be AT&T or Verizon, because they’ve lost control of all the layers above infrastructure — the telcos no longer control which devices you can use on a given network, the operating system that devices run nor the apps.

Traditional banks that fail to dramatically reinvent themselves for modern consumers will find themselves playing the role of a simple inbox for depository funds.

Apple’s newly announced Upgrade program to buy the latest iPhones from Apple directly is the latest salvo in this battle. With this program, consumers can forgo purchasing their phones through telecom network providers and buy directly from the manufacturer, squarely casting carriers into the role of “dumb pipes.” Apple is smartly asserting influence over multiple layers in the communications stack: devices (iPhones and iPads), operating system (iOS) and apps (iMessage, FaceTime, PhotoStream, etc.). By doing so, they’re gaining the power to shape how telecommunications services evolve.

We can look at the last couple decades of competition in the telecommunications industry as an analogy to predict where the financial services industry is headed in the United States. The big U.S. banks have historically dominated financial services because they controlled or influenced infrastructure (ACH networks, bank branches, regulatory structure), customer hardware (ATM machines, checkbooks), operating systems (rules and procedures for check clearing and underwriting loans) and financial applications (cash management, paying bills, depositing checks, wire transfers, car loans, mortgages, etc.).

Now, just as with telecommunications, all the layers above infrastructure are up for grabs. That’s what “unbundling” means for banks. Banks lose power when consumers are no longer reliant on an ATM machine to move money, or when consumers are able to get a loan through a non-bank online lender or when a personal finance app becomes the primary interface for a consumer to manage their money.

The telcos hate the term “dumb pipes” — and for good reason. They are being relegated to the common conduits through which meaningful communications and commerce take place. But telcos won’t go away overnight because there’s still a lot of value in the physical network infrastructure and cell towers they built through decades of investment.

Similarly, “unbundled” banks won’t go away overnight; there’s still a lot of value in the intra-bank money transfer networks and the depository role that banks are uniquely allowed to play in the U.S. economy. However, over time, traditional banks that fail to dramatically reinvent themselves for modern consumers will find themselves playing the role of a simple inbox for depository funds and pipes that move the money to other financial services providers who will increasingly influence consumers’ financial lives.