Category: banking

Business method patents: good or bad for the U.S. financial services?

PaymentNews pointed to a research paper title “Business Method Patents and U.S. Financial Services” authored by Robert M. Hunt of the Philadelphia Fed.

As any researcher in knowledge economics would know, maximizing the value of knowledge for society is a difficult problem:  on one hand, you need to provide the proper incentives for innovators to invent (typically a patent system that provides a time-limited monopole), and on the other hand you want this knowledge to be used as fast as possible by as many people. Finding the right balance is not easy. This is a subject I’m really interested in, and business method patentability is a very interesting on its own, so I went through the paper. Here are my notes.

Here is the most important part IMO from the conclusion:

There is at present very little evidence to argue that business method patents have had a significant effect on the R&D investments of financial institutions. It is possible that the availability of business method patents has encouraged more entry and R&D by start-up firms or more efficient trading of technologies. At present, however, these represent intriguing possibilities and not outcomes that have actually been measured. In short, we still cannot determine whether financial patents are creating value for the U.S. economy.
[…]
The combination of significant technological overlap among firms, elastic patent boundaries, inadequate enforcement of disclosure requirements, and weak patentability standards raises at least the theoretical possibility of perverse outcomes (Hunt 2006). In such environments, firms may obtain more patents but perform less R&D, since the fruits of such efforts would be subject to an innovation tax imposed by rival firms.

My thoughts:
I think this area of patents is still evolving and regulators are still learning how to best optimize the value of the U.S. economy of patent issuance. There is a risk that startups be issued business method patents that other FIs license only to see themselves fought to death by large FIs in court. I don’t think it will be a big problem for niche markets, but it would be interesting to see what a court would decide if consulted on the non-obviousness of a business method patent issued to a small firm and which possibly has a huge impact/potential to many large FI players.

More excerpts:

A decade after the State Street decision, more than 1,000 business method patents are granted each year. Yet only one in ten are obtained by a financial institution. Most business method patents are also software patents.

That’s 10 business methods per year coming from a FI. Wow! The remainder of the article is basically trying to explain why these numbers are so low. Probably most of banking related business method patents come from startups (ex. SmartyPig has a patent on their business method).

Financial exchanges and the central bank are more research intensive than credit intermediaries (banks and thrifts).

I don’t think that will come as a surprise to anyone. I wrote earlier about the innovation problem at banks (I should have precised credit intermediaries as I’m well-aware that innovation is thriving in the investment side of banks).

Number of financial industries rely heavily on standard setting arrangements esp. payments networks and financial exchanges.

The article seems to imply here, if my understanding is correct, that business method innovation requires multiple parties to implement it, which means it’s hard for any one party to patent it at the same time that it seeks others to use (license if it’s a patent). That’s as if you had to pay to use a standard…

Lerner (2006) finds that business method patents are litigated at a rate 27 times
higher than for patents as a whole.

The reason for this is that the legal aspects of business methods patentability is still evolving. This might be another reason why business patents are few. It’s easier to keep them as good old trade secrets when possible, than try to patent them only to have to pay an army of lawyers to litigate them.

The article also talks about the legitimacy of licensing a patent and fighting in court in validity at the same time.

Les banques devrait-elles devenir des fournisseurs d’OpenID?

This is a translation in French of an earlier post.

Il y a presque dix ans, au sommet du boom Internet, je me rappelle avoir avoir discuté avec un banquier qui me suggérait que dans le future, le rôle des banques ne se limiterait pas a garder l’argent de leur dépositaires, mais aussi à garder leur identité en ligne secrète. D’une certaine manière, cette prediction s’est concrétisée par le biais des programmes de protection contre le vol d’identité. Cela dit, si l’on définit l’identité comme la somme des informations personnelles qui distingue une personne d’une autre et qu’il est difficile voire impossible de se procurer, on voit bien qu’une grand partie de ces informations (et en particulier les secrets tels les mots de passe) sont disséminés dans un grand nombre de services en ligne (60 en moyenne, bientôt 200, d’après une étude du Yankee Group sur OpenID).

Comme chacun sait, OpenID constitue la solution non-propriétaire à ce problème, et pour les raisons présentées ci-après, il semblerait que les banques soient des candidats parfaits pour devenir fournisseurs d’OpenID:

  • “Qui peut le plus peut le moins”. Le niveau de sécurité imposées par les services en ligne aux mots de passe de leurs utilisateurs ainsi que l’intérêt des utilisateurs à avoir des mots de passe difficiles, varient d’un service en ligne à un autre, mais la banque en ligne est probablement un des services ou le niveau de sécurité des mots de passe est le plus élevé. La raison est simple: il s’agit du service où les utilisateurs ont le plus à perdre si leur mot de passe se retrouve dans de mauvaises mains. Ainsi, on peut difficilement imaginer un utilisateur s’authentifier auprès de son service de banque en ligne avec son le nom d’utilisateur et mot de passe de son compte Google, mais l’inverse est beaucoup plus plausible
  • Les banques ont plusieurs actifs existants relatifs à la sécurité:
    • Elles ont déjà en place une infrastructure technique assurant la sécurité de l’accès en ligne aux comptes bancaires,
    • Elles ont pour la plupart une image de marque forte en terms de sécurité, et
    • Elles ont déjà en place des programmes de protection contre le vol d’identité qui fourniraient un complément d’assurance à OpenID, et ferait de cette technologie une vraie solution/vrai produit
    • Les banques sont tenues légalement de connaître leurs clients, et ont pour cette raison probablement beaucoup plus d’information sur leurs clients (par example, documents officiels comme carte d’identité) que n’importe quel autre service en ligne (mais pour combien de temps encore?). Cela veut dire qu’elle possèdent le plus large éventail d’options d’authentification, leur permettant de supporter plusieurs niveaux d’authentification. Elles ne sont pas limitées au model d’OpenID classique de l’URL et du mot de passe: elles peuvent non seulement décider d’émettre des URLs OpenID qui soient distinctes du nom d’utilisateur, mais elles peuvent aussi et surtout utiliser une authentification multifacteurs, par exemple envoyer un numéro personnel secret par SMS à un téléphone mobile, ou demander à un utilisateur de cliquer sur un bouton pour être appelé par un centre d’appel, comme spécifié par les OpenID policy extensions.
  • Enfin, il existe de très bonnes raisons économiques. Un service OpenID offert par une banque consituerait:
    • Un service à très forte valeur perçue (mot de passe unique pour potentiellement tous les services en ligne utilisés par un utilisateur) que les banques pourraient faire payer
    • Une nouvelle façon de promouvoir leur image de marque: compte tenu du fonctionnement d’OpenID (redirection vers le fournisseur OpenID pour chaque authentification) les utilisateurs verraient le logo de la banque à chaque authentification.
    • Un formidable outil marketing: les banques auraient connaissance de quand quel utilisateur utilise quel service et pourraient présenter en fonction des offres et publicités liées ou non à leurs produits lors de chaque authentification,
    • Une très bonne manière de garder leurs client: le coût de changement de fournisseur OpenID s’ajoutant aux autres coûts de transfer de comptes bancaires à une autre banque.

What the IT at Google Bank would look like

As I was watching the Google I/O keynote presentation, I thought about how all the development tools provided by Google (Google Gears, GData, OpenSocial, etc.) could be put to work to create a Google-powered Bank, and what the IT architecture of this Google Bank would look like.

Here is how I think it could look like:

All user interaction devices, whether it is a teller workstation, mobile phone, ATM machine, kiosk would provide access to the bank via any of the standard Web browsers (Opera, IE, Firefox, Safari).

If access to device-specific functionality is required, it would be done by Google Gears (say for instance, that I want to access the ATM’s cash dispensing functionality, or I want to access the mobile phone’s built-in GPS or accelerometer). Ideally, these devices would be running a single application that would adapt according to the services discovered on the device on on the service cloud. But realistically, they would be running variant of a single GWT Java code base that GWT would compile in JavaScript for browser-based deployment.

Contacting customer support would be done via Google Talk click-to-call buttons. Interactive Voice Response systems would be powered by 1-800-GOOG-411 voice technology.

All these user facing app would leverage a cloud of shared GData services based on Atom Publishing Protocol. These services would be used to retrieve and update any data and transaction: update accounts, customer profiles, schedule payments, withdraw money, consult account balances, etc.

These services would be available to any developer who registered for an API key to create new 3rd party applications, with online documents, code examples, tutorials, videos, etc. There would be a related developer challenge that would award prizes ranging from $25K to $100K to motivate developers to create 3rd party applications. Google Bank would monitor usage and success via the API key, and acquire the apps that can contribute the most to their bottom line or user growth. OAuth would be used to allow 3rd party apps to accesss customer data without the user having to give away their Google login/password.

OpenSocial would be leveraged by Google Bank to provide an easy framework for friends to share bills, family member to send money to one another via any device, and to loan money to friends/families or friends of friends. Google Bank would use this data to provide preferential loan rates or optimize transaction fees.

Google Bank analytics would analyze my transaction patterns, build nice spending usage pie charts for me, and suggest relevant ways to save or make more money via competitive offers aggregated in Google Shopping. Bank marketing managers would use Google Bank analytics to analyze usage patterns, create marketing campaigns and target specific demographics and customer types in Google Adsense.

And last but not least, users would be able to search all their personal data using a simple one input field user interface.

Did I miss anything?

Can financial services providers do good and make good money at it?

Brad Garland’s latest post raises an interesting question:

If a company’s employees passion for their company’s product or service is ultimately what transpires in their brand and what drives customer to buy their products/services – think Google (“Don’t be evil”), REI or Apple, is it possible to have financial services providers’ employees being passionate about their products/services, and if so how?

As I was reading this post, I could not but think about Paul Graham comments in this presentation about the necessity for startups to be benevolent. His theory goes like this: if a startup focuses first on making the life of its users truly better, it will help employees stay motivated in the most difficult times, and will help in attracting the best geeks, who are usually idealists; once you have enough happy users, they will be happy to contribute financial support.

There many startup examples that have followed this pattern. eBay is a good example. According to Wikipedia’s entry on Pierre Omidyar:

The service was free at first, but started charging in order to cover Internet service provider costs.

REI, Brad’s example, is not a startup, but actually follows this benevolence pattern. They are actually a particular kind of business since they are a cooperative and as an REI member you get a yearly dividend (about 9% of the money you spend there), which you can redeem for REI products.

To go back to Brad’s question, and adapt it based on Paul’s suggestion: Can financial services providers do good and make money at it?

Of course they can.

Here are a few examples:

  • The disruptive contenders such as p2p lenders are effectively freeing loan seekers from bank loans and re-creating a more human and direct relation between lenders and debtors.
  • Large incumbent banks can leverage their operational infrastructure to create independent brands dedicated to specific communities or values (ex. using local deposits to finance local, sustainable developments, “green banks”). After all, different people have different ideas about what “don’t be evil” involves. In general, it is my opinion that banks can do good and be perceived as such by leveraging Web technologies to reveal the social links loans represent, rather than abstract/hide them. For instance, they could provide visibility into where the money in my CD account goes and provide me with the option to express my preferences. Ideally, I should be able to say that I want my money to be only used to help finance sustainable farming in a 50 miles radius around where I live.

Just my quick thoughts!

Should banks bank on OpenID?

Almost a decade ago, at the height of the Internet boom, I remember talking to a banker telling me that in the future, banks would not just keep your money safe, but also your identity. To some extent, this has materialized with identity protection programs offering insurance against the risk of identity theft. That said, if you view the identity as the collection of hard- or impossible-to-obtain information about a person that uniquely distinguishes her from others, you would certainly admit that a big part of this information (in particular secrets such as passwords) are spread around in a variety of online services (60 on average, growing to 200 according to a Yankee report on OpenID).

OpenID, as everyone knows, is the open solution to this problem, and banks seem to be excellent potential OpenID providers for the following reasons:

  • “He who can do more can do less”. Password strength requirements and password strength user incentives are not equal among online services, but online banking is probably one of the services where password strength is highest, simply because this is where for most people the loss would be the highest if their password was to fall in the wrong hands. So, users won’t use an easy-to-remember Gmail username/password or blog commenting account to login at their bank, even if the bank trusts Google’s security, but they would probably not mind the reverse.
  • Existing security-related assets:
    • Banks already have the security infrastructure in place to secure financial accounts,
    • Most banks are already trusted brands in terms of security, and
    • Banks already have identity theft protection program in place that would complement OpenID, which is just a technology
    • Banks are required by anti-money laundering laws to know their customer, and have probably more identity-related information about their customers (ex. government-issued documents) than any other online service. This means they have the widest range of authentication options, allowing them to support multiple levels of authentications. They are not constrained to a public URL/private password model: they can not only decide to issue a OpenID URL that is distinct from the existing username, but also use multi-factor authentication for instance by sending a PIN by SMS to a phone or requesting the user to click and get a call from a call center agent, as requested by OpenID policy extensions.
  • Last but not least, compelling business reasons. A highly secure OpenID would be:
    • A value-add service that the bank could charge a premium fee for
    • A great way for banks to promote their brands (you’d see their logo everytime you authenticate), get to know their customers’ online usage patterns (which service you are using and when) and present new offers/ads (banking-related or not),
    • A great way to retain customers.

The problem with banking innovation and how to fix it.

Allen Weinberg has a great report on the first day at Payments 2008 that confirms some of the thoughts I’ve had in the past few weeks: that non-banks are becoming the primary source of banking innovation, threatening to relegate banks to mere accountants.

Allen cites the difficulty for banks to hire innovative employees because their lack of coolness, and I partly agree, but I think that is a bit too imprecise. It’s a bit like saying “We failed b/c we are were not lucky”. I think smart innovative employees go to companies that have an innovative management environment and culture, and there are very practical ways to create such an environment and culture, if the top management wants to.

To me such a culture starts by embracing the facts that:

  • Committee planning does not work for innovation because most innovations fail and slight differences between similar projects can be huge key factors of success, and as a result it is impossible to predict from which team innovation will come from.
  • People with innovative ideas (ex. new online service, new investment theory) as well as execution capabilities (ex. coding, sales skills) are a company’s greatest human asset and should be given opportunities before they leave and join a company that does.

Such an innovation culture consists then in implementing a management policy where such people can submit their plans, get a green light to allocate part of their time (whatever their direct manager says) and get a bootstrap budget as necessary. Then, just like a good option portfolio manager, define progress/success metrics, and allocate more resources to those with the most traction. And finally, reward success. All of this is something Google seems to be doing very well.

Banks are now at a most critical time and their ability to innovate in sustainable business models will be key to their survival. Nouriel Roubini noted this morning that banks’ unsustainable “originate & distribute” business model of the last few years is crumbling with the broken “securitization food chain”.

Banks are social intermediaries, and as a result, social services that focus on social lending or social saving pose a major threat to them, but could also turn out to be a major opportunity if they manage to re-intermediate these relationships and combine it with their unique competitive advantage: creating money from thin air.

Think for instance about the idea of a “college car” savings account solely dedicated to buying a car and that grand-parents could contribute too knowing where the money would end. Think of the negotiating power the bank could have by aggregating all the buying power behind these savings account and exchanging secured rebate from car manufacturers with secured future sales. This is what SmartyPig does, but environment/culture aside, it seems to me much easier to do it from the inside of a bank than from the outside. John Gaskell, SmartyPig co-founder was quick to comment that they have a patent pending on this process, so banks may actually not have this option.

Think also how a bank could leverage the fact that 50% of your student loan on a peer-to-peer lending site comes from your mum and dad, and grand-parents, and how little risk it would be for a bank to lend the remaining 50%, especially if the bank gets preferred re-payment rights.

Banks have some of this social data, in a way that is most likely much more authentic than a Facebook (think about all the documents you need to provide to open a checking or brokerage account compare to what you need to provide to open a Facebook account). It is just a matter for them to put in place the right environment and culture in place to attract people.

If they cannot change their culture, their next best bet might be to do what Apple or Facebook do: expose some of this information via easy-to-use APIs in a way that is more secure than their startup competitors. Then, allocate a VC fund to fund startups using this API (which is equivalent to buy an option to invest more/buy out the most promising ventures later).

Mint.com: a perfect banking use case for OAuth

Mint.com provides a free service, which is able with your authorization, to connect to your bank(s), retrieve your bank account information and all your transactions and provide value-add services with the data. In particular, it allows you to see where you money is spent and give you hints at how you could save money. I personally think it is a superbly designed UI to the user data held at banks, which shows how much value there is to unlock, and also how much startups can be so much more efficient at delivering innovating services than banks themselves sometimes. Yodlee, a partner of Mint.com, was a dot com era example of this and Mint.com might be their Web 2.0 equivalent.

One problem is: Mint.com requires you to provide your actual username and password to the online banking service provided by your bank, which you use not just to view transactions, but also to make payments, transfers, etc.This approach has several drawbacks. One is that the user can be legitimately concerned about what would happen if this information would get compromised. Right now, Mint.com reassures its customers by saying: “We don’t store your info, Yodlee does”.

Another problem is that every time your online banking username or password changes, Mint.com stops working until you reconfigure it:

Mint.com screenshot showing: wrong username/password

Not very convenient. Add to this the fact that you can’t have any guarantee of what happens to your username/password when you want to terminate your relationship with Mint.com/Yodlee, and you may feel like you won’t use this application for now.

An implementation of OAuth protocol between Yodlee/Mint.com, the user and the bank can solve these problems at once, and would certainly further drive user adoption.

OAuth is self-described as a protocol for “secure API authentication”, but a better way to put it is that OAuth is a way for users to grant controlled access to their data hosted at online service A to another online service B. To use the car metaphor, if your data at online service A was a car, and online service B was the valet parking person, OAuth would be the way for the valet parking person to ask you for your car’s valet key, with which he can only drive a few miles and can’t open the trunk, and the way for you to give him the key. In security jargon, OAuth allows to delegate capabilities on your data to other applications, in the form of signed tokens, i.e. authorizations to do specific things with specific data that you sign with your identity. The beauty of it is: because these capabilities are signed by you, it can be presented by online service B to access your data at online service A without you having to provide your identity credentials (username/password typically) to online service B.

Coming back to the Mint.com/Yodlee use case, here is how it would work:

  • The user would go to Mint.com to request access to his data at the bank.
  • Mint.com would request his bank a token for a specific capability, for instance, retrieving transaction data
  • Upon receiving this request token, Mint.com would redirect the user to the bank’s token authorization page.
  • The user then authorizes the token (If he is not already logged in, he would do that first)
  • Mint.com can then substitutes the request token with the access token, and access the user’s data as they requested and as the user authorized, until the token is invalidated or expires.

Here are the benefits of OAuth for the user in this use case:

  • Mint.com/Yodlee never know the username/password used to log in at the bank.
  • When the user changes his username/password, Mint.com/Yodlee can still retrieves transaction data
  • When the user decides to terminate the relationship with Mint.com/Yodlee, he knows they don’t have is username/password and he knows that they can’t access his data anymore.
  • When you don’t want to use Mint.com/Yodlee anymore, you can simply invalidate

The big question is: how much work would be involved at banks and Yodlee to support OAuth, and in particular, what would they have to change?

SmartyPig: socializing savings accounts

NetBanker has an interesting post about a new banking service called SmartyPig, which socializes savings.

Essentially it combines:

  • A interest-bearing FDIC insured savings account with a specific goal can be shared with friends and family
  • An easy way for friends and family to contribute money to your goal directly from a checking account or a gift card
  • Rebates from partner companies.

SmartyPig screenshot

So, for instance, a teenager can open an account with the goal to save x thousand dollars to buy a car, have his family contribute directly to the account on this specific goal, and get a rebate from one of the retail partners on the purchase of the car.

I like this idea for multiple reasons:

  • It’s what a product should be: not technology, but very well-done integration.
  • It comes at a perfect timing: Americans probably will have to learn to save more and get in debt less as we enter recession and the rest of the world becomes less and less interested to finance them.
  • It really comes back to the essence of money: a trusted promise between multiple people that increases collective wealth instead of moving it from the havenots to the haves. The manufacturer gets the promise his product will be bought at a certain point of time and can plan production accordingly. Friends and family who contribute get the promise that their money is used for what they intended.

In a nutshell, SmartyPig can be viewed as a small attempt at bringing back the social role of money.