Few things are as pervasive in modern business than the spread of pesky buzzwords. Shifting paradigms and incorporating synergy have transcended the boardroom to the bar-room in cartoons, eliciting snorts of derision from those wearing loosened ties. Today’s financial industry has a similar buzzword, save it brings forth dread behind the smirks of derision: unbundling, referring to the individualization of banking services within the sector by multiple firms that is chipping away at the bank’s ancient monopoly on all money matters.
Two trends are serving to disrupt major banks in modern markets: financial technology start-ups (fintech firms), and increased levels of regulation since the Great Recession. Specialist fintech startups have branched out since their inception, and now offer competitive and convenient money transfer services, personal loans, investment options and financial advice, leaving the banks with exclusive market share on only lower-margin services. Increased regulatory burdens, including Dodd-Frank and Basel III, have placed requirements that banks carry greater capital reserves to reduce their risk of solvency, thereby again limiting profitability through a restriction on access to liquid investment capital.
Banks are split on how to view fintech firms: some see them as a disruptive force capable of eradicating banking as an industry, and others view them as a temporary blip that still require bank accounts to be effective, thereby making the great ones potential partners and the pesky ones in need of greater alignment. But the reality remains that fintech firms have had unprecedented success, and regulatory burdens will not fade fast. So the role of a bank must either evolve, or pray that the optimist at Goldman Sachs is somehow the only sane one in the room. Evolution seems more likely.
One idea that has been floated is regulating banks as utilities – a fear that banks would once again fail and monetary stimulus had gone too far in the Great Recession saw the re-emergence of the theory that tougher regulations limiting profitability would increase the total utility of banks to the public. The argument emerges that banks are too integral to daily life to exist without and, much like energy or water, must therein be prevented from failing through regulatory means. In theory, regulations that impose capital controls could be tightened to create an industry that maintained financial infrastructure non-profitably, meaning it would be as a public service. Typically utilities are government-owned or heavily subsidized due to carrying high-debt loads. Some may argue that another bailout like that of 2008 would actually technically fill that definition. This is wrong – receiving bailouts does not make one a utility. But systemically receiving them whenever they are needed and being prevented from failure, that just might.
The direct impact of this would be reducing banks to the role of financial intermediation (converting assets to liabilities and vice versa) and little else. As this is a core function, it should be heavily regulated. And it is. In fact, intermediation is the very basis of modern banking, and is subject to all regulations therein. But the concept of limiting banks to this core role, and mandating a fortification of their balance sheets with substantial surpluses of cash, is the basis of the utility conversation, one which provokes several eyebrow-raising questions.
Utilities often function as natural monopolies in a set region, given their need to develop infrastructure within a defined territory. Would banks be subject to territorial borders or set offerings of specific financial products? Would they be offered territorial protection from competitors? Requiring banks to hold massive capital amounts is only just if competitiveness within their region is guaranteed, lest individual firms be unable to spend the revenue they accrue. Additionally, forcing banks to sell a set product mix would limit their future financial competitiveness and make them less responsive to innovations, thereby reducing their desirability to clients. This will also hurt the competitiveness of firms.
None of this, of course, includes the vast political fallout such an designation would yield, ranging from the need to abandon free market principles to the forcible drawing of boundaries for one industry within the United States. Such a move has no precedent, and likely never will. But a move towards the median may be in play – existing regulations have imposed stricter capital requirements and developed flusher balance sheets, and that may limit growth moving forward. And a designation as a public utility could have positive impacts for the valuation of smaller banks, given the perception of greater consistency and stability as an investment vehicle a utility would have over a small regional financial institution.
The concept of regulating banks like utilities will likely stick around the fringes of mainstream debate until one of two scenarios occurs: either banks survive another Recession without being bailed out (current interest rates make that questionable), or fintech start-ups devour enough market share that it happens accidentally. If the latter ends up the case, it may be the banks who beg for a buzzwordy-spin on designation as opposed to the other way around.