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Why the “fintech disruption” threat to banks might be overdone

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Why the “fintech disruption” threat to banks might be overdone

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Chris Davis is a famed value investor and a high conviction bull on large bank stocks pretty much all the time. He reasons that the purported existential threat from disruptive technology is overblown. I am on the other side of this debate. Putting aside all the SPACs and startups and other new lenders / trading platforms / credit algos / mortgage apps etc, there’s something even bigger out there to consider…

There’s a credible threat of the Federal Reserve minting its own digital currency and potentially even allowing people to bank directly that way rather than through an intermediary like Chase or Wells Fargo. The rules aren’t written this way currently, but suppose someone a bit more, shall we say, activist than Janet Yellen finds herself in a position to “democratize banking” in this way. It would be a major shock to the incumbent private banking system but not necessarily unpopular with Twitter. And Twitter popularity then makes it palatable for elected officials, who are the second most Twitter-addicted group of people in America (after journalists, for whom it’s their very own ticker tape). I could see AOC throwing her tweets behind a People’s Bank directly or indirectly controlled by the government with zero profit motive or real autonomy.

China is using Alipay and the other online platforms to distribute and custody the newly minted digital yuan, but from my perspective, the Chinese payments giants (and their CEOs) are always one stupid conference remark away from being dismantled, disenfranchised or…worse. And if China could do it, Europe could do it too (look what little regard the monetary authorities of the Continent hold their banks in, grinding their profitability into dust via negative interest rates for the last decade). Read Niall Ferguson for a very well thought out take on central bank backed digital currencies generally here.

Admittedly, this possibility might represent both the gravest potential threat as well as the least probable one. But every day that goes by, another team of kids exits the garage with a digitized answer to some of banking’s most egregious (and lucrative) profit centers. And they can practically get funding with a logo and little else to show for their effort. There’s so much money in the aether pretty much everyone with a pulse fancies himself an angel investor these days. Some of these experiments and art projects are going to stick. So I think the threat of disruption to the centuries-old banking leviathans is extremely clear and present. Ironically, bank stocks should rally with rising rates not just because of the salutary effect this has on net interest margins, but because all this free money will eventually fund the trebuchets, catapults and other siegecraft that finally breach the walls irreparably. So taking it away sooner would be better.

Davis doesn’t see it that way. He points out that banking in the modern era is actually pretty efficient (my retort: Yes, for the 50% of the country who the banks actually want to deal with). So, rather than worry about the threats of a million newly-IPO’d fintech upstarts, here’s the other side (via Barron’s):

Banks withstood the recent crisis, but skeptics say that fintech is the real threat. How do you account for disruption?

That is the most important question. When people look for excuses not to own financials, it’s usually about liquidity, credit risk, or interest rates. But those things are episodic, and banks have been managing that since the beginning.

I agree that obsolescence is the biggest threat, and that’s true of any industry. But I would also point out that over my career I have had a front-row seat to incredible disruption in the industry—the money market fund, mortgage-backed securities, ATMs, internet-only banks, pure-play credit card companies. All of those innovations were absorbed into the banking system. Somehow, the fundamental business of making a spread on money persists.

We’ve already seen a huge advantage with the companies like JPMorgan that are able to make enormous investments [in new technology] and scale them off their existing customer base. Think of a bank as an operating system, like Microsoft, where there are all of these applications incorporated into it. Banks can absorb this innovation, in part because they already have scale and the regulatory hurdles of getting into the banking business.

What about blockchain?

People say blockchain is going to destroy the custody business. Here’s what I say: Bank of New York Mellon provides global custody on trillions of dollars worth of assets, and they charge less than one basis point. That’s already a pretty efficient system. I would like to see blockchain disrupt real estate commissions, title insurance, credit cards, and some other areas where there are big fat commissions and fees.

I suppose I’ve got bets on in both directions. JPMorgan and PayPal are two of my personal positions I’m expecting the most out of this coming decade.

It’s a Great Time to Own Financial Stocks. Here’s Why. (Barron’s)

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