The Private Debt Crisis

The Private Debt Crisis

China is drowning in it. The whole world has too much of it. History suggests: This won’t end well.
By Richard Vague from Fall 2016, No. 42 – 28 MIN READ
Tagged DebtGDPGreat RecessiongrowthIMF

Why does the IMF keep badly missing its global growth forecast? And what does that have to do with the 2016 presidential election?

In the years since the 2008 global crisis, when the world’s growth rates tumbled, the IMF has dutifully printed forecast after forecast predicting rebounding growth rates. But in reality, rates have fallen well short of these prediction……………..

The Private Debt Crisis

The Cloud, SaaS, Digital Payments and low interest rates will revolutionise banking

Whilst we are still at the very start, low cost technology, innovation and the ability to compete with the establishment will change the face of banking over the next 20 years. The great debt cycle that is nearing its end reshaped banking globally. Banks became the centre of western and eastern economies but now that dominance can be attacked and broken down into its components for a better deal for society. The following article is but one small example of what’s possible and coming.

by: Emma Dunkley for the FT

OakNorth, a UK challenger bank that focuses on lending to small businesses, has broken even in its first year in a sign of strength among the wave of recent digital-only entrants to the British banking market.

OakNorth, which appointed former regulator Lord Adair Turner to its board last year, is the first such digital lender to turn a profit within 12 months. The bank has not disclosed the financial details but confirmed to the FT that it had made its first pre-tax profit.

Doubt has been cast by some analysts about the ability of start-ups to attract customers from established banks, as well as increase lending amid uncertainty in the wake of the UK’s vote to leave the EU.

OakNorth said that it had nearly doubled lending in the two months following the Brexit vote, however, approving more than £100m of loans to small businesses.

A number of other digital-focused start-ups, such as Monzo, Starling and Tandem, have gained licences in the past few months. Atom, the UK’s first app-based lender that launched in April backed by Spanish bank BBVA, has said it expects to break even in two to three years.

OakNorth, which has lent £180m since launch last September, focuses on serving entrepreneurs within the smaller business sector. In the past few weeks, for example, it closed a £19m deal with the healthy fast-food chain Leon. Other specialist lenders focused on the small business sector have also become established in the past six years, such as Aldermore, Shawbrook and OneSavings, and again have posted strong recent results. Shawbrook reported a 14 per cent rise in pre-tax profits for the first half, while Aldermore posted a 50 per cent increase, and One Savings Bank 36 per cent.

Rishi Khosla, co-founder and chief executive of OakNorth, said: “We have a fundamentally different approach to the other challenger banks — we are a bank for entrepreneurs.

Atom Bank, the UK’s first app-based bank, has registered nearly 40,000 potential customers of which only 2,000 have opened accounts, in an early sign of the challenges start-ups face as they attempt to exploit the shift to mobile banking.

“We’ve taken a disciplined frugal approach to building the organisation while not compromising on technology, people, and processes. If you look at the technology we have built, it’s more flexible and scalable than other challengers who have used much older technology.”

Earlier in the year, OakNorth opted to use the cloud for its core systems by using Amazon web services. OakNorth said the move allows it to scale up more quickly with fewer resources, enabling it to launch new services and products more efficiently. The cloud is a virtual way of providing an outsourced range of IT services over the internet, rather than through a physical computer server.

An adviser to challenger banks told the FT that OakNorth has benefited from being able to keep costs low owing to its simple business model. Other new banks focused more on current accounts and transactions are required to build more complex and costly technology infrastructure.

He said: “There’s an achievement in building a loan book of sufficient size to cover costs, and it shows you can build a profitable bank in a year.”
Copyright The Financial Times Limited 2016. All rights reserved.

Australia’s future; negative rates and quantitative easing, what are they good for? Part 2

by: Graham Andersen
Founder and Executive Director
Morgij Analytics
Let’s say, just as an example, that short term interest rates undoubtedly bottomed on -5%pa for government bonds and -3.5% for bank funding costs or deposit rates as the bottom of the cycle. Over a 5 year period there would be significant decreases in debt and money supply whilst simultaneously reducing asset values. A forecast which is totally against traditional thinking because wouldn’t both private and public sectors borrow like there was no tomorrow with the cheapest cost of borrowing in the known universe?
Cheap is a relative term. Maybe it’s cheap for borrowing for productive purposes but at the bottom of the interest rate cycle and well into negative territory, inflation of asset prices ceases with deflation the norm. So if you add the loss on the asset or risk capital discount to the negative interest perhaps the net cost is a disincentive to invest in non-productive assets as opposed to future business cash flows.
Governments would face the same incentives, borrowing to cover expense shortfalls is just a spiral down in credit ratings which will increase the risk premium and deter investors from lending. Productive infrastructure makes sense but there’s a limit to that and a similar analysis to the private sector would say that, even in negative territory the total cost of borrowing is not necessarily low. Borrowing today to accelerate the building of large infrastructure in a deflationary environment, simply means that the cost of building that infrastructure is higher today than in the future, that’s the cost of risk capital in a deflationary environment.
So in a significant negative interest rate environment when the bottom is in, the deduction is that actual total borrowing costs are not that cheap but incentives have finally been achieved to deter asset investing in favour of productive business endeavours. Great, but why would anyone at that point put money in a bank? Wouldn’t we all hoard cash?
We wouldn’t be able to hoard much cash because the amount of physical cash relative to digital cash in our banks is very small and it’s not hard to put a limit on the amount of cash anyone can hold and is printed. Sure people will take advantage of the situation but it’s manageable and who cares?
The issue though is whether the government and CB can control digital currency? By that I don’t mean crypto currencies, rather fiat currencies held in digital form outside the banking system. Again perhaps manageable by regulation but perhaps also an opportunity for an aspiring fintech.
It is hard to imagine however, the populace not being outraged by negative rates on deposits in banks. This where CB collective behaviour again helps the politics because if it’s the same around the world then we can all point the finger at it being some foreigners fault. Aussies are masters at that one.
Let’s now examine quantitative easing or QE, that mysterious thing invented by CBs since the last financial crisis. QE is when CBs buy government and other bonds from banks, on the pretence that banks will then have more money to lend out, and, just like negative rates will increase lending particularly to the business sector. As Steve Keen has shown QE does nothing more turn a bank asset into another form of bank asset and that’s about it.
Well perhaps not quite, QE changes the nature of the bank assets from bond to digital cash which can then be changed into a loan. The loan could be for productive or non-productive purposes. Of course whilst interest rates are decreasing banks will be incentivised to loan against or into rising asset prices. The complete opposite of what the CB is saying that QE is for.
However, CBs and politicians continue to sprout the magic of QE, even Obama seemed to think QE provided some form of multiplier to lending as if it was core capital, astounding. The act of lending itself creates money in the system and as such any individual bank has many avenues to fund its lending book. QE does not help the banking system increase productive lending as this is quite evident with the results of QE in the US and Europe since 2010. So what use does QE have?
Perhaps QE is more about CBs saying they’ll stand behind any liquidity issues that any bank may have. Liquidity problems occur in banks before any credit crisis perceived or otherwise. So if lenders and depositors to banks are confident that any bank run is covered by CBs through QE or otherwise then any liquidity crisis is a much lower risk. The lowering of liquidity risk through QE perhaps lowers the risk of a financial crisis before interest rates are lowered into sufficient negative territory for a sufficient period of time. Again avoiding the CBs and politicians fears of no crisis on my watch.
It’ll be interesting how QE is used as interest rates fall further. Will CBs be buying bonds at market value, ie at large premiums top face value? A means to provide the market with locked in capital gains not possible in the open market and further strengthening market liquidity.
Australia has its own unique structure of QE with the committed liquidity facility which is actually a long term borrowing facility with the RBA supported mostly with securities backed by mortgages. All set-up any ready to roll when needed to support the liquidity of Aussie banks or fill any whole caused by offshore capital flight.
So negative rates and quantitive easing fit nicely as a package to manage the system so that the amount of excess money created is eliminated and thereafter new money creation is distributed into the productive hands that need it. It just takes many years to play out. I may be somewhat delusional in my assessment of the future but in the absence of a hard crash or war that disproportionally effects the privileged, I cannot see any other scenario playing out. Can you?
Not everyone will agree with me, probably, the majority won’t. The well-respected Bill Gross certainly doesn’t,…………………… or does he?
There are other obvious drawbacks to near-zero yields and interest rates. Historic business models with long-term liabilities — such as insurance companies and pension funds — are increasingly at risk because they have assumed higher future returns and will be left holding the short straw if yields and rates fail to return to more normal levels.
The profits of these businesses will be affected as will the real economy. Job cuts, higher insurance premiums, reduced pension benefits and increasing defaults: all have the potential to turn a once virtuous circle into a cycle of stagnation and decay.
Central bankers are late to this logical conclusion. They, like most individuals, would prefer to pay later than now. But, by pursuing a policy of more QE and lower and lower yields, they may find that the global economic engine will sputter instead of speed up. A change of filters and monetary policy logic is urgently required.”
FT 18 Aug 2016

Australia’s future; negative rates and quantitative easing, what are they good for? Part 1

by: Graham Andersen
Founder and Executive Director
Morgij Analytics

Official interest rates are heading negative everywhere that public and private debt levels are at record highs on every measure. Australia fits squarely at the top of the pile. No doubt influencing Australia’s central bank, the RBA, to reduce the official cash rate a further 25bps in August. Whilst lowering official rates to 1.5% was predictable, the explanation in the RBA minutes seems more confused than informed, more noise than signal.
Whilst the RBA seems to sweat on inflation, unemployment, income and growth numbers throwing in house prices, debt levels and what’s happening with the $A and in the rest of the world, so does every other central bank. Its central bank think. Figures like GDP, unemployment and inflation are constructed measures whose meaning is determined by the input, the algorithm and the interpretation. Things of beauty to any central bank bureaucrat and mostly weapons of obfuscation and deception.

This collective yet disciplined behaviour means that all central banks, no matter what narrative is portrayed ultimately do the same or similar things. It’s not a conspiracy but collective behaviour triggered by the same noise and motivations. But, behaviour is predictable if you look for the signals and remove the noise.

Forget central bank noise of manipulated statistical constructs, the signals for future interest rates are as follows:
• Global GDP growth for a very long time has been driven by credit growth which under current settings is maxing for governments and households.
• Much of the credit growth has been collateralised by non-productive assets which in turn have grown spectacularly in value with the risk concentrated into 4 very similar banks in Australia
• Australia’s 4 major banks are undercapitalised. They are not in the top quartile internationally. They are at best average and therefore vulnerable to capital flight and credit downturns
• Credit growth in both productive and non-productive assets creates new money and bank deposits, reduction in debt does the opposite
• If there’s too much debt there’s too much money but almost by definition the debt and the deposits are held in different and mostly generational hands, so the net of zero is irrelevant in assessing risk
• Australia is locked into the trifecta of budgetary, trade and current account deficits, ensuring that the AAA credit rating will be lost and downgrades continue. The caveat here is that rating agencies are not consistent and act in self-interest. But more importantly, offshore borrowing needs to continue to grow to fund the deficits, so at least in the short term the rating agencies may be kind.
• No central banker is going to deliberately crash asset prices to reset debt levels by causing losses on loans and a reduction of money in the system
• Currency wars prevail around the globe with exchange rates set just as much on capital account as on the trading account.
• Not to undermine the importance of the other signals but how about the fact that Australia has no means to pay back what it owes to the rest of the world ever, other than to sell the country, is some signal to be taken notice of and take action on.

Using that piece of wisdom that the herd will always act in immediate self-interest, the signals tell me that the politicians are not going to change deficit settings in any meaningful way so debt levels will not be reduced significantly, deliberately. Concentration of risk and liabilities means the markets overall do not want a crash and will avoid that by any means. Central bankers will take notice of the signals whilst generally denying them and do the only thing they can, keep cutting interest rates into negative territory.

Whilst the CB meme will be that rate cuts are for stimulatory purposes in encouraging businesses to borrow to invest, this is noise and false. In an environment where the signals say structural risk and debt cycles are maximising but lowering interest rates increases asset prices, why is any business incentivised to take the risk to invest in productivity rather than assets?

To understand what will happen as risks in the system are cranked to breaking point we need to come at things from a different angle. Throw out traditional thinking. Perhaps the whole notion of principal and interest needs a bit of a rethink. Maybe a concept of risk capital should be built into the balance of each loan and deposit and repaid or not based on macro criteria would make system management easier.

Negative interest rates are simply losses on capital over time whilst simultaneously increasing the real value or purchasing power of the currency unit. To put it another way, negative interest rates destroys the money that was over created by excess debt leaving the money remaining having a greater value per unit. So rather than CBs lowering rates into negative territory to be stimulative, they’re destructive of volume yet value creative of the unit.

By lowering rates, driving credit growth and inflating asset prices, CBs have created an allusion of sovereign wealth creation when all they’ve done is rearrange the deck chairs on the Titanic. Creating excess money from unrepayable debt is a can kicking exercise of mammoth proportions but to the man in the street I suppose it seems like CB magic and for a time it feels great. Its only as time marches does the realisation hit that its nothing more than screwing those left holding massive debts for the benefit of the privileged. All orchestrated by CBs and their political masters in order to look good.

That’s because the holders of excess debt (the victims) and excess deposits (the privileged) are in different hands and reducing both debt and deposits together is a political land mine. Whilst there’s a real sting in the tail most mortgage holders would be happy about repaying less than they borrow. Personal entitlement by the privileged screams that their deposits are untouchable. Negative rates are a way of making the pain more acceptable or more to the point, realigning investment in unproductive assets into a position where it’s more attractive to invest in productive assets.

Sounds like a pretty neat solution, but is it? Certainly explaining how we’ll be better off by making losses on capital is something of a challenge.
The questions that come to mind are; what level of negative rate will do the trick? How do you get there and what damage will the movement down do before things start to reset to the positive?

The movement of interest rates down into negative territory is necessary in the absence of a short term bust. However, it will drive asset prices up and this movement distorts investment decisions and incentives, but, it is likely to drive credit growth and therefore support CB statistical constructs that make them look good whilst actually making the problem worse. Its only when the interest rates have unequivocally hit bottom that the rebalancing will take hold and reality bites. That bottom must be significantly negative. Zero or close just won’t cut it…….

To be continued in PART 2

Strong industrial strategy has many benefits

The argument should be about the best way the state can help drive growth, writes Mariana Mazzucato

Almost every technology behind the iPhone was government-funded.

In a brief moment after the financial crisis, policymakers set their sights on something higher than mere growth: not a return to the consumption and (private) debt-driven growth that had created the trouble, but investment-led growth. Time passed, however. The obsession with austerity set in and that interesting debate dwindled away.

Now, British prime minister Theresa May’s revival of industrial strategy is an opportunity to engage in the conversation again. Certainly, the concept of having such a strategy has not lost its power to shock. Commentators have been swift to denounce its revival as misguided and protectionist, a 1970s’ tribute to failed attempts to revive zombie companies. But the idea that the choice is one between protectionist policies and the elimination of any strategic role for the state is false.

In South Korea, China, Finland, Israel and the US, for example, the state has played an active role in increasing innovation and the productive capacity of the economy. Almost every technology that makes the iPhone smart was funded by government. This was not just about basic research but rather engagement across the whole innovation chain, including demand-side procurement policies.

Today the argument ought not be about whether the state should or should not be involved in driving growth but how it can do this in the best way. There are, for example, legitimate concerns that certain approaches to industrial strategy can lead to incumbent companies and sectors winning unwarranted favours from governments through persistent lobbying. Sectoral approaches sometimes increase these risks.

Much better to look to the lessons of innovation policies that have focused on getting companies to find ways around social and technological problems by working together across sectors and with public agencies. The Apollo mission to put a man of the moon, for example, required collaboration between sectors from textiles and aerospace.

Such an approach demands new types of public-private partnerships, targeting real co-investments rather than concessions and subsidies . In the past, this led in the US to the likes of Bell Labs and Xerox Parc, engines of future innovation, and in the UK to chip designer Arm, through spillovers from BBC investments.

By increasing business expectations about growth areas, mission-oriented investments encourage private sector investment. Unlike indirect measures such as tax credits, these policies create animal spirits rather than assume them. They also allow greater synergy between macroeconomic stimulus, financial market reform and innovation. This can lead to bigger multipliers than “infrastructure spending,” the policymaker’s default panacea.

On the finance side, the problem is not quantity but quality: industrial and innovation policies require long-term, strategic finance, while the UK continues to reward short-term finance. The few attempts at building sources of patient public finance have been neglected, with the successful Green Investment Bank , for instance, in the process of being privatised.

Indeed, just as the debate should not be industrial strategy versus free market, at the organisational level it should also not be about public versus private. There is no reason for the government to sell its entire stake in the GIB. It could retain a significant share, ensuring that it is neither fully public nor wholly private, and use the public share to direct green innovation in the long term.

Similarly, there is no compelling reason for Channel 4, the British public service broadcaster, to be privatised. It can continue to offer opportunities for private sector broadcasting activity, through procurement; so far it has done this successfully with a good return for the taxpayer.

Why should the public sector not get some return on successful investments, sharing the risks and rewards, precisely so that it can cover the failures that inevitably come with innovation? This also entails seeing intellectual property (patents) not as “rights” but as contracts to be negotiated between government and business so that innovation is nurtured rather than stifled. We need the interesting conversation about investment-led growth but the last time it began it was cut short before it really started. This time, we must do better.

We do not need false or ideological choices between market and state. This time we need a real debate about the social missions that can drive public and private investment to claim the opportunities of the future.
The writer is a professor at the University of Sussex, author of ‘The Entrepreneurial State’ and co-author of ‘Rethinking Capitalism’

Half of big banks unprepared for accounting shake-up

Published by the Financial Times 14 Aug 2016
Caroline Binham and Emma Dunkley in London

Nearly half of big banks around the world are unprepared for an international accounting standard due to take force in less than two years, even as they expect provisions for bad loans to soar as a result of the new rules.

A poll of 91 banks across the globe — excluding US banks that are governed by their own rules — has found that 46 per cent of those surveyed do not believe they have enough resources to deliver changes by the 2018 implementation date, with a significant minority going on to say there were not enough skilled candidates in the market to hire.

With less than 18 months to go before the change, nearly two-thirds of banks are unsure how the rules might impact their balance sheets, according to Deloitte, which undertook the global survey.

The rules force banks to have a provision on their balance sheets for expected losses in the future rather than actual losses already suffered.

Those banks that have made the calculations reckon the rules will result in a surge of at least 25 per cent in total impairment provisions across all asset classes.

Banks are also forecasting that the rules, dubbed IFRS 9, will cause their capital ratios to deteriorate: they are expecting core tier one capital — one of the most keenly watched metrics of the health of a bank’s balance sheet — to decrease on average by half a per cent as a result of moving to the new standard, according to Deloitte.

Uncertainty is not limited to the banking industry: 99 per cent of respondents said their local financial regulator had yet to say how they might incorporate IFRS 9 numbers into regulatory capital requirements.

IFRS 9 is part of a suite of measures by the International Accounting Standards Board to overhaul accounting since the financial crisis. The reform package is an attempt to increase regulatory co-operation between the US and international standard setters. Converging the different corporate reporting frameworks has been fraught.

By moving from an “incurred loss” to an “expected loss” model in 2018, under IFRS 9 the regulators hope to avoid the problems that occurred during the crisis, when banks could not book accounting losses until they happened, even though they could see them coming. This should help to keep banks properly capitalised for the loans they have made.
UK banks have experienced historically low impairments recently because of the record low interest rate.
However, there are some concerns that if economic growth were to stall following the Brexit vote, impairments could go up even without the new rules.
Steven Hall at KPMG said the estimated increase in provisions as a result of IFRS 9 was actually “cautious”.
“IFRS 9 will be almost as difficult to implement as it is to say,” he said. “Firms need to consider a range of future scenarios, and in today’s uncertain economic environment assessing the impact of that is not an easy task.”
Mr Hall has called for a grace period during which the new systems might be tested and embedded.

The Founder’s Mentality: How to Overcome the Predictable Crises of Growth

Extract from an interview with the author:….

Knowledge@Wharton: This founder’s mentality is more toward the thoughts of the company than the actual bottom line. Does the bottom line come as a by product of it?

Zook: Yes, it’s really about the inner health of companies. I remember reading that the best-selling sports book of all time was The Inner Game of Tennis. This is a little bit the inner game of business. We found three elements that we referred to as the elements of the founder’s mentality, which we felt were the best measures of health inside of a company. Boards of directors don’t typically ask as many questions or track these, although we found they are 85% to 94% of the reasons companies break down on the outside.

Number one is what we called an insurgent mission. Every founder is either at war against their industry standards because they are frustrated with it or trying to create something new, like Elon Musk is doing with SpaceX — creating a vehicle potentially to put people on Mars or Google is doing to organize information. Yet over time, companies can become just another company. We found that only 13% of people in the world now say they have any emotional commitment to the company that they spend probably half of their waking lives with.
The second element of the founder’s mentality is what we called frontline obsession. A great image for me was a description from Vikram Oberoi, the CEO of Oberoi Hotels, which were voted for a number of years as the best luxury hotels in the world. He would describe how on Sunday mornings he would visit his father, who was a poor villager who began this story in this incredible, humble beginning. Even at the age of 94, he would be holding customer comment cards in front of his eyes when he could barely see, scratching notes about the temperature of the tea for customer complaints. To me, that gets lost often in big companies.

The third is what we called the owner’s mindset, which is an aversion to bureaucracy and a desire to jump on problems, take responsibility right away, which often gets lost in big companies. It’s the essence of private equity’s success, in a way.

Chris Zook is a partner at Bain & Co., a management consultant firm, and served as co-head of its Global Strategy Practice for 20 years. In his new book with James Allen, The Founder’s Mentality: How to Overcome the Predictable Crises of Growth, he draws on his decades of experience to demystify the secrets of companies that push themselves past a slump.

Australia headed for recession next year, Professor Steve Keen says,-professor-keen-says/7674154

Australia headed for recession next year, Professor Steve Keen says
By The Business presenter Elysse Morgan

Australia’s credit binge will lead to a bust as soon as next year, with house prices to fall between 40 and 70 per cent and unemployment to rise sharply, Professor Steve Keen says.
The professor famously lost a bet when he predicted a catastrophic crash in Australian house prices following the GFC and had to walk from Canberra to Mount Kosciusko as a result.
But he says, this time, he is right and does not have his hiking boots at the ready.
“We have borrowed ourselves so much to the hilt that we are now dependent on that continuing to rise over time and it simply won’t,” he told the ABC’s The Business.
Many believe the Reserve Bank has been a steady guiding hand to the Australian economy in the years since the GFC, but Professor Keen believes it has guided the economy “straight toward the shoals” by encouraging households to borrow with low rates which has led to asset bubbles.
“They don’t know what they’re doing,” he said.
“Our debt level according to the Bank of International Settlements, private debt level, has gone from 150 per cent of GDP to 210 per cent of GDP.”
He argued that means a large part of the growth that Australia has enjoyed since the GFC, while many other countries plunged into recession, has been fuelled by a 60 per cent rise in household debt.
“Ireland did the same thing when they called themselves the Celtic Tiger and they don’t call themselves that anymore,” he said.
“Spain was doing the same thing during its housing bubble and we’ve replicated the same mistakes.
“It is even worse for us, we are the last idiot on the block.”
He believes the Reserve Bank will be forced to take rates down to zero from their current level of 1.75 per cent as the economy continues to slow, but that will not stop the collapse of the credit binge that has kept the country afloat until now.
“[Lower rates] will suck more people in, it will suck more people in for a while and the [Reserve Bank] can delay this for a while by cutting the rates,” he said.
Government deficit worries overblown, Keen says
He said the catalysts for the recession were the declining terms of trade, the continued fall in investment into the economy and the Federal Government’s “stupid” pursuit of a budget surplus.
“The Government is frankly stupid about the economy and is obsessed about running surpluses when it is bad economics.”
A major round of government stimulus that takes the deficit to 10 or 15 per cent of GDP and a massive uptick in foreign investment, especially into housing, would allow the country to avoid a big recession, according to Professor Keen.
But he said neither options were politically palatable.
He said worries about huge government deficits were overblown.
“The Government is not like a household. A government is like a bank. And a government running a balanced budget is like a bank that simply lends back as much as it gets in repayments, therefore the money supply never grows and without that, you don’t have a growing economy,” he said.
Professor Keen, who was formerly an associate professor of economics at the University of Western Sydney and is now at Kingston University in London, says economists and governments around the world have their thinking completely wrong on the issue of budget deficits.
He said the best way to prepare for the coming recession was to sell assets and reduce debts, but he admitted that was the type of behaviour which could set off a credit crunch.

The Prince and The Fintech

Nicolo Machiavelli’s The Prince has been lauded for centuries for the wisdom it imparts about the actions and motivations of men and women in establishing and managing enterprises. Machiavelli sets the book in the form of how a Prince should manage or acquire a….. Principality of course. There is an argument that The Prince was written as satire and not meant to be taken seriously. The fact that Machiavelli dedicated the book and gifted it to a member of the Medici family after they sacked him from his important and well paid job would seem to add a little weight to this view. Let’s go with conventional wisdom that there’s usually more truth to satire than in a “how to” instruction book.
What’s a book written by an Italian in Venice in the 16th century about a satirised prince got to do with building a fintech? Everything and nothing as they say, but the reader can make up their own mind. I’m selecting some of Machiavelli’s more revealing quotes from The Prince and putting them in a modern context. Let’s see if we can make the connection, firstly from Chapter 6.

“A wise man (The Prince) ought always to follow the paths beaten by great men, and to imitate those who have been supreme, so that if his ability does not equal theirs, at least it will savour of it”

Nicolo is imparting his wisdom. When starting your fintech the smart founder should not just head-out blindly, stand on the shoulders of greatness. This does not mean that the fintech product should be only a marginal improvement on existing technology as true valuable innovation comes in leaps and bounds. Rather, look around for advice from those who have been through the process successfully and not so successfully. Get the value of their experience and not their opinions and put that solidly in the innovators plans.

From Chapter 6: “Let him (The Prince) act like the clever archers who, designing to hit the mark which yet appears too far distant, and knowing the limits to which their bow attains, take aim much higher than the mark, not to reach by their strength or arrow to such a great height, but to be able with the aid of so high an aim to hit the mark they wish to reach”

A bit of an inelegant description by Machiavelli but it was around 100 years before Newton’s theory of gravity was first published, so we should forgive him for not reaching for that analogy. The aim of our fintech should not only be to have lofty goals for her product and business but those goals should be fashioned to the limit of your ability and resources and beyond. By hitching a ride on existing systems which can extend your reach you can make these goals a reality. Use networks, existing sales infrastructure (but be careful), whatever tax incentives or government assistance is available but most of all where ever and whenever you can hitch a ride on anything that can catapult your business forward get on it, it’s way too hard to do it on your own.

From Chapter 6: “And it ought to be remembered that there is nothing more difficult to take in hand or more uncertain in its success, than to take the lead in a new order of things. Because the innovator has for enemies all those who have done well under the old conditions, and lukewarm defenders in those who may do well under the new……….Thus it happens that whenever those who are hostile have the opportunity to attack they do it like partisans, whilst the others defend lukewarmly..”

Machiavelli tempers the enthusiasm of aiming high with, perhaps his most famous quote, by pointing out how difficult a mission any fintech may take on. A fintech has no friends in the market you are trying to disrupt whether it’s good, bad or indifferent for the participants. Be prepared to be attacked and to have to deal with those attacks without support. A fintech must be resilient as well as all those who reside within her. On the positive side, all true innovation has to deal with a total lack of support and indifference and if this is not the case, perhaps the truth of the innovation should be questioned.

From Chapter 6: “It is necessary, therefore, if we desire to discuss the matter thoroughly, to inquire whether these innovators can rely on themselves or have to depend on others: that is to say, whether, to consummate their enterprise, have they to use prayers or can they use force? In the first instance they always succeed badly, and never encompass anything, but when they can rely on themselves and use force, then they are rarely endangered. Hence it is that all armed prophets have conquered, and the unarmed ones are destroyed”

This quote from The Prince is the immediate follow up to the oft quoted “innovator has for enemies” and is the real guts of the issue. Whilst understanding that all innovators face the same battles may make them feel a little warm inside and not alone, what do you do about it? Machiavelli lays it on the line here. Hope is not an option nor is a reliance on co-operation. The innovator must fight for herself and use every option to crush both opposition and indifference. There is no other way. So all innovators need to have right on their side. The right to provide a better deal to customers, the right given by the law to provide a product that improves society or the right to compete and crush the established rent seekers. All innovators must be prepared to fight and show no mercy.

From Chapter 17: ‘Mercenaries and auxiliaries are useless and dangerous; if one holds his state based on these arms he will stand neither firm nor safe; for they are disunited, ambitious and without discipline, cowardly before enemies, they have neither the fear of god nor fidelity to men, and destruction is deferred only so long as attack is; for in peace one is robbed by them, and in war by the enemy. The fact is, they have no other attraction or reason for keeping the field than a trifle of stipend, which is not sufficient to make them willing to die for you”

So what do you really think Nicolo? No time for mercenaries then? If the fintech innovator is going to fight she needs her soldiers, her employees, but they must be bought in and motivated. Without that they will be useless when the going gets tough. Every fintech is a target and every fintech needs to fight for its existence and future. Without employees with serious skin in the game these battles will be lost and employees will flee when the real pressure is applied and they have to step up and give the extra yard. Reliable employees, no matter how skilful, are those who have equity in the business and serious incentives to perform and be successful. No mercenaries, hangers on or employees and directors with free options and no accountability, because with that sort of back-up the fintech will fail.

Back to Chapter 6: “Therefore such as these (innovators) have great difficulties in consummating their enterprise, for all their dangers are in ascent, yet with ability they will overcome them; but when these are overcome, and those who envied them their success are exterminated, they will begin to be respected, and they will continue afterwards powerful, secure, honoured and happy”

Now the good news, whilst the fintech has many enemies, no support and has to fight every step of the way, with ability and motivated employees, these things can be overcome. Once overcome however, the fintech becomes entrenched with great rewards to the innovator and her employees. It’s much tougher to get to the top than one can imagine but once there the fintech is in a highly defensible position and therefore equally tough to be displaced. It’s a truism or existing systems would be in a constant state of chaos and unworkable.
So unleash the innovators, follow The Prince and fight to the top with those heavily motivated soldiers and you’ll never look back.

Graham Andersen
Founder and Executive Director

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