Over the years I have written several columns in which I have told you that if you are a long-term investor you should never invest in a bank ever.
I haven't changed my mind. I chaired a panel at a financial services conference this week and the first question I asked the panellists was whether they thought the banking sector as we know it would still be with us in a decade, or would its own frailties and the surge of dynamic competition coming up around it have made it more or less irrelevant?
Everyone tried to say something nice in support of the current system, but in the end the answer leaned towards "irrelevant". And if you look at the challenges facing the sector it is hard to argue with that.
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Think about trust. The banking sector comprehensively lost the trust of much of the global population after 2008: we don't think it is stable and we don't think it works in our best interests. That lack of trust feeds into two things. The first is regulation. Most people think that the financial crisis was partially a result of a paucity of financial regulation. Regulators have spent the past eight years trying to make up for their pre-crisis deficiencies.
The result is lots of rules that make it harder to make money, an insistence that banks hold significantly more capital than they did before the crisis, and a wave of fines for bad behaviour that mean the banks have to keep even more capital on hold for what the industry likes to call "resolution".
The problem here is obvious. It is hard to raise capital when the market knows that you aren't growing (the return on equity of European banks is now a mere 5%); that your business model is under constant attack; and that you might be handing its money straight to the US regulators anyway. Witness poor Deutsche Bank. Who'd be nuts enough (voluntarily) to give them capital?
This isn't over yet: this month the US Federal Reserve suggested that banks that trade commodities should have to hold billions more in capital. The saga of banks needing capital and not being able to get enough of it is going to run and run.
The second thing that lack of trust affects is competition. If your customers don't trust you and you can't learn to communicate with them better, they will go elsewhere, particularly if there are a large number of new and exciting elsewheres popping up all over the place.
This brings me to the number that should have all bank executives planning to sneak out of the back door with whatever cash they can grab to keep them going in retirement. It is 40%. That's the proportion of people who told an EY study on worldwide consumer banking that they now have a "decreased dependence" on their bank to be their primary financial services provider and that they "have used non-bank providers for financial services in the last 12 months".
Another 20% of those surveyed said they intended to use a non-bank provider "in the near future". And it isn't just the non-banks (by which we mean peer-to-peer lenders, money transfer firms, companies such as Amazon lending to their users, asset management companies providing finance to unlisted companies, robo advisers and the like) that are nipping at the heels of the world's banking oligopolists: there are actual challenger banks too.
In the UK they span the sector: Metro does ordinary retail banking; Hampden does classy private banking; and OakNorth lends to fast-growing SMEs. Many of the non-bank competitors in particular are able to move quickly (they don't need much capital and, while the ECB president Mario Draghi was muttering last week about creating level playing fields, so far the regulators have been quite nice to them). They can focus on niche areas. They need have no physical presence. They have hugely better technology one of the nightmares for the banks is that they are saddled with horribly outdated systems which it is operationally and financially difficult for them to replace.
That means the challengers can, as a report from the World Economic Forum puts it, "automate activities that were once highly manual, allowing them to offer cheaper, faster and more scalable alternative products". The upstarts will take in bank customers across the board (cheap and simple online wealth product providers could even take customers who in the past have only held cash in banks) and their very existence will push down the margins the banks can make on any customers left behind as well.
These aren't the only problems the world's banks have, of course. There are the low and negative interest rates that slam the margins between deposit and loan rates and so destroy the basic business model of the sector. And there is the fact that there are just too many of them. Draghi doesn't like to think that low interest rates are too big a part of the problem for Europe's banks (that would suggest it was somewhat his fault). So he insists that it is also about the "intensity of competition" driving down margins, a problem which can't be cured in the normal way by the big banks buying up and taking out the competition because they haven't the capital to do it.
That's a valid point. But it is the rise of competition that bank investors should worry about the most. Low interest rates will pass. Regulation will settle. M&A will happen. But the huge change to the entire business model will not.
The big banks are used to controlling the financial environment cross selling and middle-manning every part of our financial lives. Given that the future of finance will belong to those that we trust and who have the technology to keep us trusting them they just aren't going to be able to do these things for much longer. So why invest in them as though they were?
This article was first published in the Financial Times
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