THE BLOG
10/31/2010 11:35 pm ET | Updated May 25, 2011

The End of the Banking Era

Recently, Blockbuster Video declared bankruptcy. The news wasn't particularly surprising to anyone who had been following the market for video rentals over the past ten years. Netflix emerged in 1998 with a better, more efficient model for video rentals, and as the speed of broadband internet connections increased throughout America, going to the store, the public library, or even the mailbox to get a movie made progressively little sense.

Banks are next.

Given current market trends, retail banking as we know it today will no longer exist by 2020. Even by 2015, almost all small retail banks will be struggling, and even some of the large banks will be trying to re-invent themselves as software companies as they are confronted by competition from more agile and technologically adept competitors: the people who make your cell phone. Aside from the obvious challenges posed to banks, the rapid pace of change will present challenges for consumers and government regulators as well, who may not immediately comprehend the various facets of the new financial paradigm.

A number of factors will influence the coming sudden shift away from brick-and-mortar banks. Foremost among them will be the availability of multiple, inexpensive money transfer services from technology companies that take advantage of the plethora of technologies embodied by modern smartphones. The Apple iPhone and iPod Touch, phones based on the Google Android operating system, and the newer generation of BlackBerry phones have all proved immensely popular with consumers and each phone individually contains enough processing power and data storage to run a bank (or several), let alone enough technology to perform the simple act of accessing an account.

The second factor that will accelerate the death of the banking system is the extreme reluctance of the financial industry to take any meaningful action on the myriad inadequacies of the Automated Clearing House (ACH) network, which was designed in the 1960s to facilitate electronic transfers of funds between banks within the United States. While the ACH network has done a marvelous job of facilitating commerce for half a century in what is arguably the most vibrant economy in the world, it also has serious shortcomings that will soon prove to be fatal as the system is already on the verge of obsolescence. Specifically, the fact that ACH transactions are processed in batch mode a set number of times per day means that money transfers are not instantaneous. While bankers are forming committees that try to solve common problems such as bill splitting at restaurants via ACH, software developers on the west coast are already advertising products that offer bill splitting in real time. No matter how hard these committees work, few customers will choose the option that alerts them as to their transfer's status twelve hours later.

In addition, the ACH network lacks the fundamental flexibility necessary to record important data about the nature of money transfers from bank to bank, which means that with the proliferation of wireless devices it will be increasingly difficult to prevent fraud, the third factor in the demise of traditional banks. Internet-based fraud is an enormous problem for banks; robbing a bank is a much different crime than it once was, and today it rarely involves ski masks, guns and getaway cars. Financial institutions are fighting a losing battle, and they know it. Virtually all of the banking sector's efforts to stem the ever-growing tide of phishing and related internet-based scams have been defensive in nature. In other words, once funds are stolen and an intrusion has been reported, the industry is occasionally effective in recovering funds and apprehending criminals, whether via direct cooperation with law enforcement agencies or through the civil court system. A large proportion of internet-based attacks originate from outside the United States, however, requiring the cooperating of law enforcement agencies in other countries that often have no incentive to take immediate, or any, action. In some cases there may actually be incentives for foreign agencies not to take action at all. Since the banking industry has failed to undertake any coordinated initiative to fashion new software technologies that might thwart attacks, such breaches will continue unabated, causing an increasing amount of damage to banks' balance sheets and reputations, which ties into the fourth factor: perception.

Never in the history of the nation has the banking industry been perceived in such an intensely negative and hostile fashion by consumers. While fraud is not presently the main reason for the industry's poor image, the ever-increasing number of data breaches and security precautions necessary to avoid them will not help as time goes on. The reputation of banks and bankers as unfriendly, untrustworthy and greedy, largely thanks to the excesses that led to the 2008 financial crisis, will eventually prove to catalyze consumers' rush to abandon them for good.

This fourth factor of public perception has already begun a feedback loop with the fifth factor, government regulation. As banks try to recoup lost revenue that the recently-passed financial reform bill has mandated into oblivion, they will effectively nail their own coffins shut. Consumers will react with outrage to new fees on common checking and savings products that were once free. Technology companies offering similar financial products that can safely store money will not feel the same competitive pressures as banks and will take every opportunity to undercut their more established competitors.

In summary, the banking industry faces serious challenges in the years ahead. With effective leadership and a better understanding of the competitive pressures at work, some will manage to survive, but by and large consumers will think of their checking accounts the way that they now think of glass milk jugs--and younger consumers won't remember them at all.

Aaron Greenspan is President & CEO of Think Computer Corporation and the author of Authoritas: One Student's Harvard Admissions and the Founding of the Facebook Era. He is the creator of FaceCash, a mobile payment system.