July 22, 2016
What We’re Reading This Week
Last week I talked about some of the changes retail banks are facing. With this quarter’s earnings releases, we see banks struggling with the same headwinds they’ve faced since 2008 and the inception of Dodd-Frank. JPMorgan, Bank of America, Wells Fargo, and Citigroup all reported profit declines due to net interest margin and revenues. This squeeze on profits isn’t limited to retail banking institutions such as Morgan Stanley and Goldman Sachs, which both also had interesting quarterly numbers. Both segments have responded to the profit crisis in similar ways, focusing on dramatically reducing expenses in trivial ways (like cutting back on tellers!) or in the case of Goldman, firing 2,100 employees in the past nine months as well as barring executives from travel unless it involves meeting clients to win new business. The reductions are representative of the bizarre ways banks think and operate. Bank revenues are tied to clients. Without clients, banks don’t exist. It is far cheaper to keep an existing client happy than it is to replace that client every few years. Cutting operational staff at branch locations or banning executives from traveling to meet existing clients amount to the same thing. It’s a slow march to doom.
In the years following the financial crisis cutting costs were the only way banks could generate any profits. Many of these cuts were needed to make these institutions more efficient, but at some point it becomes less about increasing efficiency and more about shooting yourself in the foot. Retail banks need clients to generate revenue. Clients want convenient branch locations with lots of tellers. When you cut the teller staff it makes people not want to bank there anymore. The banking industry threw itself at the online banking revolution without stopping to think about how many of their clients would never bank online. Generally, these people are older clients with lots of money in their bank account. Oops. Very recently, JPMorgan was forced to start hiring more tellers due to increased complaints from branch customers. It’s profitable to keep staff costs low but it’s not profitable to fire staff and re-hire new staff (assuming the layoffs aren’t performance related). New staff requires recruiting, interviews, background checks, drug screening, and training. Ultimately it comes back to what bank executives and shareholders want, which is not a long term, healthy, sustainable business. Bank executives want big bonuses and shareholders want a profit this quarter. Ultimately, executives have to give shareholders what they want or they can’t keep their big bonuses. So, they continue to cut costs at the lowest levels of the bank in a feverish attempt to trim fat. They are now finding that even when successful, these cuts don’t do much to improve the bottom line. Cutting costs to improve revenue numbers is a short term game and it looks like we’re nearing the end of that term.
Bank of America
I can’t seem to get away from retail banking this month. Reuters had a great article about Bank of America and how much it costs them to “shuffle papers around and transport money in armored trucks.” There has always been a massive disconnect between people that run banks and the people they serve, bank clients. Full disclosure, I worked in the retail banking division at JPMorgan Chase from 2008 to 2012 and when I was there I was consistently surprised by things high level executives would say. Bank of America found that they are paying roughly $1 billion annually to move cash within the company. According to Reuters “BofA executives describe that cost as a particularly frustrating one. In a world where digital banking is possible, moving paper around should be a thing of the past…” I mean, sure, I guess. If we’re going to take that stance I guess we should work harder to bring the block chain to the masses, which doesn’t really do much to improve the banks’ future. If everything is electronic, what is the advantage of Bank of America vs Chase, or PNC? In this country the number one reason people choose a bank is still convenience of location. Even though banks don’t really work like this, people still seem to enjoy the idea that they could theoretically drive down the road and touch their money. Even though their money isn’t necessarily there, they still like to think it’s there, waiting for them to be reunited. As long as people that use banks want to go to branch locations you (the bank) will need to make sure that money is in those branches. Near the end of my time at Chase the bank did a study and found that our most affluent (and profitable) clients visited branch locations once every quarter, or four times a year. If you listened to the bank’s rhetoric on online banking this is four times more than you’d expect. Clients don’t really care what the bank wants, even if it saves the bank money.
And so, Bank of America may one day get its wish granted – no more armored trucks! The Bank of England proposed a central banking system with a distributed, electronic ledger. Currently, banks do have the unsavory job of moving paper money around and keeping track of everyone’s money in their database. This database is crosschecked with a database run by the government. Much of this is done electronically but not at the speed of light. When a client moves money between their investment accounts and their bank accounts it can take several days. That’s probably too long considering that our cars will soon be self-driving (supposedly). There are lot of people that think moving to a public, electronic database of a central bank digital currency would be better. This is a rough (and overly simplified) explanation of blockchain. If people have their accounts at a central bank then 1) the government can’t really use commercial banks to manipulate the economy by playing with the money supply and 2) people don’t really need banks any more. By the transitive property, the banks would no longer need to move money around because they don’t exist. That’s a win-win, right? Closing the doors on the bank is pretty much the ultimate cost cutting measure, right? Obviously, there is a lot that needs to be worked out before the U.S. implements an electronic currency (most dollars are already electronic but ignore that) or a public, central ledger. However, it does explain why so many commercial banks have divisions researching how to make blockchain profitable for them.
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