By Brandes Elitch
CrossCheck Inc.
I've been writing a monthly column for The Green Sheet for about eight years. I typically start with a lead-in about Sonoma County, where CrossCheck is located. For most people, Sonoma County means Wine Country. But this month I'm introducing something different: beer.
Sonoma County was a hop growing region before Prohibition, so there is a rich history of brewing. Today, it is a world class brewery destination, with such notable brands as Lagunitas Brewing Co., which is now owned by Heineken and is thus technically no longer a craft beer, and Russian River Brewing Co., whose Pliny the Younger was called the "top beer in the world" by BeerAdvocate.
There are approximately 50 breweries and cideries with an unmatched range of variety, niche and specialization, including craft/micro breweries and nanobreweries (brew houses that produces 90 gallons or fewer of each batch).
Making beer is different from making wine. With wine, it's a long time after bottling before you can taste and evaluate it. A lot of time passes between vintages. The raw material is constantly changing; the finished product has to be stored for six months to a year; and it is vulnerable to poor storage conditions, light, cork taint, oxidation, etc. With beer, you can brew something and put it into different batches, ferment them differently at different temperatures, use different yeasts, and run parallel experiments in the course of a day or two.
Brewing is 90 percent cleaning and 10 percent paperwork, according to local HenHouse Brewing Co. brewer Collin McDonnell, who said, "Beer requires an absurd amount of sanitary vessels to make and the fermentation and packaging process leaves a trail of very dirty vessels, tools and instruments in its wake. … It's hot, dirty and wet. It's labor-intensive work that will give you some borderline-OCD cleaning tendencies."
Now, let's talk about the similarities between brewing and my central topic: banking. McDonnell's statement about doing business today will sound familiar to anyone with even a little knowledge of banking. "As co-owner of a small brewery I spend way more time working on regulatory compliance than I do making beer ‒ same with digging through P&L statements and writing budgets," he said. "And sales work is endless and exhausting. Beer is a heavily regulated industry, regulated by federal and state agencies and wastewater treatment agencies.
"These regulators work for agencies that are underfunded, understaffed, and underappreciated. The regulations require constant reporting and inspection. Tracking the expenditures and income and projecting them to provide a solid understanding of the financial operations. Being intimately aware of the company's financial health is as important as monitoring your fermentations or selecting hops."
Readers of The Green Sheet tend to pay more attention to the card brands, major payment processors and new developments in mobile and other emerging technologies than to the banks behind the curtain that issue cards and acquire the transactions. That is a mistake, because these banks control the entire process.
ISOs devote considerable attention to worrying about the potential payment disruptors, Google, Apple, Facebook, Amazon, and Microsoft (known as GAFAM). Are they going to become real banks like the major issuers and acquirers today? Yes, they offer payments products, such as mobile wallets, person-to-person money transfers and, in some cases, even loans to small and midsize businesses (SMBs). They have plenty of capital, too. It is estimated that Google, Apple, and Microsoft have over $400 billion in cash on the balance sheet!
Let's start with Aite Group's Top 10 Trends in Financial Services, 2018. The first is "Tech firms become banks." The second is "Banks become tech firms." Aite said, "Financial institutions' ability to overcome organizational and technology constraints and turn data into intelligence will dictate whether they can survive and thrive."
Things are changing in the world of commercial banking. I'll explore a few of these topics, because as an ISO, you need to understand what is happening in banking. First, the new tax law requires banks to write down the value of their tax-deferred assets. Citigroup Inc. will take a $16 billion hit to quarterly earnings as a result. The other side of the coin is that banks will see their corporate tax rate drop from 35 percent to 21 percent, which will supercharge their earnings in the future.
Banks already have a very strong capital position, and credit quality today is also healthy. Banks curtailed lending activities, starting with the recession in 2008 and continuing up to today, but as interest rates rise (the Fed is likely to raise rates at least two or three times this year) lending will pick up, as will margins.
There are more than 5,000 commercial banks in the United States, but a dozen of the largest banks completely dominate the statistics. For instance, the four largest banks have a total of $8.7 trillion in assets. The fifth largest bank (U.S. Bancorp) is only 25 percent the size of number four, Citigroup. Second, it's important to understand the difference between an average bank and a high-performing bank. When you look at a bank, you want to see certain ratios. These include return on average total common equity, return on average assets, net interest margin, and efficiency ratio. Ideally, these should be in the range, respectively, of 15 percent, 1.25 percent, 4 percent, and 50 to 60 percent. You can, and should, look up the primary bank your company uses and read the 10-K, which is a comprehensive annual report summarizing a company's financial performance that is required by the Securities and Exchange Commission. It is preferable to bank with a well-managed bank. Why would you bank with a laggard or underperformer?
Third, there has been copious talk in Washington about reducing the regulatory burden for banks, particularly community banks (those with less than $1 billion in total assets). This is a good thing for community banks. They are spending most of their management attention on regulatory and compliance issues that really pertain to very large banks, and this has caused them to curtail lending activity to the SMBs, that is, your bankcard processing clients, their natural constituency.
But don't overlook what caused this scenario: the fines and penalties that the very largest banks have paid to the government for unscrupulous conduct covering 14 categories during the period from 2012 to 2016. These numbers are enormous. The award for the absolute worst performance goes to Bank of America, with a total of $62 billion in total fines paid for misconduct. You have to wonder how a Board of Directors can keep management in place for an egregious performance like this.
Fourth is the elephant in the room in the banking community: replacing banks' core systems. Fintech companies use a microservices architecture leveraging a software development kit network of application programming interfaces. To quote observer Chris Skinner, "It's about speed, change, service, updates and vision." He pointed out that banks have the opposite focus, "risk, security, stability, control and management," with data spread across multiple systems and silos. These are opposing goalposts for a bank.
More than 90 percent of banks use IBM mainframe architecture, much of it deployed before Y2K; over 40 percent use programs written in COBOL. For a big bank, it could take five years to replace the old core systems. This is troubling for banks but good news to fintech insurgents.
You might think blockchain will solve these problems, but not so fast. Observers have pointed out that similar prognostications were made about TCP/IP when it emerged as an experimental network for researchers and universities. But it took 30 years for it to become a ubiquitous communications platform that enabled new products and services.
It took a long time for the players involved in this evolution to turn it into a trusted business process. Blockchain is not a magic bullet. When we talk about restructuring solid, stable and long-lasting infrastructures, such as clearing houses and data exchanges, that process enormous volumes of transactions, it would be a big mistake to write them off as inefficient. Checks and balances built into these systems serve a legitimate need and purpose. There are a lot of moving parts in the banking and fintech world. It is almost a full-time job just to keep track of them. Hopefully, this column will provide some help with that 
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandese@cross-check.com.
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