Goldman Should Stick to Investment Banking

Blockchain development benefits from the wisdom of crowds.
GOLDMAN SACHS GROUP INC
-2.21
At Closing, April 20st
251.96 USD

Goldman Sachs Group Inc. bankers used to be known as the smartest guys in the room. Perhaps those meetings weren't about technology.

The firm's decision to quit R3 CEV LLC , a group of more than 70 banks formed to enable the use of blockchain technologies, seems unwise. And it's a reminder to Goldman's peers of the choices they face as their world is turned upside down.

R3 is preparing its first round of equity fundraising, and the investment bank decided that acquiring a sizable stake with a seat on the board would be too expensive, people familiar with the matter told Bloomberg News. If history is a guide, sticking with R3 may have turned out to be the cheaper option, regardless of cost. 

Here Comes the Boom

After a decade of reducing capital expenditures, the world's banks will have to invest heavily in new technologies

Source: Bloomberg

* Median value for information available on 2,527 publicly traded banks.

Outside the group, Goldman will have to develop its own digital-ledger plans, or find third-party options that may not be widely adopted. So there's a risk it might either spend a lot for something similar to R3's offering, or use a marginal alternative that leaves it relatively isolated from the global financial system.

The pattern of spending on technology that might be better served by imported processes is nothing new in banking. When computers were introduced, most banks hired coders to create internal systems. As the world became digital, they had to go shopping for software to connect a mass of programs that often didn't talk to one another.

Not to mention that these systems remained in use even after they (quickly) became obsolete -- it's hard to ditch something in which so much was invested. Banks that acquired competitors could take a year or two to merge operations, and decades, in some cases, to fuse operational systems. A McKinsey article in 2014 found that:

Globally, the banking sector spends an average of 4.7 percent to 9.4 percent of operating income on information technology, more than other sectors.

Now it's happening again. Banks must prepare for a world in which digital ledgers replace many of the processes that require human input. I've argued that this could be a huge source of savings for the industry. It will require significant initial investment, though, exactly because many lenders still run those outdated systems.

New Machine Age

Bank spending on the technology that enabled Bitcoin is expected to grow exponentially -- and that's with most outsourcing development

Source: Aite Group

* Data available here: http://aitegroup.com/report/demystifying-blockchain-capital-markets-innovation-or-disruption.

Banks that have learned the lesson will probably leave development with experts such as R3 or Hyperledger, and pay to benefit from (and help direct) their work. Even that won't be easy. A group of institutions such as R3 has many egos and conflicting interests, so progress will be slow: People familiar with Goldman's departure said the inability of group members to work together was behind the move. Whatever is achieved will be widely adopted, however, and that's key.

As financial firms move into the digital age, they face the question Goldman did on collaboration versus independence. Smart investment bankers usually tell their clients to focus on their core competency, because it's cheaper and better to outsource the rest.

Gadfly's Tim Culpan contributed to this column.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Christopher Langner in Singapore at clangner@bloomberg.net

    To contact the editor responsible for this story:
    Paul Sillitoe at psillitoe@bloomberg.net

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