Bypassing Banks Using Tech
let me start with a personal anecdote right how is technology affecting Finance but how does technology affect any of us how does affect our personal day-to-day lives well as Wendy pointed out my name is raghavendra right and this is a complicated name most people find it difficult to pronounce but I had no idea just how difficult it was until I realized that even computers had a difficult job pronouncing this let me explain I use a service called Google Voice so when someone you know calls my phone and leaves a voicemail Google transcribes it into an email and sends it to me on email so this is what Google did to me says hello this is Robert Greene I'm calling you from National Market Research form we would like to speak with the Avenger you know raghavendra the Avenger kind of similar right I mean I'm okay being called the Avenger but it's kind of seems rather silly right so I said okay I'm going to change my name to something else I'm going to shorten it I'm going to call it Raghu unfortunately technology screws up here as well you type the word Raghu into Google and search for it this is what you end up with sauce you have Ragu but there's no human being I said all right let me try something else I took a photo of myself uploaded to Google and did a reverse image search on that photo said who is this person and Google very confidently says this is who you are some of you may recognize the gentleman the former head of the Federal Reserve in America very important guy he was charged with setting interest rates in America and therefore the world but he's also 20 years older than me I said okay let me find someone else someone maybe a little younger and so Google says this is who you look like some of you may recognize this gentleman right especially those who watch English Premier League football it's of course Pep Guardiola so what are we going to talk about today well we're going to talk about the problems that Financial intermediaries have and specifically the major problem financial information we didn't have is how to deal with information specifically three types of information number one imperfect information we do not have enough information to make decisions properly second one asymmetric information the person on the other side of the deal has more information than we do and the third one behavioral problems that means in other words even if we do have the right amount of information we don't know what to do with it we make mistakes in dealing with that information so these are the problems that Financial intermediaries face and the thrust of my six lectures is about how technology is changing the way we deal with these problems and in particular I'm going to talk about three types of Technology cryptography big data that is basically sensors smartphones and artificial intelligence let me start with an example of how technology transforms the world of Finance in the example goes back all the way to 1838 with the patent by Samuel Morse of the telegraph now before the telegraph came along what was the prior technology available well there were homing pigeons there was the Pony Express people riding on horses from one town to another your visual telegraphs people standing on top of big Hills wearing Flags to each other and railroads the common thing with all these Technologies were number one they were slow number two they were expensive and number three they were limited so what did the telegraph do the first thing the telegraph did was replace all these Technologies and it replaced them because it dramatically reduced costs initially there were a bunch of firms competing with each other to introduce Telegraph Services Across America later replaced by a single firm Western Union and ultimately the telegraph itself was displaced by a new technology the telephone but how did the telegraph change the world of Finance well the major thing that Telegraph did was basically centralized prices they had one price everywhere let me give you an example in 1846 in New York two cities Buffalo Upstate New York and New York City the prices of corn and wheat in Buffalo lagged four days behind those in New York City what that essentially meant was suppose you're buying corn in Buffalo you have no idea whether the person who is selling the corn is actually maybe really want to sell the cone or maybe he has news that the price in New York is about to fall you don't know which one is true so you always worry about trading in a place where the corn and wheat prices or prices of any commodity lags behind that of another place well in 1848 those two markets were linked telegraphically and the prices were set simultaneously and this happened all over America and people tried to capitalize this Sunday as well over the 19th century literally hundreds of exchanges appeared and then disappeared all over the country only five exchanges remain important New York Philadelphia Boston Chicago San Francisco and each of them specialized New York for example specialized in stocks and bond trading 90 percent of stocks in Broad trading today in Americas carried on Wall Street in New York Chicago options and so on so each market specialized in a particular type of financial transaction but why was centralization so important well the big thing centralization does is it increases liquidity as I said one of the things we are worried about in finance is that when we buy or sell something the price moves against us because the market infers information from our Trading if we buy for example lots of corn the market thinks oh this guy has information about where corn is going to go the price moves against us before we have a chance to take advantage of that same thing when you're selling price drops when you're trying to sell because people assume that you know what's happening to the market when liquidity goes up we become price takers not price makers so in other words regardless of how much you buy and sell the price doesn't move against you Beyond this because of the presence of increased liquidity people were more willing to invest in these new Final securities right there was an increased amount of investment in the market and brand new types of Institutions arose to cater to this demand if investors wanting to invest in these new types of opportunities well a brokerage house would come in and say you know what I can help you buy shares which will we allow you to invest in these opportunities analysts came along to say well we'll help you Analyze This companies you figure out which one of these are good Investments and of course your investment Banks who came along to say to the firms we have an idea what the market is thinking will enable you to price these shares appropriately so all these new institutions arose because of Technology eventually of course the telegraph disappeared so from 1850 when the telegraph was first introduced it would cost about 1.55 for a 15 word message price slowly dropped over time until 1902 when the telephone was introduced and now notice that the price of the telephone call keeps dropping the price of the telegraph keeps going up today the cost of a phone message is effectively zero most of us have unlimited minutes or big buckets or minutes so the marginal cost of a phone call is close to zero in contrast you can still send your telegram by the way uh not everywhere I don't know if any of us have sent a telegram at least I haven't sent one since the possibly the 1980s but in Japan you can send a telegram people send it for birthdays for weddings things like that but the way they send the telegram is curious you go to the telegraph office you say I want to send a message congratulating this person on his graduation the telegraph operator takes a message types an email sends the email across the country the person on the other side prints out the email onto a telegram form and then hand delivers it to the recipient so you know it's a telegraph sort of but it doesn't actually exist anymore but so what this basically says is the telegram the telegraph Services improve the speed of communication the telephone increased it even further but is improving the speed of communication enough let's go back to 1754 BC the Hammurabi code if you lose think of the Babylonian economy at that time the Babylonian economy was partly barter partly currency so they had about a hundred laws which talked about property and commerce right things about debt about interest about collateral and they had very strict standards to prevent usury for example if you are a lender you can't charge more than 20 percent for silver based loan you can't charge more than 33 percent for a grain based loan you also had certification as a lender you could only sign finalize the contract before a witness and finally there was collateralization so these are secured loans now think of these four things they are what we have today nothing really has changed from 1754 BC to 2022. so there are some things which have changed for example collateral would be you know houses or property like today but you could even use your wife or your child as collateral in those days that by the way you cannot do today right if you really didn't have either a wife or a kid and who blames you I mean you know you're willing to sell them off as collateral you would have to enter into slavery yourself to pay off your debt from that though the rest of the features are pretty similar to what we have today so what does the finance world look like today well we have enormous sums of money wired daily across the world right we have hard payments for the standard method of payment for most of the developed world for example I mean I don't carry cash I almost never have cash or everything on my phone or we're paying payments by card if you want to borrow money credit is granted with credit score models but none of this is really new right if you think about wiring money across the world doing the Crusades when the knights would go to the Holy Land to fight the infidels they would carry letters of credit with them from their Banks the letters of credit is just an ancient form of what we do we're now we wire transfer the money then you just go pump you know carry a piece of paper with us to tell the bank there to advance US money on our account back home card payments is just an advanced form of stock Credit in fact the earliest credit card was in New York where a group of merchants basically restaurants got together to have a Diners Club and the idea is if you have a Diner's Club card you can go to a restaurant and have a meal basically you're taking a loan to have a meal you pay off the loan over time right but that's tall credit and store credit has been around since stores have been invented nothing new in this or even the credit score models we use today 300 years ago we'd have the same credit score models being used so what's the takeaway here the takeaway is simple in the past technology has dramatically reduced the cost of collecting and processing information but it has not changed the business of making payments and loans and it has not eliminated the essential frictions on war from adversal action to mall Hazard right for example if you took a loan in the time of Hammurabi you'd face roughly the same moral hazard and reverse selection of a role at the time of Bill Clinton and just as important the incumbent institutions were the only ones who had the money to apply new technology so whenever you had new technology coming along the incumbent institution would apply it first and they would earn more money so what has changed well there have been lots of developments in the last 10 years some of these developments include Central Bank issued digital currencies what we call Golf coins we have private digital currencies stable coins we have decentralized Finance what we call defy we have Tech platform firms arising Apple Google Alibaba we have big data we have ai algorithms to understand who you are and predict your preferences what are the technological innovations that cause this change as I said there are three major Innovations I'm going to talk about in this series the first one cryptography the second one big data basically sensor technology right so beginning with the introduction the first smartphone the iPhone in 2007. and of course artificial intelligence there are a host of other ancillary Technologies for example you need hard disk space right that's the cloud uh you need cheap computing power processing power has become cheaper and cheaper every year but that's ancillary it doesn't really change the business of Finance the first three have really changed the way Finance works and that's what I want to focus on to understand that let me give you a very simple picture of the cycle of Finance what we have here on the left hand side is the form The Firm needs money to invest it doesn't have any money the people with the money on the right hand side the financial markets the investors so the firm goes to the investors and issue securities what are the Securities well short term debt long-term debt and Equity what are these things well the basically pieces of paper for example that would be a bond that looks like this it says give me money and in return I'll give you interest payments every six months and then after two years I give you your money back after five years I give you your money back whatever or they can say give me your money and I'll give you a share of my profits if I make a lot of money you make a lot of money I lose money you may lose some money as well so different type of financial instrument the market values these financial instruments and decides how much they're worth and so they transfer the money to The Firm the phone takes that money and invests in assets short-term assets called current assets long-term assets like fixed Assets in a restaurant for example your current assets will be your food um your accounts receivable things like that your fixed assets would be the building would be the kitchen equipment like the refrigerator and so on your long-term assets but the key is those assets generate cash flows part of those cash flows go to the government in the form of taxes unless of course I guess if you're part of the trust government which doesn't believe in collecting taxes but you know part of that is pained by The Firm in the form of retained cash flows and part of it flows through the financial markets in the fact for dividends and debt payments so this is the cycle of Finance money from investors to the firm flowing back to the investors in the form of dividends and debt payments so where do the banks fit in well the key thing is the form and the market don't know each other The Firm doesn't know who is willing to offer money I don't get any emails in the morning for example from Google saying hey we have a new investment project would you will would you be willing to give us money I mean okay nothing I do get some messages from Nigerian princes but those have been falling off lately as well right but apart from that we really don't see we don't see anybody The Firm doesn't know who we are we don't know which funds need money so the first job of a bank is to match the borrowers and the lenders I deposit my money at Barclays Barclays lends the money out but I don't know who Barclays is lending to the money goes beyond my site I don't know and I don't care the second thing deposit my money in a bank to withdraw my money at the drop of a hack so for example I might go to to a restaurant and I want to pay my bill I want to be able to withdraw my money from my bank account right away so that's a short-term deposit but firms don't borrow for the short term they borrow for five years they borrow for 10 years 20 years so the bank has to transform maturity from short term to long term and of course the borrowers have to be good because if the borrowers don't pay back the money the bank is out on a limit so the borrowers have to be assessed for credit worthiness and finally the banks provide liquidity so this is the major roles of most of these Banks do they make money is this lucrative the answer is yes how lucrative is this well this graph here is taken from a paper by Thomas philippon who's a professor at NYU what he's been what he shows us in 1880 this graph here represents Finance income as a proportion of GDP U.S GDP so in 1880
if you look at that number it says two percent of American GDP was in the finance industry by the year 2014 it was eight percent that basically means that the finance industry has grown in importance by four times it's quadrupled in importance over 130 years so why do banks make so much money well typically three ways right one is of course we talked about matching borrowers and lenders but that's one of the ways they make money I deposit my money in a bank I get maybe one percent maybe 1.5 it's really generous these days um but the borrowers pay eight or nine percent that difference the net interest margin is what the uh makes the banks the money second thing to facilitate easy payment so when I make a payment Visa Mastercard a group of banks get that money they charge a fee to the merchant when I make a payment and of course Bank charge fees they charge fees for everything right they charge fees for finding good Investments they charge fees for advising firms that like in corporate finance for example this in fact I was actually recently reading um a novel by an author called Alan Campbell very good Auto highly recommend him uh but it's called damnation for beginners it's about this old woman who comes to a bank to complain and she says look I borrowed money from you guys a long time ago to buy my son a graduation present and I've been paying back that money and I've been paying it back for eight years but money wasn't that much I didn't borrow that much why am I paying back so much money and the teller looks it up and says well you know I see that you actually did pay back the money you were supposed to make 26 payments she says well I made 86 payments he says well no you were supposed to make 26 payments but on the 26th payment you paid too much instead of paying 10 pounds which is what we were supposed to pay you paid 20 pounds so we said what are we going to do with the extra 10 pounds and we said well obviously she wants to open an account with us so we'll open an account for you unfortunately our account opening charges are 20 pounds so we gave you a loan to open your account for with us and of course you have to pay interest on that loan which you didn't and then you had to pay interest in the interest which you didn't so now you was another thousand pounds now this is a story right but there's an uncomfortable element of Truth in some of these stories okay so are banks doing a good job this is the second graph from the same paper by Thomas philippon and this shows you the profits that banks are making on the amount of money they manage what you see here is the ratio of Finance income to the level of assets they manage and notice a difference between this graph and the previous graph previous graph very steep this is relatively flat what does that mean well what this means is profits from Financial intermediation have been relatively constant for the last hundred and thirty years at about two percent what that means is there have been zero efficiency gains in banking since 1880 whatever work your grandfather would do at a bank that's pretty much the kind of work you do at a bank today kind of depressing when you think about it anyway this would all be okay if banks were doing enough of their jobs are they well let's talk about before to after the financial crisis on the top left hand corner that's the amount of European securitization across across Europe before and after the financial crisis the beginning of the financial crisis Banks had about 710 billion pounds of Youth Securities available by 2012 that had dropped to a 240 billion simultaneously the bank of Bank of England and other Central Bankers around the world dropped interest rates so the average interest rate to the bank of England from 75 to 2008 was 8.6 percent on 2009 to 2013 the average of 0.5
percent after that from 2013 onwards for a few more years it became 0.25 percent very little opportunity for the banks to make money on that simultaneously people became very comfortable doing stuff online and most interesting right in the bottom uh left hand corner there was a survey done by the British social attitudes group and they would ask firms every year do you think your banks are well run you ask people every year do you think your banks are well run in 1987 91 percent of the people they have thought that banks will run by 2012 that number had dropped to 19 a drop of 80 percent effectively today banks are usually at the bottom of the trust tables every year year after year banks are at the bottom this is the latest Edelman trust results so adamant Frost has this surveys every year where they ask do you what do you believe do you believe that these any of the people in these industries will do what is right it's kind of impressive the banks stay usually right at the bottom of the trust tables this 2021 the only industry that did worse than Banks was so social media but you know relatively new banks have been consistently at the bottom of their class every year since the test barometer was introduced so I want to ask yourself do you really need a regulated Financial intermediary today well if we eat alone you can go to Lending Club or Arch over to directly borrow loans without a bank being involved if you want to buy cryptocurrencies there's things like coinbase which will allow you to buy cryptocurrencies if you want to send cash overseas wise we'll do that for you you want to buy a house social Finance so far will lend you money to buy a house without being a bank if you need a wealth manager wealthfront and betterment will manage your money for you if you want insurance car insurance will be done by provided by Route lemonade provides Gadget insurance if you have no idea what banking alternative you need you can go to Angel lust it has a list of literally hundreds of banking Alternatives all of them providing services that the banks do not do so what are the pain points for traditional Banks right the first one is of course this emerging competition I was just talking about but that's just fintech companies there's a whole bunch of other competition also coming into play Here For example we have tech companies telecom companies and of course the fintech startups customer expectations have been evolving over time burden of of regulations on banks has dramatically increased since 2008. and finally banks operate with a host of Legacy systems systems written in the 1970s and the 1980s let me ask you guys a question here right if you were to learn a computer language today before Finance what if what do you think is the most lucrative computer language to learn okay excellent the answer actually is Kobo excellent right Cobalt is a language which is written in the 1970s it was actually my second computer language shows how old I am but the point with Cobalt was all Bank programs are written in there but all Cobalt programmers are retiring or dead well I'm not yet either but but the point about this is if you want to learn how to run these systems you have to go to think about how to maintain the bank current system if you bolt down new stuff onto this this is like flying a plane and repairing the engine while the plane is flying right it's super tough for banks to do this so they create they have a lot of problems and the biggest problem deal with information and as I said three types of information imperfect information asymmetric information and behavioral problems we'll talk about these issues as we go forward but for first I want to focus on asymmetric information for the remainder of this talk so what is asymmatic information asymmetric information arises from something we call principal agent problems a principle is someone who hires an agent to do something for them for example if I hire a mechanic to repair my car I'm the principal the mechanic is my agent if I hired a broker to sell my house I'm the principal the broker is my agent if I'm working for a company the company is the principal I am the agent so principal agent problems are but there are two big problems for finance one is called adverse selection and the other is called moral hazard what are these two things well at first selection arises before you write the contract for example think about a car insurance company if you're a car insurance company what type of drivers do you want you want safe drivers right you do not want reckless drivers they'll have accidents they'll and it costs too much to keep them so what do you do you can ask them right are you a good driver but honestly who's going to tell me they're Reckless or a horrible driver right it's almost impossible to get that information from you well that's the adverse selection problem it's called a hidden information problem the information that the agents have that you want to get out of them but they won't tell you what that information is adverse selection the second problem is moral hazard Mall Hazard is after the contract is written the person changes their behavior for example this is called hidden actions because you can't see the actions after the person signs a contract again going back to a car insurance example now that I'm insured I drive a little less carefully than I would had the car not been insured because now the insurance will pick up the tab if something goes wrong so let's see how these problems the way Banks and other insurance companies and other financial institutions let's see some new and novel ways of solving these two problems let's start with a simple question if you borrow money from a bank assume you're credit worthy assume that you have the ability to borrow from a bank I'd like to see you know I can sort of see Hands over here but let me ask you guys would it be easier to borrow a hundred pounds from your bank or a hundred thousand pounds from your bank let's take a show of hands how many people will say a hundred pounds okay excellence and it's going up beautiful a hundred thousand pounds okay some hands going up there too the answer is I'm going to side with the hundred thousand pounds rather than 100 pounds the reason is very simple the bank has the same adverse selection problem as it always had you'd have to judge whether you're credit worthy or not whether you're going to pay back the money or not so let's put somebody on the job somebody goes through your you know your credit files somebody checks whether you have an employment record somebody checks all these things for a hundred pounds there's no profit the profit margin is so small I can't hire somebody to look at you for a hundred thousand I have a ton of margin to look at you to figure out whether you're good you know customer or not so in other words the basically they're not worth it for a hundred pounds the bank says you know I'm not even getting out of bed in the morning I mean if the bank said something like that right so now I'm going to show you an example where it works in a completely different way microfinance the first microfinance institution gaming Bank was set up by Muhammad yunus in 1976. he actually got a Nobel Prize
the Nobel Peace Prize for that a few years later but the average loan Grameen Bank makes is about 270 dollars not 270 000 270 dollars how do you make a profit with 270 if you go to Sri Lanka the average loan is a hundred and eighty dollars that's tiny how not do you make a profit with 180 dollars Mama Jonas's big realization was he has to solve this adverse selection problem he has to figure out who are these people who will be willing to pay back that money in addition he has to figure out how many of these guys are not going to change their behavior after borrowing from you now the bank manager can't do this right I mean they go around the Villages in Bangladesh and so on but they can go around maybe once a month maybe once a quarter not enough so the big innovation here was that the people who are most capable of monitoring you are your neighbors so Eunice basically in Grameen Bank does not make loans to individuals they make loans to groups of people maybe 20 people usually women women are more trustworthy than men right they men tend to get you know drunk and they Gamble and stuff like that so gaming lends mostly to groups of women and you to get into a group to borrow from Grameen you have to be introduced by somebody in the group already right so that means basically somebody is already solving the adverse election problem this person will pay back the loan but why do you solve the problem well I mean also tells the women if any one person in this group doesn't pay back their money the entire group gets their loans cut off so now you have an incentive to watch what your neighbors are doing if your neighbor is not you know take the money and goes gambling with it you're like sorry that's my money you're gambling with so they keep their fellow members under control that's an example without technology let me give you an example with technology this is another company this is one of several companies this is not the only company but it's called tala operates in four countries Mexico Philippines Kenya and India and here you make loans on smartphones so if you apply for a loan using a smartphone so what kind of information does tala ask you when tala doesn't lend to groups it lends to individuals okay so what kind of information do you think a company like tala wants before it makes you alone let's ask some questions so credit history what do you guys think yeah yeah see his hands going up okay what about um jobs that be okay yeah salaries any others what else do you think that dollar would ask for answer is none of the above what tala asks is very simple you upload your photo the answer of maybe a three question questionnaire and that's it and they make you alone wait how are they getting how are they solving the adversal action problem the answer is when you install an app on your phone the app usually asks for permission can I access your location can access your camera can I access blah blah blah right how many of us actually pay attention to that do we many of us just say you know what okay whatever I just want the app right right but during that time when you're making the loan application the first thing that tala does is to check all your contact list right to have any of your people on your contact list borrow from tala before if they have have they paid back the money if they have paid back money that's good news because assumes that people hang out with other people who are like them if your friends haven't paid back the money you're not going to get a loan because they assume that deadbeats hang out with other dead Beats but that's not all maybe all your friends none of your friends are born in tala before and tala checks your entire list of contacts how many people do you talk to on a regular basis do you talk to at least 56 people a month that's a sign that you have a deep Broad Social Network you can call on people to get money maybe if you need owe money to tala how many people do you talk to on the length of time to at least one person you talk to at least one person for more than four minutes a day that you have a deep social relationship to at least one other person it goes deeper how do you spell the number names on your contact list for example if you say rahu Gardner might many of us do that for our contact list I can think of examples or you know so and so mechanic something like that right we put down names like that just the first name in the occupation to call people for their phones it's not good right if you on the other hand if you had typed in capital r a g h u space capital r a u open black parenthesis mechanic close bracket close parenthesis that's someone who's really anal that person is 16 times more likely to pay back the loan than somebody who writes Raghu mechanic so be very careful when you are you know when you're writing stuff in your contact list next we know per location every few minutes your phone is calling out to the closest cell phone tower saying here I am I want messages but I want data I want something so your phone is tracking you minute by minute so what happens well if it turns out that Tyler just checks your location records if your phone is in the same place every night from 9pm to 5 a.m tala knows you have a home because if you're homeless your phone were in a different place every night what about from 9am to 5 PM if you're on the phone is in the same place there it knows you have a job and I know approximately where the job is right you can tell it right from the location services on your phone so I don't need anything else your phone has already given me all the information you need let me take another example car insurance this is a company I mentioned earlier called root now remember that car insurance companies want safe drivers how does Insurance pricing model work well the way it works is you have maybe a pool of let's say a hundred drivers of those 10 are Reckless they will have accidents 90 of them were safe so what you do is you collect premiums from all the hundred and hope that the premiums will pay off the reckless driving accident of the 10 people and leave a profit left over root doesn't do this what root does it looks for traditional things but it also asks you to download an app onto your phone so what does the app do well it turns out they look at a bunch of factors the traditional pricing model says what's your credit score what's your driving record what's your age what's your marital status and so on root adds to that by looking at your driving behavior that means while you have the app on your phone what you do is you download the app you keep it on your phone you don't have to have it open you just have it on your phone and while you have the app open while you have the app on your phone root is monitoring everything about your driving how fast you drive where do you go around corners too fast you break too suddenly what is the congestion on the road you drive I mean that's from taken from Google Maps or things like that so many of us are thinking wait a minute when I have the app open you know I'll drive carefully right I mean I'll get a good rate and then I'll drive normally Roots already thought of that turns out that when you download the app you drive around like you normally would for a few weeks not a couple of days for a few weeks I can guarantee first day you might drive super carefully second day maybe a little less carefully day three you have totally forgotten there's an app in your pocket monitoring everything about your driving so what happens if you're a bad driver who says Bob we don't want you right you're not a good fit root isn't the right fit for everybody a moral Jones Works a polite way of saying you're a terrible driver I don't want you as a customer and the root wrap doesn't need to be open yet you basically just give it permission to run the background same thing which I just talked about now what happens to these other people well who do they go to the other insurance companies which are not using technology so now the pricing model of the other insurance companies changes they started out with a pool of 90 good drivers and 10 bad drivers but the good drivers have all gone to route and the bad drivers have come to you so suddenly you have a model where you have 80 bad drivers and 20 good drivers the only way you can make a profit increase your insurance premium but if you increase your insurance payments the good drivers leave eventually you get driven out of business so one of the conclusions from this is if one company is introducing technology everybody has to it becomes a red Queen's race okay let's take another example Gadget Insurance laminate now many of us when we pay our premiums every month right and something happens like we break our laptop or we break our phone and it is our fault do we say oh this is our this is my fault I'm not going to ask the insurance company to pay for this some of us do we are very honest people but some of us will say you know what I've been paying my premiums I'm not going to tell the insurance company it was my fault let's say it's an act of God the dog grabbed my laptop and dropped it into the into the commode or something like that right so I that small Hazard a lemonade won't eliminate that moral hazard the likelihood of you claiming for stuff which is really your fault and you know it so what does it do well his pricing model works like this when you when you sign up for laminate it asks you what do you care about for example you might say I care about saving the Dolphins or saving a whale something like that so what root does what lemonade does is basically says look we pay your claims and if you do not claim we will give the remaining money after we take our cut to causes you care about so the hope is if you're making a claim right for something which is your fault you're actually taking money away not from not from Lemonade but from something you care about so you might be more reluctant to make that claim lemonade tries its best to to to to Really emphasize that by putting all the stuff on his website like you know we provide life-saving care to so many rescued animals we planted some animal good stuff right so you're more reluctant to claim if you are working with lemonade now let's invert the model Hazard problem this is commentary first usually more Hazard means these guys are doing something which is bad for Society for example you're driving fast you're driving recklessly you could have an accident hurts people that's bad how many first is a different model in America one of the things we visit with American Life is that your medical insurance is tied to your job if you don't have a job your medical insurance not so good or non-existent in some places so if you're working for a company you have medical insurance and in some cases if you're important enough the company will take out a life insurance policy on you it's called He-Man insurance and what happens is if something happens to you you know you have a heart attack or something the company has been paying the premiums on your behalf they collect the money on their life insurance policy and use that either to treat you or replace you or whatever so here you are medical insurance through your job life insurance through your job now suddenly you're fired or in American Poland they let you go I mean it's not like you know we've been holding you back all this time and now you can fly free to new places new adventures right that's terminology so they've let you go and they're like and you're like damn I need medical insurance and they're like oh well we have this life insurance policy we're not going to keep up the premiums it's useless to us so here's the president farewell president you can keep it up you know you keep paying the premium you're totally fine but you don't want that right you want medical insurance not life insurance so you can go to Coventry first in this particular case this guy had a life insurance policy of 1.5 million and he went to Community First and Community First said you know what we'll pay you 196 000 for it we will keep making premiums on your behalf and when you die we collect the money okay these are called debt bonds probably soon so what you do you submit a questionnaire authorization to commentary first along with you know carry illustrations medical records for the last five years commonly first determines the value of this policy and then there's a change of ownership of beneficiary forms of the insurance company and then it continues making payments on your behalf and when you die they collect insurance now what's the problem the problem is what kind of customers does commentary first want health insurance companies want healthy customers these guys want unhealthy customers the ideal customer is someone who sells an insurance policy to you walks through the door and drops dead of a heart attack right there perfect customer and talk about doing things for social right so these guys in normal life usually you know the car accident stuff bad for society but these guys are going to use the 196 thousand dollars to buy medical insurance to keep them alive which you don't want either but you can't stop them right but that's that's why it's such a weird weird and interesting Innovative model anyway point of course is that's one problem these guys are doing tough which you don't want them to do keeping themselves alive the second problem is how do you find out when the guy is dead right because nobody and I guarantee nobody on that death died on that dying breath say call my insurance company I am dying Nobody Does that unless they're collecting the premium these guys aren't right so Community First has a line in their contracts which says something like we have the right to call you on the first of every month and you better pick up the phone if you don't pick up the phone you're gonna assume you're dead right so you have to pick up the phone and they call you and say how are you feeling you're still alive oh dear but you know they don't say that out loud but you know what I mean well another vessel inverting mall has a problem let's talk about another model reducing adversal action this is a company based in Germany which is about a 600 million euro turnover 3 000 employees operations in 20 countries now what was interesting about this company was that it its banks were exposed to the Asian financial crisis in 1997. so what happened was the bank said look we have you know a big crisis we've lost a lot of money so we're cutting off any funds going to the firms in Germany who are not exposed to the crisis so the CEO of this company got mad he said you know what I spent all my amount of time you know trying to get forms and stuff filled up for the stupid Banks they won't give me any money when I really need it I'm never going to deal with the bank again so what he did put an ad in the local papers he said guys the bank is paying four percent I'll pay five percent give me money and the German regulator said you can't do this you're not a bank he said well what can I do well you can issue bonds so a bond that's like a fixed deposit fine for an ad in the paper saying I'm offering bonds for five percent now who are the most likely people to buy the bond this is a small town in Germany so local people right they walk by your plant every day they talk to your employees they have beers with your employees they know how healthy the farm is so they're more willing to give the firm money unfortunately that seems like a particularly small market right I mean small town in Germany how much money can you raise these guys have been doing this from 2002 to 2013 that's last year we have data but they've been going on for a very long time what really enabled them to survive was the development of what we call Evangelical investors that's a firm over there now what turns out that when people give money to things which are you know there's an unlisted company it's an unrated company it could be risky we don't know so what do you do you give money to this company and you're nervous about it so you tell your friends you're like hey look why don't you invest in this company too you know my friend invests they've done their own investigation it reassures me a little bit so these guys started talking about it to other people they were what we call Evangelical investors and these guys expanded and expanded and expanded year after year after year so until 2013 they're all over Germany one company over there raising money all over Germany almost in Cali toward them out they never went back to a bank after 2013.
but these are just the beginning of all the things we're going to be talking about we have been talking about alternative ways of raising Finance we've talked about direct issue bonds but there's also crowdfunding and peer-to-peer Lending you can talk about alternative Wealth Management Systems advisory Services Robo advisors we've just talked about death bonds alternative Payment Systems so m-pesa alternative remittances or terms of Visa Swift interbank transfers Bitcoin distributed Ledger systems why are all these Technologies taking off now well back in 2000 when my students would come to me and say I want to start a new business how much money do I need to raise I'd say you need about five million dollars from a venture Cap Fund or an individual investor but in 2005 the rise of Open Source software like GitHub where you can just download the modules you need drop the price to five hundred thousand dollars beyond that the introduction of the cloud the Amazon web services here meant that you could start a business with just a laptop you just need to be connected to the cloud you could rent hard disk space today the cost to start a new business is five thousand dollars this is incredibly cheap let me give you a couple of examples both my students one of them came to me a few years ago and he said he started a new blockchain company blockchain for initial public offerings I said how many people are in your company it's a tree I said who are these three people I said hey I'm the CEO my wife is the co-ceo because she doesn't want to be working under me and of course I have this third guy who is the Chief Operating Officer I said who's the third guy he said well we met him and he has this team so it's like the Magnificent Seven there's one guy who deals with web services there's one guy who deals with the banks one guy who deals with technology they go to new businesses like this they take the company make it successful and then collect the money and then move on to the next Village to save them and so on and so forth exactly like the Seven Samurai if you guys have seen that the other example is actually another of my students who was from Zambia and he got two job offers one job offer was from a mining company which is old company which is involved going to a mine digging for my or refining it and selling it abroad the other one was an educational technology company financial literacy in Africa is a big problem and so the educational technology company was to try to get people you know um more involved more financially literate in Africa he said which company do you think I should join I said educational technology sounds more interesting to me he said yes but I have a son I mean he's just one year old I need a steady paycheck the edtech company is not giving me a paycheck what should I do I said I no that I can't give you any advice I'm not in your shoes I don't have any kids so he said okay fine thank you for nothing and then you know I met him a few months ago and I said which job did you end up taking let's take a show of hands how many people say he went to the Mining Company a couple of hands out there okay a few hands at the back how many people say I went to the educational technology company several hands up here excellent hands up there beautiful beautiful the answer is he took both I said we really do both he said well I work in the mine during the week and the evenings on the weekends I work on the educational technology company I said where's this education technology company based and it looked at me like I was crazy I mean I said you know where's the headquarters he said what headquarters I said where do people meet besai I haven't ever met them one guy's in Singapore one guy's in Manchester one guy's in Australia I'm in Zambia we just connect on slack and just we work on our thing together we don't physically have to be there that's one of the reasons why this Technologies are taking off it's so cheap to start new technologies and I'm as Wendy pointer on the beginning I run the Cambridge Center for Trinity Finance this was established in January 2015. we are looking at all these research teams our website is available here and all the information which published is free on our website and we talk about fintech and how it's changing the world next time next month I'm going to talk about blockchains and I'm going to talk about why blockchains succeed and I'm going to talk about that without any technical knowledge whatsoever so we'll talk about how blockchains work using the example of Romeo and Juliet but that for next time huh when I'm going to do business with a company one of the first I have a series of questions I ask myself or them one is what is your business model particularly if it's a free company a free service secondly what is your liability model in other words if it goes wrong who do I shoot and where do I find them these are good questions the point in think about this is most of these are the initial stages at least they're just that the business ideas it costs you almost nothing today to experiment and it works then you take it to you know a more traditional route but at the beginning it's much easier to experiment play with it see if it works if it doesn't abandon it and move on I think that is the difference and a lot of these things do not actually have to be regulated yet until for example D5 models which I'll talk about in January most of them are unregulated so they and the people working in these areas don't exactly know how regulation is going to be applied to them so they have never dealt with many cases with the formal Financial intermediaries that's an interesting issue and we'll talk more about that two lectures from now Cairns asks the app use that you've described contradicts data Protection Law how on Earth do they get away with it which app sorry the fella I think he missed the or she means the tala app yes yeah yes well they ask you for your permissions I mean you've given in them permission if you do not give them the permission they do not give you a loan I'm sorry it wouldn't be able to do it in the US I don't know root for example gets a lot of permission to track exactly where you're driving that's interesting isn't it it could be the um but I do note that a lot of apps even in the UK do ask for a lot of permissions and you have no idea where it's going right you don't know what they're doing with the data so in this particular case fair enough I remember I'm agreeing with you there all I'm trying to say is in a lot of cases these guys collect information and you still don't know why they're using that information do you think some of the big Banks and financial institutions will go under due to competition from leaner Tech startups that is an excellent question as I as I answered in that previous answer over there one of the issues which happening is many of these people with these startups they don't know how the modern Financial World works so there is this friction right now where the traditional Financial intermediaries are saying well we are regulated the government is allowing us to do this stuff these guys are doing stuff which is not allowed how is that friction going to be resolved it's an open question I I don't know what's going to happen but there are lots of fascinating developments in this world in the space thank you so much and we're very much looking forward to the subsequent lectures in your series thank you everyone for joining us thank you [Applause]