The first formulation of this version of Hamlet’s “to be or not to be” came from the American Bankers’ Roundtable and was popularised by Microsoft’s Bill Gates. It has stood the test of time: ‘banking is essential for a modern economy, banks are not’.
"The bank of the future might actually be an ecommerce platform, it might be a ‘neobank’ ... it might just be a behind-the-scenes factory which does the gruntwork for another brand."
The current formulation, as the curtain has risen on what might prove to be the penultimate act, is along the lines of the ‘bank of the future may not be a bank’.
The argument is cogent. It seems everything a bank can do can equally – or even more than equally – be done by someone else.
Peer-to-peer lenders can make loans. Consumers increasingly leave deposits on platforms like Alibaba (and when deposit rates are so low, the economic cost of that is not enormous). Payments can be facilitated by all manner of fintechs. Blockchain can supplant the “informed intermediary role” at the heart of risk management.
So the bank of the future might actually be an ecommerce platform, it might be a ‘neobank’ which essentially does nothing itself but pulls together a range of products and services, it might just be a behind-the-scenes factory which does the grunt work for another brand.
After all, car and airplane manufacturers have long sourced the vast majority of their components from other manufacturers while airlines do no manufacturing – the sell and service travel. Richard Branson’s Virgin brand spans consumer durables, gyms, airlines and myriad other sectors.
These existential questions hang on two fundamental forces. Disruption and disintermediation make up one, commoditisaiton another. With the former, non-banks break up the traditional value chain and do different bits and pieces (usually the most profitable ones). In the latter, higher margin products and services and so standardised the margin disappears.
There’s also another climate-change event which may threaten banks. As this bank’s chief executive Shayne Elliott said at ANZ’s last annual result, we are at the end of a ‘golden period’ of bank earnings.
“Our sector has had a golden period for 20 plus years and we don’t think that’s going to continue, it is going to be harder,” he told bluenotes.
“So in a tough world with headwinds … only the fit will really survive and prosper and that’s what we have been about, getting fit for that. We think revenue is going to be harder to come by for our sector.”
The two climactic forces impacting banks are not directly related – the former could be more of a massive meteor event and the latter along the lines of a mini-ice age. Both though presage a period of rapid evolution in financial services.
The challenge of disruption, disintermediation and commodisation is where fintechs, giant platforms, retailers and others threaten bank franchises. For banks, the massive cost and inefficiencies of legacy systems and historic silos means it is expensive to fight back against the newer, nimbler – even if they are Apple or Alibaba – rivals.
It’s tempting to extend the evolution and survival of the fittest metaphors here but that might inadvertently suggest banks are dinosaurs who can only survive by becoming birds or crocodiles.
But this the climate change event. Banks may be centuries old, large and even set in their ways. However they do have some very distinct advantages. Scale is actually one of them. They have huge customer bases and huge customer data sets. They also have trust.
Given events since the global financial crisis and what is playing out in markets like Australia, that may seem counter-intuitive. Yet research continues to show that while consumers may be less likely to say they ‘trust’ banks in general, they do ‘trust’ banks to protect their savings and their personal data. And that is a huge hurdle of trust for challengers to overcome.
Critically incumbent banks also do something no challenger can, as yet: they create money. When banks borrow from depositors for short periods and lend to investors for long periods they inject money into the economy. Their official mandates allow them to do this (which is why they are so heavily regulated.)
The other climactic challenge for the future of banks is more immediate and strategic. It’s the headwinds Elliott speaks of.
Over the last two decades interest rates have trended down and economies have borrowed more. This is good for banks: bank balance sheets historically benefit from falling rates while more borrowing translates to more lending, which is the asset of banks.
Moreover, in that period, due to more supportive regulatory regimes globally, banks became more leveraged – so when assets grew, the return on equity for banks grew even more. Since the financial crisis a decade ago, global regulation has reversed.
Banks are now required to be less leveraged, they are required to carry more capital. Incentives to participate in some more risky businesses have been removed.
Regulation is not only more inhibiting to earnings growth in letter, it will be more intrusive in practice. The costs of complying with regulation will increase – quite legitimately . Staff and management time devoted to restoring trust and the ‘social licence to operate’ will increase.
As Elliott and many others have noted, a by-product of focusing more intently on responsible lending will actually be less lending at the margins – an effect the Reserve Bank of Australia has already noted as having an impact in the housing market.
Moreover, globally and particular in Australia there is likely to be a reorganisation of the roles, responsibilities and coordination between different regulators. That is also likely to dampen activity.
Whether or not banks have a future is not out of their hands of course. Indeed, as Elliott says, it will be survival of the fittest.
There are positives as well. Regional economies, by and large, are robust. In June Elliott noted there was “still strong business formation in Australia and New Zealand, more and more Australians and New Zealanders are setting up small businesses”.
“Small businesses need a bank and we are a great place to come to,” he said. “(And) despite a lot of the rhetoric around trade wars etc, trade volumes are actually on the rise particularly in our part of the world in our back yard here in the Asia area.”
In its latest Annual Global Financial Services Default Study and Rating Transitions, ratings agency Standard & Poors observed “amid exceptionally low market volatility, falling corporate bond yields, and rising issuance volumes, financial services entities rated by S&P Global Ratings, including the bank, nonbank financial institution (NBFI), and insurance sectors, experienced more positive rating trends in 2017 than in 2016”.
Market volatility may be disconcertingly low in what is hardly a low volatility geopolitical environment – and that may change rapidly – but even that does not undermine the fundamental proposition that banking services remain essential for modern economies.
Some actual banks will seize this opportunity. But not all.
Andrew Cornell is bluenotes managing editor