Evolution of Banks:
Financial institutions have long been replacing traditional roles with newer and more profitable ones to maintain their market dominance and strengths. Banks started as goldsmiths and private banks (trustworthy individuals and families) and became giant commercial enterprises. This showcases that banks can withstand disruption and challenges and outlast their competition. The question is why and how? Banks’ traditional business of taking deposits and making loans has declined since the late 1990s (Allen and Santomero, 2011). Therefore, one wonders why and how they have survived centuries of disruption and decay. Allen and Santomero (2011) note that “… banks have maintained their position relative to GDP by innovating and switching from their traditional business to fee-producing activities.”
Banks Ecosystem:
Therefore, the modern banks as marketplaces that enable a financial system with the following:
- Facilitate and widen participation: Today’s banks strive to make banking a universal service by promoting financial inclusion. A modern bank’s prime objectives are free-of-cost banking, no charge for customer activity, and 24/7 availability of services. Unlike the olden days when a bank account was a privilege granted based on one’s cash balances, it was replaced with access to mobile and internet. This shows that modern banks are primarily ‘service agents’ who aim to become major settlers of transactions between people, people, and businesses.
- Payment Systems: Banks, for most of their operations, are online merchants who enable clients to access their capital whenever and wherever they need it. This transformation from cash-rich customers’ luxury to fundamental rights has enabled banks to survive the financial crises 2008 and the recent challenges of BigTech.
- Banking as a Service (BaaS): With the newfound role as a payment enabler, banks are now trying to outsource their activities to third parties. Just imagine, as a McDonald’s franchisee, the business owners sell for McDonald’s. They don’t own the brand. Similarly, banks now allow retailers to sell their products on their behalf, such as loans, credit cards, insurance products, and other facilities. Banks underwrite but do not provide service. This way, the retailers, without having a balance sheet like banks, can offer services and earn a decent commission. Banks without investing in infrastructure earn fees and gain more market share.
- Data Points: Banks have also become giant conglomerate which knows all about their customers. They track transactions, they have information about spending behaviour, and above all, they can exchange the data through a credit rating system. This makes banks ID verifiers and trusts developers who can help people prove their financial worth and credibility.
Banks Key Strengths:
Given these new roles and banks’ ability to survive over centuries, one can summarise banks’ key strengths into the following categories:
- Size: Banks have accumulated balance sheets of the size of countries. Banks such as Barclays, HSBC, Citi Bank of America, and others hold trillion-dollar assets. The giant sums enable banks to invest in new technologies, infrastructure, and services to compete with newer challenges.
- Regulation and Compliance Systems: Banks have become experts in understanding complex financial regulations, installing systems to meet new rules, and ensuring appropriate adherence and monitoring systems. This places banks several times better than any other firm that wishes to provide financial services.
- Sovereign Guarantees: Every country has a state-sponsored guarantee. If a bank fails, the depositors will have their money returned. In the UK, FCA guarantees up to £85,000; in the USA, FDIC guarantees up to $250,000.
- Financial Products: Banks can survive because they can offer various financial products that a simple financial company or a new startup can not offer. On one side, they may offer products ranging from simple car insurance to highly complex derivates and mortgage products. This ability to synthesise and make complex products makes Banks very special.
- Power of Inertia: Banks are part of global history. For the last 2 centuries, banks have enabled today’s leading nation to accumulate wealth, build infrastructure, and conduct their foreign and business policies. This gives banks a holistic view of the modern world and makes them an important actor to continue for the foreseeable future.
- Regulatory Barriers: Luckily, banks are immune from stiff competition due to tight regulations for new entrants. New firms that wish to join the industry must meet very high regulatory standards and comply with so many laws that it inhibits the formation of new banks.
In addition to this, banks also enjoy:
- Regulatory trust.
- Liquidity generation.
- Trusted communication.
- Part of political economy.
- Rise of non-intermediary financial needs.
These privileges have allowed banks to outlive their competitors. We will discuss in another article what they are and how banks use them for their benefit.
References:
Allen, F., & Santomero, A. M. (1997). The theory of financial intermediation. Journal of banking & finance, 21(11-12), 1461-1485.
Allen, F., & Santomero, A. M. (2001). What do financial intermediaries do?. Journal of Banking & Finance, 25(2), 271-294.
Allen, F. (2001). Do financial institutions matter? The Journal of Finance, 56(4), 1165-1175.
Allen, F., & Gale, D. (2004). Financial intermediaries and markets. Econometrica, 72(4), 1023-1061.
Beck, H. (2001). Banking is essential, banks are not. The future of financial intermediation in the age of the Internet. Netnomics, 3, 7-22.
Blakstad, S., & Allen, R. (2018). FinTech revolution. Cham, Switzerland: Springer, 121, 132.
