The Great Unbundling Of Banking

I am the Co-Founder of Treasure Financial, and I write about Fintech, capital markets and the economy.

As Jim Barkesdale, former Netscape CEO, has said: there are “only two ways to make money in business: One is to bundle; the other is unbundle.”

As many participants in the VC world know, there is a general pendulum swing in technology and business between two giant trends: bundling (gathering and combining multiple services into one provider) and unbundling (breaking down services provided by one provider into sub-components). Bundling typically happens because of convenience: It is easier to use one provider for multiple services. Unbundling typically occurs because of efficiency: It is hard for one provider to be an expert at providing multiple services.

The Core Services Of Banks

The way community and regional banks have been operating over the last century is very much within the bundling framework. Banks essentially provide three core services:

1. The warehousing of cash via a deposit account.

2. Money movement via the interconnection of those deposit accounts, facilitated by a central bank.

3. Lending by turning funds from deposit accounts into loans.

Banks monetize these three services through fees to perform tasks linked to money movement and to net interest margin (NIM)—which is the spread between the yield banks lend at and the yield they pay on deposits—for their deposit/lending business.

Thanks to rules and regulations, banks have benefited from (quasi) monopolies across all three of the services they provide. Their strongest position might be in their deposit business, since regulation makes it nearly impossible to hold cash outside of the banking system. Sure, you can hoard bills under your mattress, but no other institution can be a custodian of cash besides banks. Like all rivers lead to the ocean, cash always flows back to a bank.

Regulation favors banks on the lending side, as well—though banks are not the only capital providers to the economy, as this service is also facilitated by private credit funds. (Post-SVB collapse, I have also seen more private credit funds supporting lending for banks.) Still, for this lending service, banks have a clear advantage thanks to their low cost of capital (via cheap deposits).

On the payment and money-movement side (another regulated field), there is some competition with the emergence of different types of payment providers. But at their core, they are still powered by banks in the background, thanks to the banks’ monopolies on the custody of cash.

How Technology Is Unbundling Banking

Over the years, as in every sector of the economy, technology has been increasingly leveling the playing field and promoting competition. None of the three core services provided by banks have escaped this trend.

• Digital Underwriting

On the lending side, we have recently seen the emergence of the digital underwriting process. A regional bank might have formerly had a big advantage in their underwriting process because they had better information about their borrower and the state of the local economy. But this information advantage is being reduced by other lenders getting better access to the quality of the borrower via digital information.

• Reduced Friction

Similarly, on the payment front, technology has alleviated friction in money movement. The last bastion of monopoly for banks that is still relatively intact has been their cash warehousing service. But as the recent bank failures have shown, the banks’ monopoly in cash warehousing is also starting to be challenged.

The banking stress experienced recently is merely an accelerant; behind this, there are deeper trends at play affecting the bank deposit business. Technology provides the ability to increase the speed of money movement across banks, whereas historically, it has never been easy to switch between banks. Technology has also enabled funds to be easily funneled toward cash-like securities, such as money market funds, treasury bills, repo and commercial papers, via easy creation of brokerage accounts.

• Demonopolized Deposits

On top of this, the yield provided from those cash-like securities with the current monetary regime is significantly higher than what can be earned at a Big 4 bank. The yield at Big 4 banks is currently as low as 0.01%, compared to 5.45% on T-Bills— as much as 500 times more. Overall, the combination of these trends is now starting to challenge the monopoly of banks on their deposits business.

It is important to note that this last bastion of bank monopoly, cash warehousing, is also one of the core drivers of both payments and lending. Thus, the competition on deposits has also weakened the two other services provided, and thus the overall bank position. On the lending side, banks have long capitalized on their monopoly in deposits by using cash warehousing as a cheap cost of funding to finance loans and redeploy in higher yield loans. The main underlying premise is that deposits and loans have roughly the same duration; but as we have seen recently, deposit duration can shift drastically with little notice. With deposits losing their stickiness, banks are further hindered in their ability to fulfill the rest of their services.

In Conclusion

Technology is now enabling more competition across banks’ three main business units, thus opening some space for new entrants to emerge. This is why we are now experiencing the great unbundling of banking services.

I believe there are two broad implications of this. One is that there will be a continuation, via technology, of specialized service providers for payment, lending and cash warehousing, with banks acting as an interface to connect and bundle these (outsourced) services. On the other hand, we might also witness the emergence of non-bank players looking to provide some rebundling of these separate services while using a bank as their backbone (i.e., a Bank as a Service (BaaS) provider).

The evolution of these banking services is to the benefit of the end user, who is going to have many more options in terms of their banking as well as access to more tailored solutions. This underlines the importance for leaders in banking to have a more proactive stance on their assessment of the end user’s needs and how they are met, as the field continues to evolve quickly. One thing seems certain: The banking industry and ecosystem has never been as exciting.

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