Banking: To adapt or die...or to die trying

In December, 1995, I was asked to write an article on the future of banking for a small Spanish magazine - Mundo Español - published in London. Today, reading about the "demise" of banks because of the "fintech revolution", I had a feeling of déjà vu and thought I would share the article I wrote all those years ago. Hope you enjoy!

To adapt or die...or to die trying

The spate of mergers and acquisitions that have taken place within the banking sector since the beginning of the year, may have made bankers reminisce, some maybe with nostalgia, about the late 1980's and the fireworks over the Thames to celebrate the liberalisation of the London Stock Exchange -the Big Bang.
Then, banks and stockbrokers jostled with each other as they tried to secure a prominent position in the market by merging with or acquiring the dealer and broker firms operating in it, or by enticing away whole teams of brokers with the offer of astronomical salaries -something very welcomed by the owners of the watering holes in the City, as these individuals promptly invested sizeable chunks of their windfall in these establishments. The frantic activity that ensued in London, as in other financial centres, was boosted by the merger mania in the corporate sector, and continued until Black Monday in October 1987.

This time round, some of the reasons given for the mergers and acquisitions may be the same and will probably mention synergy, economies of scale or competitiveness, but now they are taking place in the wake of a recession, and the atmosphere is one of gloom rather than self-congratulation.

In the U.S alone, 277 mergers and acquisitions have taken place since the beginning of the year. In August, the merger between Chemical and Chase created the country's biggest bank with assets of $297 billion. In March, Mitsubishi Bank and Bank of Tokyo sealed a merger creating the world's biggest bank with assets of $700 billion. In the U.K, Swiss Bank Corporation bought the investment banking business of S.G.Warburg, Dresdner Bank bought Kleinwort Benson, and recently Lloyds and TSB have agreed to merge, to mention but a few examples.

What are the reasons for all these mergers and acquisitions? There are many, but the main one is "financial disintermediation". Traditionally, banks have had a virtual monopoly as intermediaries in the financial system; they accept deposits (appearing as liabilities in their balance sheets) and make loans (which appear as assets), with the peculiarity that most of those deposits are liquid since they have to be repaid on demand, and most of the loans are illiquid since they are granted with maturities in the future.

This "intermediation" is sustainable as long as savers continue to channel their money to the banks, and borrowers do not default. What has been happening in recent years is that banks, on the one hand have been confronted by the proliferation of non-bank financial intermediaries in the form of investment funds, insurance companies, and even the financial arm of department stores, competing to attract the money from savers and investors, and on the other have suffered losses as a result of loan defaults and/or bad management. Even their traditional business of lending to corporates has been hit by this process of disintermediation, as companies have increasingly resorted to the capital markets to raise funds.

In view of all this, analysts and academics have for some time been speculating on whether we are witnessing the slow agonising death of most banks, to be replaced by a myriad of financial intermediaries specialising in specific areas, and those banks which are deemed necessary for the smooth functioning of a modern financial sector.

Whether this scenario is probable depends, to a large extent, on how we define what a bank is. The process of disintermediation and the competition from non-bank financial intermediaries have forced many banks to adapt to the changing circumstances, and they have done so in many different ways. In some cases the transformation of a bank has been of such a magnitude that is has led to the question: is it a bank or a financial services company offering bank services? Today, many so-called banks derive a higher proportion of their income from securities and foreign exchange trading, and fees, than they do from the interest spread on their lending.

The picture that emerges is a fuzzy one, if anything because in some countries a banking group will own a retail banking operation concentrating on "traditional" lending to individuals and small/medium companies through a branch network, maybe another bank catering for large corporates and engaged in investment banking activities, a securities trading operation, an insurance company, etc.

In continental Europe, for example, there is a tradition of universal banks offering the whole spectrum of financial services, and with large shareholdings in industrial companies that result in an intimate, and sometimes exclusive, lending relationship. For a long time, these banks operated in oligopolistic markets shielded from foreign competition by regulation and the high costs of entry, but with the gradual removal of restrictions for foreign banks and the onset of the Single European Market, some of them began to break ranks in order to adapt and compete in a new environment. In Spain, Banco Santander took the initiative by the introduction of the supercuentas in 1989, and since then banks have fought fierce battles to keep or to poach each others customers as new or revamped products have been introduced into the market (investment funds, mortgage loans, personal pensions, etc.). During this period there have also been a number of mergers and acquisitions, the two largest of which created Banco Bilbao Vizcaya and Banco Central Hispano; the consolidation of the public sector banks into Argentaria; and the majority purchase of Banesto by Banco Santander after the collapse of the former in December 1993.

What does appear to be clear from the process underway in the banking sector is that banks have to adapt or die. Some, like the American investment banks have for a long time followed a strategy of providing specialised and innovative services at a global level (admittedly, forced to some extent by the provisions of the Glass-Steagall Act); others have opted to stay in their home markets trying to become a dominant force by increasing volume through mergers and acquisitions; some have sought new markets in the emerging economies; and yet others have concentrated, more than most, in providing risk-management products and in securities and foreign exchange trading.
Some will succeed and others will, for various reasons, die trying like Banesto and Barings -but as Kipling would say, that is another story.

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