Is the Current Financial Crisis Result of a Disruptive Innovation?

elokuu 5, 2009

Hätinen Antti

Etusivu » Is the Current Financial Crisis Result of a Disruptive Innovation?

As everybody knows the financial credit crisis has struck the World in 2008-2009. Trillions of dollars have been spent in supporting the in-trouble commercial banks and other large corporations. Companies report billions in losses and hundreds of thousands are laid-off. The generally accepted reason for the current crisis is the US sub-prime mortgages that nobody seems to have been able to predict they will default. Despite the fact that the banks are traditionally considered to be very risk-awerse. Makes me to wonder!

Harvard Business School professor Clayton M. Christensen gives another explanation, what is really happening. Actually the bank crisis is not about the crisis in the economy, but an introduction of a new disruptive technology called credit scoring schemes that have struck hard into soft belly of the traditional loaning businesses of the incumbent commercial banks. The credit scoring schemes are algorithms and formulas that let you to evaluate credit-worthiness of a loan applicant. The new players who are using this new technology are not banks, but new specialist lenders such as GE Capital and the others, that push the traditional banks upwards towards the higher margin investment banking. However, the large banks are starting to feel the air getting thin in the higher market segments, when the new specialist players are eating up their traditional core-businesses. It started from the consumer loans, moved into the automobile loans, credit cards and starting to reach the small business loans.

How do the banks react when their traditional businesses are evaporating? To cope with the decrease in margins they have to push the costs down by marging into larger units. This has happened already for decades. The Bank of America mergers with Merrill-Lynch, Citigroup acquires Morgan-Stanley etc. According to Christensen this is an ex-post reaction by the high-end players to a market disruption that has already happened. The new players have pushed the commercial banks to investment banking and to merge, since there is not anymore enough volume to sustain them all.

The idea of Christensen’s Disruptive Innovation -model is that the new disruptive technologies are introduced to the market as inferior alternatives and thus are ignored by the incumbents. However, after the disruptive technology evolves, it suddenly reaches the good-enough requirements of the customers, and overtakes the markets with higher efficiency business models. The incumbents try to protect their eroding high margins, but in the end are unable to compete with their high-cost business models with the new rivals.

As we remember, the credit crisis was launched by the US sub-prime mortgages. It seems that the traditional banks are truely in trouble with this disruptive technology, as the root cause of the crisis is the inability of the banks to evaluate the credit worthiness of the re-packaged sub-prime loans. The losses of the high-tier commercial banks accumulate in trillions of US dollars! On the same time the new market players are cashing in steady profits.

Bad for the banks, but good for GE Capital. But how does it affect the consumer? The bad news is that due to the trillions of dollars of Government bail-out money, the tax payer has to actually pay for it all. And the even worser news to the tax payer is that he is paying for nothing – according to Christensen’s model the large incumbent banks will be anyway be forced to merger and shrink to the oblivion, until there are no old banks remaining. The cost will be enormous, especially, if the inevitable technological revolution is stalled by taxing the consumers. The bail-outs are only pro-longing the inescapable with an ever increasing cost for all the parties involved (=everybody), when the dying incumbents are artificially resprirated.

It gets me to think, who are really influencing the political decision makers? Who has the largest amount of money in the world? The bankers of course, for the time being. Inevidably they will, however, shrink to second class players, when the new cadre of financial institutions rise. The downside is that the bankers are now puffed up with such amounts of capital that it will take decades before their final collapse.