A European family office and regular commentator in these pages looks at to what extent banks and technology stocks share growing similarities in this fintech age.
Recent days have seen controversy stirred by media claims – which the firm has slapped down – that Facebook is asking US banks for data in exchange for providing more services on its platform. (See the story here.) Whatever the exact truth in this specific story, there is clearly blurring of the edges between banking and technology. This appears to be something of a trend. For example, consider how China’s e-commerce giant, Alibaba, now has a financial services business that gets into wealth management – Ant Financial. And for some time this publication has heard that the likes of Google and Amazon are thinking of offering financial services. Let us not forget that arguably one of the largest fintechs of recent years, if not the largest, is Paypal. For many, banking on the internet, rather than going into a physical office, is the norm.
At a recent presentation to journalists about its investment views, UK private bank Coutts speculated on whether or when analysts might start to value banks in the same way that they do with certain tech firms. Clearly there are differences. Banks labour under capital adequacy standards, enjoy depositor protection under certain limits, and have faced a range of regulatory changes in recent years after the crisis. The situation is rather different for technology firms. But even so the debate remains.
In this vein, Blu Family Office, which regularly comments in this publication, (see an example here) addresses the question. The editors of this news service are pleased to share these views and invite responses. They should email email@example.com
Should banking stocks be seen in the same way as technology stocks in the age of fintech?
Are banks turning themselves into technology companies and should there consequently be a re-rating on this much maligned sector? In looking at the relative performance of the two sectors since 2007, that [argument] would seem to be a huge leap of faith.
Chart: Performance of US Technology Sector versus US Banking Sector
In the last 10 years, US technology stocks have outperformed the US banking sector by almost 300 per cent. If we had compared the European banking sector, the performance gap would be even larger. Time to buy? Maybe but certainly not because of technology.
Whereas banks have developed massive technology infrastructure, the industry has also benefited hugely from technological innovation. Massive efficiency gains have been made, and not just in the way transactions are executed or loans are extended. As well, the operations, settlements, and reporting have all become highly automated on a never before seen scale, as capital markets continue to expand. So, what is holding back the banking stocks and keeping them from being rewarded for this great productivity leap? Very simply, it’s an outdated business model.
The problem with banks is that, really, nobody actually needs them. Or when was the last time anyone visited a branch? And, as far as the consumer is concerned, we don’t really care if we are dealing with a bank or another financial intermediary, as long as we can move money from one place to another. And here, technology has practically exploded into a whole new world of disintermediation, fragmentation and specialisation.
There are now a lot of choices when it comes to “old-fashioned” banking needs from a huge range of financial service providers that operate as part of, instead of or outside, the banking system. Nowadays, there is even probably a mobile app for just about everything including paying bills, taking out mortgages or executing our pension and investment plan, and consequently, margins are falling.
In this highly competitive and fast moving field which institutions, by the very nature of their position in the globally controlled and regulated financial systems, are under most scrutiny (read: high compliance costs)? Answer: Banks. Which institutions have the highest cost base, including salaries and infrastructure? Answer: Banks. And we haven’t even begun to consider the curtailed risk taking the banks must endure, as a result of what has gone wrong in the past. All in all, it is very plain to see that banks are a slow-motion train wreck, and the chart is clearly telling us that.
Is there any hope and should we now pile into fintech? Not really, because as much as the technological innovation has taken hold, so it has also begun to feed on itself and in a world of perfect competition, there can only be one winner and that’s the consumer. It’s the ultimate irony that the very revolution that has been brought about by technological innovation should now also be the very seed of its own destruction. And if you want evidence of that please read this week’s news of a major ETF provider, Fidelity, offering its products for free now.
The winners in the sector will be those who have a niche position within the bespoke needs of individual clients or institutions and can operate on a larger (read: more efficient) scale than other competitors. As well, those that can provide solutions to seemingly ridiculous problems, such as combining the behavioural aspects of wealth management into a relationship-based business model, will continue to extract high margins. The broader market will see consolidation in a very transparent and increasingly homogeneous product offering.
Can the banks bounce from here? Sure, as they say, every dog will have its day, but the long-term structural trends within the banking industry are too entrenched for the spread versus technology to do anything else but continue to widen.