A short history of credit card design choices

One for the banking and payment nerds I suspect but I at least found this discussion of some of the design choices associated with our card payment system to be well worth reading for a perspective on how the choices baked into the system were made and how cards adapted to the proliferation of increasingly online business models

bam.kalzumeus.com/archive/credit-cards-as-a-legacy-system/

Tony – From The Outside

Bank risk culture

APRA today released the results of a survey of how Australian ADI’s (i.e. “banks” for anyone reading outside Australia) believe they are doing on the question of risk culture.

What I found most interesting was the gap between what the executives believe and what the people on the front line believe as reflected in these two charts

Figure 5. Psychological safety – Management vs Individual Contributors
Figure 8: Decision-making effectiveness – Executives vs Individual Contributors

Creating an environment in which people truely feel safe to speak up is hard but it does appear that there is a lot more work to do. The first book that comes to mind when I read about risk culture is Creativity, Inc which explores (amongst other things) how Pixar institutionalised “Candour” into the business. Michael Mauboussin’s “The Success Equation” and Greg Ip’s “Foolproof” are also useful guides for avoiding hubris and general overconfidence in your risk management process.

I have to say that the challenge of speaking up is one that resonates with me from my time in the front line and it appears that there is still more to do. Personally I quite liked Pixar’s “brains trust” solution.

Tony – From the Outside

Bronte Capital: An old story in modern times. Duncan Mavin’s pretty darn good book on Greensill

The story of people in finance doing dumb things never gets old for me. I will probably shut my blog down when I figure out why the same old mistakes keep getting repeated. I look forward to reading Duncan Mavin’s book but in the interim John Hempton’s review offers a quick recap.
— Read on brontecapital.blogspot.com/2022/10/an-old-story-in-modern-times-duncan.html

Tony – From the Outside

Margin calls …

… seem to be on the increase.

This post by Marc Rubinstein offers a short but detailed summary of what has been going on, why and what it means for markets. Read the whole post but one of the key issues for me is increased procyclicality…

The drawback of a heavily collateralized market, though, is its tendency to inject procyclicality into the system. Periods of market turbulence can drive sharply higher collateral requirements, which can prompt more turbulence if that leads to forced selling – such as we saw in the UK last week.

Marc Rubinstein, “Net Interest” Blog – 8 October 2022

Tony – From the Outside

The empire strikes back?

There is a lot written about how bad the US payment system is and why crypto solutions are the future. Against that background, Tom Noyes recently published an interesting post setting out his thoughts on a project JPM Chase is running to reengineer their payment system. Tom’s posts are normally restricted to subscribers but he has unlocked the first in a 5 part series exploring what JPM Chase is doing.

His post is definitely worth reading if you are interested in the future of banking. The short version is that the traditional banking system is not sitting still while crypto and fintech attempt to eat its lunch.

Tony – From the Outside

Those ACH payments

One of the mysteries of finance is why the USA seems to be so slow in adopting the fast payment systems that are increasingly common in other financial systems. Antiquated payment systems in TradFi is a frequent theme in DeFi or stablecoin pitches which argue that they offer a way to avoid the claws of the expensive, slow and backward looking traditional banks.

Every time I read these arguments in favour of DeFi and/or stablecoins, I wonder why can’t the USA just adopt the proven innovations widely employed in other countries. I had thought that this was a problem with big banks (the traditional nemesis of the DeFi movement) having no incentive to innovate but I came across this post by Patrick McKenzie that suggests that the delay in roll out of fast payment systems may in fact lie with the community banks.

The entire post is worth reading but I have appended a short extract below that captures Patrick’s argument on why community banks have delayed the roll out of improved payment systems in the USA

Many technologists ask why ACH payments were so slow for so long, and come to the conclusion that banks are technically incompetent. Close but no cigar. The large money center banks which have buildings upon buildings of programmers shaving microseconds off their trade execution times are not that intimidated by running batch processes twice a day. They could even negotiate bilateral real-time APIs to do so, among the fraternity of banks that have programmers on staff, and indeed in some cases they have.

Community banks mostly don’t have programmers on staff, and are reliant on the so-called “core processors” like Fiserv, Jack Henry & Associates and Fidelity National Information Services. These companies specialize in extremely expensive SaaS that their customers literally can’t operate without. They are responsible for thousands of customers using related but heavily customized systems. Those customers often operate with minimal technical sophistication, no margin for error, disconcertingly few testing environments, and several dozen separate, toothy, mutually incompatible regulatory regimes they’re responsible to.

This is the largest reason why in-place upgrades to the U.S. financial system are slow. Coordinating the Faster ACH rollout took years, and the community bank lobby was loudly in favor of delaying it, to avoid disadvantaging themselves competitively versus banks with more capability to write software (and otherwise adapt operationally to the challenges same-day ACH posed).

“Community banking and Fintech”, Patrick McKenzie 22 October 2021

Tony – From the Outside

Matt Levine on stablecoins

Quite a lot has been written about the backing of stablecoins but Matt Levine uses the Tether use case to pose the question how much it matters for the kinds of activities that Tether is used for …

The point of a stablecoin is not mainly to be a secure claim on $1 of assets in a bank account. The point of a stablecoin is mainly “to grease the rails of the roughly $1 trillion cryptocurrency market,” by being the on-blockchain form of a dollar. We talk somewhat frequently about stablecoins that are openly backed by nothing but overcomplicated confidence in their own value; to be fair, we mostly talk about them when they are crashing to zero, but still. The thing that makes a stablecoin worth a dollar is primarily that big crypto investors treat it as being worth a dollar, that they use it as a medium of exchange and a form of collateral and value it at $1 for those uses. Being backed by $1.003 of dollar-denominated safe assets helps with that, but being backed by $0.98 of dollar-denominated assets might be good enough?

Matt draws no distinctions above but I don’t I think his argument is intended to apply to stablecoins that aim to challenge the traditional payment service providers (“payment stablecoins”) operating in the broader financial system. It does however pose an interesting question about how much stability crypto traders really require.

Tony – From the Outside

Fed Finalizes Master Account Guidelines

The weekly BPI Insights roundup has a useful summary of what is happening with respect to opening up access to Fed “master accounts”. This is a pretty technical area of banking but has been getting broader attention in recent years due to some crypto entities arguing that they are being unfairly denied access to this privileged place in the financial system. BPI cites the example of Wyoming crypto bank Custodia, formerly known as Avanti, which sued the Kansas City Fed and the Board of Governors over delays in adjudicating its master account application.

The Kansas Fed is litigating the claim but the Federal Reserve has now released its final guidelines for master account access.

The BPI perspective on why it matters:

Over the past two years, a number of “novel charters” – entities without deposit insurance or a federal supervisor – have sought Fed master accounts. A Fed master account would give these entities – which include fintechs and crypto banks — access to the central bank’s payment system, enabling them to send and receive money cheaply and seamlessly. BPI opposes granting master account access to firms without consolidated federal supervision and in its comment letter urged the Fed to clarify which institutions are eligible for master accounts.

The BPI highlights two main takeaways from the final guidelines:

The Fed does not define what institutions are eligible to seek accounts and declined to exclude all novel charter from access to accounts and services.

The guidelines maintain a tiered review framework that was proposed in an earlier version, sorting financial firms that apply for master accounts into three buckets for review. Firms without deposit insurance that are not subject to federal prudential supervision would receive the highest level of scrutiny. The tiers are designed to provide transparency into the expected review process, the Fed said in the guidelines — although the final guidelines clarify that even within tiers, reviews will be done on a “case-by-case, risk-focused basis.”

The key issue here, as I understand it, is whether the crypto firms are really being discriminated against (I.e has the Fed been captured by the banks it regulates and supervises) or whether Crypto “banks” are seeking the privilege of master account access without all the costs and obligations that regulated banks face.

Let me know what I am missing

Tony – From the Outside

What’s In Store For China’s Mortgage Market? | Seeking Alpha

This post by Michael Pettis offers an interesting and detailed perspective on some of the features of the Chinese apartment financing model that make it highly leveraged in ways that I at least had not fully appreciated. In particular, the Chinese apartment buyers pay in full prior to construction of their apartment but the developers seem to have free reign to use that financing outside the strict confines of building the apartment the buyers have paid for.

The Economist “Money Talks” podcast also has an episode going over the same ground.

Both recommended.

Tony – From the Outside