Banking, Regulation, and the Information Age

Reprinted from Navigator, Volume 2, Number 3, 1998.

IOS Sponsor Tom Cirillo is currently senior advisor to the executive vice president of the Advanced Development Group of Citibank. In this capacity, he spends much of his time helping Citibank realize its global strategic goals through the acquisition and leveraging of cutting-edge technologies. He has organized consortia and joint ventures and represents Citi at the Board level of a number of key strategic partnerships. Cirillo has been a student of Objectivism since 1971, and enjoys many hobbies, including photography, audio, golf, computers, and various outdoor activities.

Navigator: Perhaps we could start with some background. Where did you go to school and what degrees did you get?

Cirillo: Well, I went to MIT and I dropped out in my second semester, so I never completed my undergraduate work. I am Bill Gates minus fifty billion dollars. Before college, I went to National Science Foundation-sponsored classes, took a lot of college credit courses oriented toward systems and electronics, and skipped a couple of grades. I was a ham radio operator when I was ten and all that sort of stuff. I won the New York City science fair in 1960 with a digital computer.

Navigator: Did you go to the Bronx High School of Science?

Cirillo: No, I went to Bayside High School in the early sixties. That was probably the last time you could get a good education in the New York City school system, but you did get a good education.

Navigator: After leaving MIT, you went into systems consulting. Was that because you were sufficiently aware of the coming Information Revolution?

Cirillo: Well, I wish I could say that was it. But when I dropped out I lived in Boston by myself and needed to earn a living. I had learned to do some programming in the course of junior high school, so I got a job as a programmer, working in Boston at the time. One thing led to another, over a period of two years, and I ended up back in New York with a small consulting company that was trying to go public. This was in the late sixties, and it did subsequently go public and we were all paper millionaires. It was a very exciting time and it was the right place to be because I learned an awful lot about the evolution of that business.

Navigator: To take the other end of your career: What are you doing now?

Cirillo: I think the segue is that after many years of doing system-level consulting I also started to do some marketing consulting and I ended up with a consulting contract to Citibank. That was in '77. We were beginning to do some systems-based target marketing: basically, lots of computational stuff; years ahead of today's so called data-mining revolution. People were trying to figure out how to market more effectively to the sub-segments of the population.

So that was the beginning of my relationship with Citibank. After a few years, they hired me into the card business; they were sinking huge sums of money into an effort to build a bankcard franchise. I went from there to running just about every major business of the bank. I ran the mortgage business, and I ran the retail branch business, leasing, and so on.

In 1991, we had made a major acquisition of an information company called Quotron, which a lot of people in their forties and fifties remember. It was very hard to digest that acquisition and make any real sense out of it, so we were struggling. Some of the reasons relate to the fact that, as a bank holding company, you could not co-mingle Quotron's business with banking businesses, for regulatory reasons. Consequently all the natural leverage that existed on the information business wasn't there. But there were other difficulties, too; I don't want to hang it all on that. Anyway, Quotron was a global multi-billion dollar business. So I spent five years basically realigning the business, selling off the dogs, trying to build a more competitive platform and get it into a saleable position, which I ultimately did. I ended up selling the last piece of it to Reuters in 1995.

Since then I have been working on all sorts of interesting technology ventures, which has caused me to be much more alert to the trends of this industry over the last decade and more.

Navigator: What can you tell us about banking, as the third millennium approaches?

Cirillo: This happens to be a hot button of mine right now. It's so interesting to watch people who took an environment for granted for so long and had very little motivation to change that. It is so interesting to see the beautiful reality of the world emerge and the reality of the markets and the tension that develops when you pit the forces of tomorrow against the forces of yesterday. I just think this is a fascinating area.

Navigator: Could you elucidate on exactly what is happening, in banking, as tomorrow confronts yesterday?

Cirillo: Banking—and financial services more generally, but banking in particular—is an industry that's struggling for its life right now, largely because it has attached itself to a very old paradigm and can't let go. This county had, until recently, 14,000 banks, which I believe was the highest per capita in the world. Of course, there have been a lot of consolidations lately, because the market certainly would not support 14,000 banks in the new regulatory environment.

The paradigm shift basically is that non-constrained competitors have built some interesting little franchises that have chipped away at banking's core franchise for a couple of decades and that have a lot of vitality. Bankers, by contrast—for a lot of reasons that are loosely called cultural—have accepted a condition of regulatory symbiosis, which is where you marry your regulator. You engage yourself in a process of keeping the host alive, because they need you and you need them. Then you work together and perpetuate what I would argue is mediocrity.

The most notable example recently is all of this effort to "self-regulate." That is where the government steps up and says it has a concern in some area, let's say privacy, and it threatens to pass onerous regulation on the area. So the banks then "self-regulate," trying to appease their regulators by creating privacy guidelines to which they will hold themselves accountable, in lieu of being regulated. We see that pattern again and again and again.

Navigator: Why do people do that? Is it philosophical, or are they afraid of the threat that government admittedly poses?

Cirillo: My direct experience tells me that the banking industry, like every industry in Corporate America, is populated at the top by pragmatists and there are not a lot of people who have thought hard about philosophy in general and how it should manifest itself in their professional lives.

I am now going to make a very broad argument here: there is a process of adverse selection at work, so that you do not find the best and the brightest in the most highly regulated industries. Obviously, across the population of bankers, you have some people that are bright and trying to push the envelope, and others who are sound asleep. But I don't see, over the last couple of decades, bright young people rushing out of schools dying to become bankers. They go into the technology area, or, if they go into financial services, they go into less regulated areas where they can make more money or have more impact or have more freedom. In part, I think that that has resulted in fewer people who have the capacity, or who will use whatever capacity they have, to develop a philosophical position in this area. Consequently, I think, we see the wholesale adoption of pragmatism.

Now you might say the same thing is true of virtually every other industry in American business, but it is certainly true in banking. That pragmatism manifests itself as a belief that compromise with the owners of the regulatory mechanism is a given and is to be accepted as part of doing business. I've worked, in the last couple years, with lots of industry groups and consortia, and I would say at the senior middle-management level it's all too rare to find an individual who is willing to take a position on principle. Instead, the motivation to take the short term—often the easy way out—is powerful.

Navigator: In his book Libertarianism: A Primer, David Boaz mentions the ATM card as a marvelous, innovative product of the market. Has banking in general been innovative during the revolution in financial services?

Cirillo: Generously, I would say, banking can be credited with two significant innovations over the last thirty years: the ATM card and the Certificate of Deposit (CD). And I say "generously" because, when you look into this stuff you might find that some drug store in Utah invented the ATM. In any case, you can't point to a lot of product or service innovations in the banking industry. Whereas if you look at financial services, you'll see a host of things that have been created, whole categories that have attracted trillions of dollars of assets.

Navigator: If bankers fall behind in innovation, will others step in?

Cirillo: To some extent. One of the things that's happening now—that significantly threatens banks—is the activity of technology providers, such as Microsoft and others. Some people have made the assumption that Microsoft wants to be a bank. But who would want to be a bank in this country? Microsoft's economics are very favorable: They have a very high return on equity and they're unregulated. Of course, there's the separate issue of their having to spend a gazillion dollars fighting off antitrust. But there's this premise going around that the technology providers want to get into banking. I'm not sure that that's a valid premise But what they do want to get into is the intermediation of information flows across all kinds of business categories, banking services among all the others.

What do I mean by "intermediation"? Let me illustrate first by talking about consumers as customers. Microsoft wants to have the place to which consumers turn to when they are engaging in commerce, making purchasing decisions, performing analysis, learning about things, whatever. Hence, the springing up of all of these so-called portals. But the real key, and I think the interesting element of this, is that technology providers are going to be able to have their cake and eat it too. The banks, by virtue of the regulatory environment and for other reasons, will continue the carry the uneconomic costs of maintaining banking as the safe and sound banking system we know. The technology companies will be able to draw on the banks, cheaply, and provide to third parties all the value-added information that can be extracted from them.

With today's technology it is possible for you and me to build a company that creates, let's say, a portal, a window on the net using active intelligent agents that go and extract information from all the banks, since the banks now, generally speaking, provide on-line access to information. So, our company can pull that information—not the bank's money, mind you, but its information—and aggregate that information in ways that are useful to third parties. And there are legions of third parties dying to get their hands on this information, which never existed in a consolidated form before. So, you'll see whole new industries springing up around the ability to anticipate your buying habits; or provide you with savings based on your historical patterns of behavior; or brokering your soft dollar instruments, such as frequent flyer miles, for hard dollar discount. An amazing amount of stuff is going to emerge from this.

And what's interesting is that the least likely competitor in this arena is the bank itself, because the bank has all the costs associated with retaining its ageing view of banking. Also, consumers historically have not wanted to consolidate all their financial relationships in one place. So they may want to turn to neutral third parties, like technology providers. It is frightening to bankers to see this happening.

Navigator: If the ageing view of banking is holding banks back, why do they cling to it?

Cirillo: It is very difficult, within a company, for innovators to convince management that it is worth pursuing new lines of business that threaten existing lines of business. And it is harder still if the initiatives threaten to "cannibalize," take away customers from, the company's cash cows.

Now, a lot of the things we are talking about—such as Internet-based technologies—do threaten the economics of the old way of doing things. So if you're with a bank, and this is true of other businesses as well, you're constantly struggling with the tension between innovating and clinging to an older model, which is your cash cow. The most successful companies innovate anyway. They go out and try to create cannibalizing models, because they know their competitors are doing it.

Navigator: What other factors influence your view that banks are increasingly noncompetitive?

Cirillo: Increasingly I see banks as viewing the category of banking—or let's say more broadly the financial services—as having a fixed value. The name of the game, then, is to take market share from your traditional competitors, as opposed to focusing on building value in the category or subcategories where your new competitors are—the ones who don't see the field as a zero sum game and who are creating new products and services.

Navigator: Perhaps you would like the opportunity to point out that your analyses here draw on experience that goes far beyond Citibank. You also work with a national banking group, do you not?

Cirillo: Yes. It's one of the large banking organizations in the U.S., and arguably the most influential: The Bankers Roundtable. It consists of over 100 of the largest banks in the country. The top 25 have formed something called BITS—a technology acronym. I work with that group and this is a subject that is very near and dear to that group because the CEOs of those banks are all struggling with these very issues right now. I will tell you that it is interesting to work in these groups. As their industry is challenged on so many fronts, it is very interesting to see the tough decisions these guys are faced with, and the relationship between their philosophies and what actions they take.

Navigator: Can I ask some questions about your bank in particular, Citibank? And first, can you straighten me out on the nomenclature: Citibank, Citicorp, Citigroup.

Cirillo: Citibank is the bank. Citicorp is the pre-merger bank holding company. Citigroup is the name for the marriage of Citicorp and Travelers.

Navigator: Can you tell us how you see the merger of Citicorp and Travelers?

Cirillo: It's a dream concept. Most of the mergers that have taken place in banking are really old-think kinds of mergers: Let's take all the excess capacity out of the system. We'll slam the back offices together and extract a lot of cost, but we'll have the same basic formula for the business. Citicorp and Travelers is a different type of merger. It's an attempt to broaden the product line across all the customers and generate higher revenue. The overlap in functions between Travelers' Salomon Smith Barney [Travelers' investment banking arm] and the insurance subsidiaries and Citicorp is really very narrow. Also, Travelers is not a very global organization and Citi is an enormously global organization. So the opportunities are immense. I do think it is a very forward-thinking idea. Citi is perhaps the only organization of its kind that could succeed at something like this. I think John Reed and Sandy Weill [the chairmen of Citicorp and Travelers respectively] are thinking the right way about this. The problem is to convince the government that this is a marriage made in Heaven. Right now, there remain laws and rules that prevent insurance companies from being bought by bank holding companies and so on. The optimists say we are going to get through this set of regulatory hurdles. Others say the bureaucracy tends to drag its feet.

Navigator: Perhaps in closing, we can go back to your younger years and to your involvement with Objectivism. When did you get involved?

Cirillo: In 1971. I was with a software company in New York and one of the product managers introduced me to Objectivism through Atlas Shrugged. I was one of the guys who had the "Oh, my God!" sort of reaction to this. I had had a very confused philosophical-political history, ranging from being a Goldwater supporter to a McGovern supporter.

Initially, there was something about Atlas Shrugged that really put me off, and then perhaps about a third of the way through it, it resonated and was so compelling that I took a day off and couldn't put it down. One thing led to another and I started to read everything I could get my hands on and study everything I could. I went to Harry Binswanger's course at the New School and all that. And I've remained a student of Objectivism throughout these years.

Reprinted from Navigator, Volume 2, Number 3, 1998.

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