100 YEARS AGO How are banks responding to an era of massive tech disruption and prospects of lower interest rate margins as global interest rates fall? The banking industry used to be the most profitable business, because interest rate margins (lending rate less deposit costs) were high. In the 1960s, when bankers were considered trusted custodians of other people’s money, the dictum “three three’s” meant interest margin at 3 per cent, 3 hour lunches with clients, and 3 o’clock at the golf course.

The average net interest margin (NIM) of American banks was traditionally 3 per cent for quite a while, but when the Fed and European Central Bank (ECB) started cutting interest rates after the 2008 financial crisis, NIM got squeezed. The stock market valuation of the banking industry took a beating with prospects of slower economy, threats of larger non-performing loans and heavy overhead costs. When tech and fintech platforms arrived at the turn of the 21st century, banks and financial regulators poohpoohed the threat of technology in disintermediating banks. Fintechs began to take the payments business from banks, then started to eat the banks’ lending lunch.

Tech platforms can deliver financial services with less overheads, legacy branch fixed assets and staff with more reach to online customers at faster speed. According to McKinsey, by the end of 2019, cumulative market capitalization of the 200 largest banks had a price-to-book valuation of between 0.8 to 1.2, whereas the seven largest big tech companies had price-book valuations above 5, with both groups valued at roughly $6 trillion in market cap. Today, the largest bank market cap is JPMorgan ranked 14th in the world with $600 billion, whereas the top eight companies valued at more than $1 trillion each are the Magnificent Seven tech companies plus the Saudi oil company Aramco.

The largest Chinese bank ICBC has a price-to-earnings ratio (PER) of 4.5, compared with 12.3 for JPMorgan, whilst Google and Nvidia have PER of 23 and 66 respectively. Bank assets used to dominate the total assets of the financial system. But hemmed in by bank capital requirements and much stricter bank regulation, banks could not expand fast compared with nonbank financial intermediaries (NBFI), so-called shadow banks, after the 2008 financial crisis. By the end of 2022, the Financial Stability Board estimated that bank assets accounted for 39.7 per cent of total global financial assets, smaller than the NBFI’s 47.2 per cent share.

Boston Consulting Group (BCG) argued that banks are unlikely to get back to their old stock market valuations unless the industry takes a bold leap in technology. There were three ways to improve their profitability and market share. The first was move out of traditional interest-rate products towards non-interest earning services, such as asset management and private banking. The second was to move overseas and into trading markets such as FX, bond and derivatives trading. The third was to use technology to reduce costs and upgrade client offerings in terms of service. Indeed, McKinsey’s latest data showed that since 2010, US bank productivity has been falling on average at the rate of 0.3 per cent a year, compared to higher gains in most other sectors.

Banks have been increasing their spending on technology fast in recent years, with 2023 investments of $650 billion, roughly the GDP of Belgium. Banks have not been that successful in competing online due to the simple fact that it is not easy to convert older legacy staff towards online service mentality. Risk-adverse bankers with even more risk-adverse regulators have been wary of technology. The regulatory “sandbox” approach to ask banks to play with technology like kindergarten kids has resulted in banks looking to bank regulators’ approval for tech experimentation, rather than jumping all in and competing head-on with tech competitors.

As former Fed Chairman Paul Volcker quipped in 2009, “the ATM has been the only useful innovation in banking for the past 20 years.” Artificial Intelligence (AI) has today brought real change to the finance industry. We are witnessing very rapid improvements in online and offline banking services, as intelligent chatbots are now replacing the frustration of trying to get simple answers through the antiquated call stations where you have to wait and push 1 for language, 2 for type of service and 3 for self-destruct. As long as banks are prone to periodic failures like the implosion of Credit Suisse or Silicon Valley Bank, they will not find it easy to rebrand themselves as the next tech product provider with five times more stock market value.

The typical bank leader does not talk like tech titans, more like conservative bureaucrats who engage in nonintelligible bank-speak. The bank CEO is today more likely a former Chief Financial Officer, rather than the Chief Technology Officer. In essence, banks have been concentrating on fintech, the application of technology on finance, which is chasing lower and lower spreads on payments and traditional bank products, rather than techfin, which is the monetization or financialization of technology. Tech platforms create a story of transformation and profit opportunities, whereas banks seem to be defending their turf with less creative technology. We see the same trend in the car industry, where the EV innovators like Tesla have a PER of 60, compared with Toyota with 7.

This is a mindset problem whereby the corporate leaderships have not understood the competitive threat from technology and have not responded with a good corporate story. Boston Consulting presented the banks’ digital transformation story as a $7 trillion opportunity. But banks also face higher capital and other regulatory demands in the face of higher risks. The global financial infrastructure, such as the SWIFT payments system and other clearing mechanisms, all need upgrading and face geopolitical threats. Governments and the consumers also expect banks to lead the climate warming and green transition challenges and costs. Whether banks can transform themselves into tech platforms today depends on a collaborative mindset between the banks and their regulators. In the meantime, expect the tech giants to eat everybody’s lunch.

(The writer, a former Central banker, writes on global affairs from an Asian perspective.