RE:Big U.S. Banks Could Take A Back Seat To Digital Payments Co The current pandemic has forced Americans to adopt new behavioral patterns, some of which will prove temporary, while others will endure for much longer.
So far, tech and e-commerce companies have been the beneficiary, as people bound to their homes have increased Netflix NFLX consumption, relied heavily on Amazon AMZN for vital goods, and spent more time on social media.
The biggest losers include any business relying solely on a brick-and-mortar presence. Most retail brands, movie theaters and restaurants are in a struggle for survival.
Another surprising consequence of this consumer shift away from anything with a physical location may soon rattle the world of finance. For traditional banks – which rely on outmoded revenue streams and have high fixed costs – this crisis may be a turning point.
Bank Headwinds
Over the past decade, domestic banks have outpaced their global counterparts. This trend began in late 2008, when bailouts outside the U.S. were more politically unpalatable than they were here, and continued after the eurozone debt crisis.
In the future, however, U.S. banks such as J.P. Morgan Chase, Citi, Bank of America BAC and Wells Fargo WFC – whose revenues come from proprietary trading and loans – could begin to recede.
NEW YORK CITY, UNITED STATES
SOPA IMAGES/LIGHTROCKET VIA GETTY IMAGES While many trading desks did well during the recent period of heightened volatility, defaults are expected to mute profits for several quarters and deposits could wane as the impact of millions of job losses begins to mount. What’s more, even when the environment improves, lending will continue to underperform as net-interest margins remain thin, with rates unlikely to budge from near zero anytime soon.
Granted, big banks have put a lot of effort into downsizing real estate footprints and human capital costs in favor of more consumer-facing tech offerings in recent years. Still, their obligations in these areas are significant. J.P. Morgan Chase, for instance, has over 5,100 branches and nearly 200,000 employees nationwide.
Regulatory costs are another issue. After the financial crisis, lawmakers sought to minimize the chances of large banks contributing to a future crash by imposing stricter reserve requirements and implementing new rules for trading activities and disclosures.
In March, J.P. Morgan Chase CEO Jamie Dimon expressed concern that the need to hold significant cash-equivalent assets would impede how well banks could support markets during the most recent downturn.
Banks also face increased scrutiny over violating other, more basic rules. Wells Fargo was fined $3 billion in February after bankers created millions of fake accounts to boost their incentives. And in 2018, regulators conducted probes on other banks for similar sales abuses.
It’s not a stretch to say, therefore, that banks could begin to resemble utility companies: heavily regulated pass-through mechanisms that exist in large part to inject cash into the financial system.
Digital Tailwinds
Compare that to digital payments companies. The likes of PayPal PYPL, Square, Mastercard MA and Visa have less exposure to loan defaults, better technology and lower overhead costs.
In 2019, PayPal generated $17.7 billion in revenue and added more than 37 million active accounts, bringing the total to over 305 million worldwide. Square also had a healthy 2019, expanding its gross profits by 45%.
Both firms have high valuations, but with rates low, there are fewer places to invest. For anyone willing to consider a company’s future earnings potential, these continue to be attractive opportunities.
Meanwhile, Mastercard and Visa are mature credit businesses that operate without branches. That much most realize. What’s less apparent is that each has evolved into leading digital payments companies.
Last year, Mastercard acquired global digital payment firm Transfast and cybersecurity company RiskRecon, and Visa announced in January that it would buy Plaid, which allows users to connect their financial accounts to various apps.
Critically, all these firms have access to a massive amount of customer data. That should allow them to expand into lending and credit services more easily and limit their exposure to toxic loans.
Indeed, since they would already have reams of analytics concerning borrowers with similar profiles, whether it’s small businesses or individuals, these companies can take better calculated risks. And because their fixed costs are lower than traditional banks, profit margins will be higher despite charging the same loan rates.
Also, don’t discount the possibility that many could gravitate toward digital payments companies simply out of a desire to avoid handling paper money. Health risks brought to light by efforts to fight COVID-19 will have a lasting impact.
Great Unknowns
Consumers will no doubt act in unpredictable ways in the months and years to come. This makes any attempt to forecast what happens in the financial markets something of a guessing game.
Even so, the global crisis has only accelerated national retail and e-commerce trends, meaning the transition from traditional banking to digital payments seems to be one of the safer bets.