Is this UK Banking's Kodak Moment?
Updated: Oct 16, 2018
If one works in the FinTech space, it won’t be long before you hear someone say, “The Big Banks need to become Tech Companies with a Balance Sheet!”.
Anyone in banking knows major disruption is inevitable, and clearly senior bankers appreciate this. But ‘becoming a tech company’ is not about tech or talent or balance sheets – it’s about culture; and that’s the really difficult bit.
Take Banking in the U.K….
The big banks in the UK are doing a great job at supporting the emerging FinTech ecosystem. They back incubators, provide workspaces and foster communities: This means innovation, mentorship and ideally the cashflow required for commercialisation. As a tech entrepreneur I think this is awesome, long may it continue, but as a defence against the coming competitive threat it won’t be enough.
Traditionally, as the staunchest defenders of free-market profit-maximisation, banks have dominated the capital and payments markets. Fortress balance sheets, complex infrastructure and costly regulatory compliance resulted in historically high barriers to entry for anyone thinking about opening a bank. This meant big banks could easily out-price, out-spend or simply acquire any real emerging threats.
Regulators were derided as ‘anti-business’, and risk and compliance tolerated as a ‘cost of doing business’. Trading room culture spread across retail and commercial banking divisions, and soon customers were treated like counter-parties…. until the sh!t hit the fan in 2008.
Ten years on and things are completely different. The big banks now face a totally different beast of a competitor. The question is not whether banks can ‘become tech companies with balance sheets’, the real question is how banks avoid the same fate as the UK’s High Street retailers. It’s simple maths…
Take the market capitalisation, in £ Billions, of the UK’s traditional ‘Big 4’ banks….
Clearly, some bank stocks are under pressure. Book Value – Assets less Liabilities – is loosely used as a basis for determining what the market thinks of a business’ ability to generate market-related returns going forward. A P/BV ratio of a 100%, indicates investor sentiment that a said bank can earn market related returns on its equity. A higher P/BV means higher expected returns and growth - why investors are prepared to pay relatively more than the simple net worth of a share; while a lower P/BV ratio suggests the opposite. Simply Google P/BV + “Bank Name” and there’s plenty of detail on hand.
Just so we’re clear, banking is not subject to laissez faire free-market forces. If it were ‘too big to fail’ wouldn't apply. And we saw what happened last time one was allowed to fail. But in a hypothetical (and admittedly far-fetched example), a classic predatory tactic would be to buy Barclays or RBS on the open market and liquidate them. In theory, buying any business at 55% of book value and winding it up would yield a neat profit. Not that that is ever going to happen, but the idea that it is the regulator that provides, and will have to provide, banks with protection is a theme we’ll return to later.
Contrast this to Four Big Tech companies' market cap, in $ Billions…. and the cash they held in the bank at the end of 2017.
The fact that Google could buy Barclays, Lloyds and RBS with the cash it held in its bank account at current prices clearly illustrates the point – The Big Tech Companies already have MUCH BIGGER Balance Sheets.
Big balance sheets made banks the gorillas of the economy 20 years ago, but that ship sailed long ago.
Google’s market capitalisation is almost 3x the size of the UK’s ‘Big 4 Banks’ market cap combined!
This is just what the numbers tell us so don’t shoot the messenger. I know a lot of bankers who hate me reminding them of this. This is not an indictment on bank management – nearly every services industry faces a similar situation. The key is how banks respond.
One obvious response is the acquisition of banks by the tech giants. This is unlikely – tech companies have zero-marginal cost business models, hardly any technological legacy challenges and very, very, very different organizational cultures. They just aren't interested in office politics to the extent that bankers are.
Rather, banks will need to change from within.
Assuming a bank wants to grow it's balance sheet (some are probably better off keeping their capital base as is), for a large bank to grow faster than real GDP it needs to issue more loans or cut costs a.k.a. raise productivity; do more with less. In order to lend more, by that I mean enough to grow their balance sheets, they need to raise more capital. That’s expensive at current share prices, which are largely outside of the direct control of management (in the medium-term at least). They could do stuff like issue long-term Tier 2 debt, acquire some others etc. but I’m trying to make another point here. That leaves efficiency gains: Lowering Cost/Income ratios, expanding margins, retaining earnings etc.
Cost-optimisation and technology-adoption are going to dominate internal bank narratives for the foreseeable future; especially after the 2008 Global Financial Crisis kicked off the Control and Compliance Costs mega-trend in banking of the last decade.
JPMorgan (2016 AFS), for instance, reported a rise in Compliance, Risk and Audit headcount from 26,000 to 43,000 over the 2008 – 2016 period. That’s almost half of what Google’s total headcount, 89,000, was at the end of 2017. The point? The tech companies aren’t saddled with the legacy costs that many banks are; nor do they run the patchwork of old systems, branches and high fixed-costs infrastructure either. Buying a big bank is unlikely to feature on Larry Page’s EXCO Agenda any time soon.
What to Do?
The first, obvious, point is for banks stay close to the regulator. Ten years ago, bank attitudes to regulators were apathetic at best. Regulators were viewed as a hindrance to free-wheeling, free-market enterprise (and still are by many). Compliance, never considered a potential source of competitive advantage (I argue it will be in future), is still little more than a cost centre for the bank’s revenue generators.
Except now, facing an entirely new kind of competition, it is the regulator that may well stand between banks and 'true free-market' oblivion. No regulator is going to stand back and watch the High-Street banks suffer the same fate as some of the UK’s favourite century-old High-Street retailers.
Is Amazon ‘Too Big to Fail’? We’re not talking about a £30bn business here, we’re talking about a $1 Trillion company!
If you’re still not convinced, consider a company like Facebook using existing Open Banking APIs to offer their customers a personalised banking platform on their profiles. A simple side bar, providing users access to their digital identity with Facebook A.I. applications selecting financial products and services in the background. Technology lowers switching costs, it allows customers to move seamlessly between financial services providers, and digitises on-boarding and KYC requirements.
This is what ‘banking as a commodity’ looks like.
This threatens to relegate traditional banks to wholesale suppliers in the value chain and gives Facebook complete control of the customer relationship. Competing on price is a very different business model - then it's all about market share. I mean a litre of gas is a litre of gas, but we are hardly likely to ever hear a bank executive say they want to become more like a ‘Petroleum Company with a Balance Sheet’.
Is the above scenario that far-fetched? The tech is already in place.
The second point is understanding what becoming a “Tech Company with a Balance Sheet” actually means. In the next article I argue that it is actually not about the Tech, or the Balance Sheet: It’s about what it means to be a Tech Company.
Banks can easily afford to buy the tech, hire great talent and acquire as many Fintechs as they want; but for a bank to become truly competitive in today’s tech-driven world, the bank has to fundamentally change the way they do EVERYTHING. Hiring, Reward, Promotion, Reporting, Systems, Client Experience, Process, Governance, Risk Tolerance, Attitudes, Behaviours... Leadership!
Is this the UK's Banking Kodak Moment unfolding in slow motion?