Web 2.0: A quiet banking revolution?

Bob Giffords

Out in the blogosphere, a transformation is happening that could have long-term consequences for financial services companies and their clients.

Something is happening. Without the fanfare of the dot.com boom, the second generation of the internet, Web 2.0, is bringing real innovation. As banks become deeply embedded in the daily lives of their customers, they are reinventing themselves as real time enterprises, using intense machine intelligence to sustain that relationship.

Web 2.0 is about social networking and peer-to-peer transactions. While bank-centric B2C technology made the running in the first internet boom, P2P and viral communications are now key. Zopa in the UK, with 170,000 “members”, is one of the global market leaders, matching private lenders with borrowers to disintermediate the banks. This retail-financial initiative reflects what happened with credit derivatives in the corporate market.

“Essentially we are a broker and a managing agent for the lenders, licensed under the consumer credit act,” says Tim Parlett, chief operating officer and co-founder of Zopa. “We make our money from fees.” Zopa discovered that people want to invest in each other. “They like spending the time online, evaluating the alternatives,” says Parlett, “then seeing the photos or reading the blogs of what people have done with their money. It’s not so much ‘fun’, as a strong ethical satisfaction of helping others.”

There are many P2P strategies available. Zopa takes a conservative approach, rather like a mutual fund, finding the borrowers and taking all the investment decisions for lenders. To minimise credit risks, investment portfolios are split over 50 different loans.

LendingClub, a P2P broker in the US adopted a different approach. “Our launch in late May with FaceBook was the first of several planned collaborations with established social networks, which could include clubs, alumni networks, and professional associations,” says Renaud Laplanche, founder and chief executive. “We believe adoption will be faster in an environment where people feel connected to each other.” Sure enough, by the end of July LendingClub had issued over $500,000 in loans. Laplanche explains how the FaceBook Platform API allows them to integrate their application directly into the FaceBook look and feel, so when people log into their FaceBook profile they can also see their LendingClub details and offers. “It also simplifies the referral process between friends,” he adds.

Zopa is also looking very much at member-get-member and friend-of-a-friend type promotions. “Earlier this year in Las Vegas we demonstrated with Microsoft a one-click feature to allow users to invite their friends on Hotmail to join Zopa,” says Parlett. “The Microsoft infrastructure hasn’t yet been released, but when it is, we are ready.”

Moreover, while Zopa makes the underwriting decision on behalf of lenders, LendingClub only makes a recommendation. “Lenders choose their risk preference,” says Laplanche, “and we make a ‘recommendation’ of twenty to twenty-five fractions of loans for his portfolio, using a Markowitz model to calculate the efficient trading frontier. It is all very transparent.” The lender can then either accept this proposal or edit the portolio to make their final choice.

Boober, a new P2P broker in the Netherlands, took a third approach. “We only provide the marketplace,” says Guus Drijver, chief executive. “We make no recommendations, provide no advice except general guidance on our web site, but we do impose market rules on members.” However, besides lending portfolio rules, Boober offers a guarantee for lenders on both principal and interest, said to be provided through Intrum Justicia, the collection agent. “This can be as high as 99.5% for the best loans with the highest, AAA, credit ratings,” says Drijver. “For AA ratings the guarantee drops to 90% and so on. The risks are clear, but lenders take their own decisions.”

In all cases advanced financial engineering methods are applied to manage risk as well as subtle social engineering features to encourage word-of-mouth promotion and other viral communications to attract new members.

Seriously virtual

A very different sort of challenge is raised by 3D virtual worlds like SecondLife and Entropia Universe. SecondLife, developed by Linden Lab, is one of the largest, well established metaverses, combining social networking among nine million residents with a virtual game and elements of a real economy. Residents travel and trade through avatars in SecondLife by buying Linden dollars that can later be converted back into US dollars. Because transaction sizes are often small – just a few cents –players mostly take it as entertainment.

Many banks have opened on SecondLife. The first was Wells Fargo, which created “Stagecoach Island” back in 2005 for financial education. Later ING became involved with a number of partners to explore the commercial opportunities in these virtual economies and build their own island called “Our Virtual Holland”. BNP Paribas also uses SecondLife for virtual events and some recruitment interviews.

Another pioneer is Saxo Bank, the international investment bank based in Denmark. “We see SecondLife as part of the online gaming trend, which is exploding,” says Stephan Martinussen, head of product development. “It will condition young people’s expectations for trading, when they grow up in, say, ten years. They will want much more than just left or right click functionality.”

Elements of gamesmanship are already entering securities trading through strategies for stealth and dark liquidity, so it makes sense.

“We have learned a lot,” says Martinussen, “how to present ourselves in an attractive way, to keep innovating to hold people’s interest and to deal with people in a hurry.“ He explains how things of value have to be virtually close, just a couple of clicks away, since people’s attention span may only last a few seconds. “It’s a challenge,” he says. “People are packing so much into their lives, they don’t have much time for virtual worlds so they have to live it faster.”

Martinussen believes the 3D metaphor in virtual space is an interesting first step, but finds it limiting. “We are already feeling pressure to break out,” he adds. “People want to move at an even faster pace.”

Even more intense intelligence may be coming. “I think we will see robotic services where avatars are machine driven,” says Wichert van Engelen, director of innovation at ING Retail. “When the questions become too difficult a person will intervene to control the response, still through the avatar. It will be a science fiction world, but we are not such a long way from that at the moment. Now, it’s still quite labour intensive.”

Van Engelen notes that Postbank is already using a kind of artificial intelligence to interpret voice queries over the phone in its call centres. “It is only a matter of time before we can use it in our virtual business,” he adds.

SecondLife currently runs on a large computer grid to cope with web scale surges in demand and its viewer software is offered as open source, which encourages a lot of creativity. However, recently when online gaming started to tend towards gambling and anonymity was seen to challenge US child protection legislation, Linden Lab has had to intervene with policies that suggest rather more regulation.

There appears to be real demand for increased controls. “Lately some virtual companies calling themselves ‘banks’ disappeared from the virtual worlds,” says van Engelen. “Any consumer should know who he or she’s is dealing with as soon as money is involved: be sure to know the real company behind the fancy facade.” He admits this could be difficult in today’s virtual worlds but believes in the long run these “security issues” need to be integrated into the platforms.

Entropia Universe, created by MindArk in Gothenburg, Sweden, is another futuristic, virtual world of planets in a distant galaxy with an ambitious cash economy and a stated policy of greater control. Although smaller than SecondLife with around 630,000 registered members, Entropia is potentially much bigger business. A fixed exchange rate to the US dollar aims to promote a sense of security.

“Commercial transactions in Entropia Universe now total over $1 million per day,” says David Simmonds, business development director at Mindark PE. “Virtual land sells for between $15,000 and $40,000 per lot. One member bought a space station for $100,000 and it’s now said to be worth over $2 million. This is serious business.”

While SecondLife has been pretty much open to anyone to pursue any legal virtual business or leisure activity, Entropia Universe is much more controlled. “We auctioned and sold over $404,000 worth of banking licenses to 5 different parties interested in lending money in Entropia Universe against virtual collateral,” says Simmonds. “One of these was a real world bank in Germany. The licenses specify what they are allowed to do, but they are also subject to their own regulation in their home jurisdiction.”

Clearly security and trust need to be paramount, and Simmonds claims that Entropia Universe has “more security and identity checks than most banks”. In all virtual worlds investors of course will need to satisfy themselves regarding security and soberly to assess the speculative hype that may be inflating the value of such virtual property. Banks too will inevitably need the tools to advise them.

In May MindArk received a vote of confidence from the Cyber Recreation Development Corp of China when it signed a contract to build several planets in Entropia Universe for launch late next year. “The Chinese expect to attract 150 million visitors globally to their planets,” says Simmonds, “generating over $1 billion in annual turnover and creating 10,000 new jobs. Virtual games are hugely popular in China already.“ This would be serious business indeed with huge opportunities, and banks should take note.

Blogosphere blues

Online P2P communities also create challenges like the blogosphere, where everyone is talking, sharing their experience and opinions. The technology needs to be rock solid and intensely intelligent to cope.

“We have a very active bulletin board and members chat to each other and to us,” says Parlett at Zopa. “Everything is transparent. This is very important to what we do.”

Drijver agrees. “From the day after we launched we have had blogs watching us closely and commenting on what we do with typically positive feedback,” he notes. “Many lenders are organised and members of this Boober-watch website, which they manage.”

Web designers need to find creative ways to leverage these forums in their business models. “This is the first time we have had to go head to head with a community like this,” says Martinussen at Saxo Bank. “Now we are launching a community forum for our algorithmic trading clients so they can share their algos and trading ideas. It’s very powerful.” Thus SecondLife is having a direct impact on Saxo Bank’s trading products and their main web site as well.

All of the early Web 2.0 adopters were impressed by the free publicity they received, much of that on blogs. “We need to find a way to capture that,” says Martinussen.

Because of its volume, the only practical way to capture the useful blog content is to use robots. “Natural language processing has advanced greatly in recent years,” says Vaughn Peterson, vice president of business development at Attensity Corporation, a supplier of such technology. “We are now able to undertake exhaustive fact extraction from a text including entities, roles and relationships.”

By taking a cutting-edge linguistic approach, firms can now listen to the “voice of the customer” in blogs, emails, market research surveys or call centre notes. “We can also carry out deeper analyses to identify indicators of fraud,” says Peterson, “or profile the root causes of customer satisfaction or complaints.” Indeed one company, on seeing the kind of analysis now possible, commented that Attensity appeared to understand their customers better than they did.

P2P social networking, virtual gaming and the blogosphere are three social forces quietly working to revolutionise the technology of banking.