By Paul Gorman, Bank Aston CEO

Payment banks were originally conceived in 2013 by a Reserve Bank of India working group. They were designed as retail-facing institutions, with no mandate to take credit risk and limited ability to take maturity-mismatch risk. These banks were intended to be technology-driven and user friendly, enabling access to payment systems for the segment of the unbanked population.

The concept and context has now extended to other geographies (e.g. Nigeria, UK, Australia and Singapore and more recently into the EU) as well as to other use cases relevant to those jurisdictions (e.g. institutional). The idea remains the same: a bank that helps solve a particular jurisdiction’s problems and that is technology-driven, user friendly and takes no material credit or maturity risk.

Bank Aston is a payments bank in a similar style. We have designed it to solve a specific institutional banking issue for offshore jurisdictions. We have not attempted to solve all offshore banking problems: we will not lend money or serve retail clients. It is designed and purpose-built specifically to support offshore financial institutions.

Bank Aston was conceived from the outset as a technology-enabled, offshore, institutional, payments bank. The whole point is to limit the risk the bank takes by NOT using customer deposits to capitalise or part-fund a lending operation. Our original decision to build a bank for this specific market was to address an opportunity left wide open by the incumbents.

This also means:

Bank Aston will not have any clients that would be eligible to make a claim under the Depositor Compensation Scheme (DCS).

• These protection schemes exist largely because retail depositors’ funds are used to fund banks’ lending activity.

• The unspoken inference is that each bank’s participation in a DCS is primarily to protect consumers from bad lending practices.

• The combination of a DCS and implicit government support (from e.g. the UK’s banking ringfence) could lead to moral hazard.

• Circling back to the top of this article, payment banks were conceived (in India) precisely to avoid taking this risk at all.

  
  

Bank Aston will not need to borrow capital to fund any lending activity:

• Banks typically do not fund their lending activity entirely from their depositors. They also raise a substantial amount of this capital in the public bond markets.

• Bank Aston won’t need to raise money in the public bond markets to support lending activity as we will not be lending money.

  • If we don’t need to access the bond markets, there’s no obvious need for us to have a public credit rating (from Moody’s, S&P or Fitch).

  • A credit rating is a published measure of risk of whether the bank will repay the bond. The rating indirectly measures how well-run the bank is; a substantial proportion of that measure is the quality of that bank’s loan portfolio.

• Bank Aston’s deposits will be held largely in highly-rated government bonds. A small proportion will be held with other banks.

  • Most of the money we hold as deposits will be held in a portfolio of UK, US and EU government bonds. Holdings with other banks are useful to maintain liquidity for day-to-day client operations. However, there are sensible limits that recognise the fact that those other banks are themselves risky.

  • A depositor into a Bank Aston account is therefore NOT taking vicarious credit risk on borrowers (other than a tiny and restricted amount with other, much larger, banks). They are, rather, indirectly investing in government bonds which are safe, secure and predictable.

    
    

Credit ratings are not really that helpful in assessing the counterparty risk of a bank, even one that lends. There are many reasons, but just one of these is timeliness:

• A (hypothetical) publicly-rated bank’s financial year finishes on 31^st December.

• The results reflect income derived from activity back to 1^st January that year, which of course reflects risks dating back into the previous year(s).

• They publish full year results in Q1 or early Q2 the following year.

• Their updated credit rating that reflects full-year results is then published between July and September, using the most recent accounts. Ratings are also ‘negotiated’ with the credit ratings agencies with the support of specialist advisors.

• In the absence of other changes, the rating remains as-is until the same date the following year.

  
  

An institutional client could therefore be making a decision on bank counterparty risk using a credit rating which relates to an accounting year that ended up to 21 months ago and risks that were taken by the bank in question 36 months (or more) beforehand. A public credit rating is hardly that useful in deciding whether to use a banking counterparty. If you want to follow the herd…

Payment banks were originally conceived to reduce risk in the financial system, including issues with rated banks. Neither we nor the HBR article’s author (How Payment Banks Could Prevent The Next Bank Collapse) are claiming that individual payment banks like Bank Aston will (on their own) be able to prevent systemic financial crises or external shocks. Neither do we offer to provide protection from impact of a crisis on the institution’s underlying business. We do believe that having payment banks in the financial ecosystem, including Bank Aston, will help to smooth-out shocks to the institutions who choose to use us.

Those institutions which (dogmatically and quite unnecessarily) choose to use only publicly-rated banks will be subject to their banks’ survival of, or reaction to, external economic shocks. Perhaps the boards of these institutions need to ask themselves what bank counterparty risks they are actually trying to control-for.

Characterising the 2008/09 Global Financial Crisis as a “credit crunch” is, in my view, incorrect. The crisis was actually a liquidity crunch that was caused by taking excessive credit risk. Contraction of credit was also a result of the crisis. The original cause and ultimate outcome were credit related, which is presumably why the media refer to it as a credit crisis. However, looking behind the curtain, it was actually the lack of liquidity for banks that led to their collapse or need for a bail-out. Even the more recent banking issues have been liquidity issues. In the case of Silicon Valley Bank, for example, it was a balance sheet maturity issue; the US headquarters held long-dated bonds and these fell in value as interest rates rose. This led to a ‘run’ on customer deposits. They couldn’t liquidate assets or borrow elsewhere so they had a liquidity issue.

There are numerous other examples where banks have faced existential liquidity issues; some have survived, some haven’t. These liquidity crunches have undoubtedly led to a decline in the number of banks in the offshore markets and contributed (in my view) to a managed degradation of available services.

Bank Aston has focused on addressing an underserved market that these banks have pulled back from. We will provide better services without running either credit or maturity risks. And our design means that our liquidity risk is extremely low. How refreshing!