Is this the end for Banks?

The banking industry has undoubtedly changed. COVID-19 is proving to be a massive disruptor of business models. The huge impact on future cost structures, income generation opportunities and returns on equity, will likely also influence the performance of their stocks in the long term.

Long before the pandemic, the industry was navigating a challenging operating environment. In Europe, for example, banks faced low interest rates, unfavourable regulatory conditions, and poor long-term demographics. All of these posed a threat to income generation. On top of that, the coronavirus has delivered weaker consumer spending and the risk of a massive spike in non-performing loans. And with a backdrop of spiking public borrowing, this is not a great environment for banks to make money.

But critically this period has also accelerated technological change within the industry. In the UK and elsewhere, consumers are now more willing to embrace service delivery through digital platforms. This has shaken up how traditional banks engage with clients. Pre-COVID, such an evolution was simply another part of a bank’s long-term strategy. Now adoption is becoming more time critical.

The problem for many institutions is they remain chronically underprepared. Yes, several have managed to adapt to immediate customer needs in the current environment. But most big banks still operate like unwieldly slow-turning ships. They have their legacy systems, structures, bureaucracies and priorities. They have stakeholders with long-held incentives. They have not felt the need to speed the process along, even if their existing business models have thrived less since the financial crisis. Now banks have been forced to face the future faster than they had planned. And that has massive ramifications for how competitive they will be in the future.

The big banks are also not “digital natives” in the same way as the new breed of challenger banks and fintech companies that have invaded the space. Traditional banks like to sell themselves as adaptable to client needs. But the newer upstarts are better positioned for that with fewer staff, lower overheads and an inherent technological bias. They were designed for the structural changes we are seeing. The big banks, less so.

More change ahead
Banks are being forced to invest heavily to adapt to market needs. IT budgets have expanded at a time when weaker revenue trends would suggest they should be trying to keep a lid on costs. The old business model used by the banking establishment feels less relevant. New consumer behaviour and preferences show us as much.

The significant changes in the way banks will operate in coming years is heavily dependent on how technology is adopted. But “technology” is not just about fintechs and start-ups; companies that can’t always compete with the big banks when it comes to resources. The broader technology industry is taking the lead, and this will pose a huge threat to banks.

 

Imagine Apple or Google as bona fide financial services companies in the next decade? Suppose Amazon offered the best rates on US dollar deposits? What if Facebook capably serviced all your cryptocurrency transaction needs?

None of this feels that fanciful. Lines have been blurred. We can’t ignore the billions of dollars sitting on the balance sheets of these technology companies, ultimately looking for a better rate of return. This gives these giants the kind of firepower that will allow them to turn their hands to whole new verticals, and possibly start to dominate. Google Pay and Apple Pay are just for starters. Look at what Alibaba and Tencent have been able to achieve in China, major players in an increasingly cashless society. We should not be surprised to see similar inroads in Western economies.

Should we expect to see JP Morgan and Goldman Sachs usurped from the top of M&A rankings any time soon? Probably not. Certain aspects of banking will be tougher to disrupt. Technology alone will not replace the value of relationships and brand loyalty built up over decades. But the overall financial services landscape will undeniably be altered. And all of this change should force UK investors to re-evaluate the way in which they view bank stocks.

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