Banks Should Get Down on Their Knees and Pray for Regulation

Everyone’s talking about this Wall Street Journal article that covers the regulatory flood. The banks brought it on themselves because of their actions before and after the Great Financial Crisis. And now they’ve got to live in the world they’ve created…

The 2010 Dodd-Frank law … is one of the most complex pieces of legislation ever. At more than 22,200 pages of rules, it is equivalent to roughly 15 copies of “War and Peace”…

The six largest U.S. banks by assets in 2013 together spent at least $70.2 billion that year on regulatory compliance, up from $34.7 billion in 2007…

At J.P. Morgan, the nation’s largest bank by assets, the head count associated with what it calls “controls,” which includes many compliance-related staff, has grown to 43,000 in 2015 from 24,000 in 2011…

I have a few comments.

The first is, “Good.” These companies forgot that their very purpose is to foster economic growth and development and to help money and credit circulate around the business world. Finance is a utility and ought to be treated as such. Utilities are highly regulated because of how critically important their health is to society. Banks are equally important and their health is of paramount concern, not their profit growth. A profitable bank is a healthy bank, of course, but the question is about where the profits come from.

Activities that earn profits for the banking system but jeopardize its survival should obviously not be celebrated. They no longer are – have a look at the multiples that large US banks currently trade at – price/book, price/earnings – all severely depressed. This will get better, but not much better. We probably won’t see a return of the empire building that got started in the late 1990’s. The age of the global-hedge-fund-as-bank ended eight years ago. The multiples from that bygone era are not soon to return.

We should be okay with this. Banking is not meant to be a swashbuckling endeavor or a means to its own ends, it’s meant to support real activity in the real world.

One other thing that no one is saying but I will – the banks should thank their lucky stars for regulation. It’s the only thing keeping them safe from technology companies coming in and threatening their ability to exist. Google, Apple, Amazon and Facebook have zero interest in getting involved with a highly regulated industry like banking – at least for the time being. That’s a good thing, because Apple Bank or Google Lend would be a death sentence for the marble lobby crowd. Can you imagine if Jeff Bezos could set his sights on checking and savings accounts without having to worry about the SEC or the New York Federal Reserve or the FDIC or the CFPB or the OCC, etc etc etc?

But Bezos can’t just waltz in and upend the economics of the banking sector. They should count their blessings that he can’t.

Google and Facebook, with their billions of users, can’t do it either, regardless of the fact that they’ve got an incredibly deep pool of data on every individual bank account holder in the world. Turning on a banking feature tailored to how each user typically spends, vacations, communicates and shops would be a huge opportunity for these giants. And they have more cash to invest than there are currently investable ideas! Hundreds of billions sitting idle around the world, and virtually none of it being deployed toward the banking sector.

The banks may not always be so fortunate. Consider the case of Ant Financial, a spin-off and subsidiary of Alibaba. When Alibaba launched its quasi-money market fund, called Yu’ebao, the idea was to provide a cash substitute for the millions of buyers and sellers transacting across the company’s eBay-like commerce platform, Taobao. Today, it one of the largest wealth management products in China. Some stats (via Forbes):

44.5% Yu’ebao users are between 20 and 29 year of age, and 39% are between the ages of 30 and 39, and the average balance is around RMB 5,000…Despite the fact that it mostly attracts small, micro and low-income investors, Yu’ebao has amassed over 260 million clients and $90 billion in assets in just three years of existence.

Alibaba was not satisfied with merely offering one product in the space. It floated Ant Financial, a subsidiary comprised of Yu’ebao, as an initial public offering in China. This spinoff now has a market value of around $60 billion. It’s since branched out into lending and credit scoring. It’s likely not going to stop there. The engine of customer acquisition for all of these features and services is Alipay, itself a critical part of Alibaba’s ecommerce platform.

China’s large banks are state-run, and so they are more insulated from competitive threats like Ant than US banks would be, should Amazon or Google decide to make a run at them.

Apple Pay may be the beginning of an incursion into finance, but look at how they chose to proceed (at least initially) – they’re having transactions settle using traditional, bank-issued credit cards. Visa and MasterCard can continue to earn their interchange fees for the time being. American Express can comfortably sit alongside PayPal in the Apple Pay ecosystem.

When we launched Ritholtz Wealth Management in 2013, we needed new computers and laptops for all of our employees. Because of how quickly the technology improves, we wanted to lease the machines rather than buy them outright. And guess what – Apple itself didn’t offer any kind of leasing program internally. They sent us to a variety of third-party firms who handle that aspect for them. I was shocked that they weren’t in the space themselves.

Why isn’t Apple, with almost $200 billion in cash at its disposal, building out a full-fledged financial institution? Why isn’t Google handling loans and making credit decisions based on its trove of user data? Why hasn’t Facebook more thoroughly interjected itself into the middle of all the commerce taking place on it’s platform? Why has Amazon singularly spared the banks amidst all of the other industries they’ve turned upside down?

One-word answer: Regulation.

If you’re a banking executive, it’s time to stop complaining about the only thing preventing the onslaught. It’s time to start looking at capital requirements and multiple points of oversight as what they really are: The last barriers of entry.

 

 

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