Fintech, a rapidly growing industry which seeks to use digital technology to make finance more nimble, has been getting more attention in the press recently. And for good reason — it could fundamentally change the way investors think about Bank of America‘s (BAC) stock.
We saw the impact of digital disruption play out in many other industries, including music, print media, publishing, retail, transportation, and hospitality. Entrepreneurs developed platforms that connect buyers with sellers and cut out the middleman, creating profitable businesses with low capex and toppling industry leaders.
Now, banks are waking up to the fintech challenge. Last November, former Barclays (BCS) CEO Antony Jenkins sounded the alarms, warning that banking is facing its own “Uber moment“. The Economist Intelligence Unit found that “more than 90% of bankers project that fintech will have a significant impact on the future landscape of banking”.
Will fintech threaten established players such as Bank of America (BAC)? Let’s look at the reasons why fintech will threaten banks, and the reasons why it may not.
Fintech Threatens Bank of America (BAC) Stock: Disintermediation
Networks such as Airbnb and Uber simply connect people with needs to people who can satisfy these needs, cutting out the middleman, a process known as disintermediation. If people can use the internet to find people to borrow money from and lend money to, what will they need banks for?
Fintech startups want to steal the most profitable business activities from banks. McKinsey & Company found that banks earn a 22% return on equity from sales and origination, but only a 6% return on equity from the extension of credit. Sales and origination accounted for 59% of banking profits in 2014. Those who own BAC stock should keep an eye on peer-to-peer (P2P) lending.
Banks earn money from the interest rate spread, the difference between the rate at which they lend and which they borrow money. P2P lending will probably reduce the spread, and with it, profit margins for BAC.
Fintech Threatens Bank of America (BAC) Stock: Lost Opportunity in Growth Markets
In recent years, with sluggish growth in the eurozone, global banks have been looking more at growth markets such as China, India, and countries in Africa and Southeast Asia. However, 2 billion people worldwide still lack bank accounts, according to the 2014 Global Findex. There is a gap between access to banking services and access to mobile phones, and this is quickly being filled by payment services such as Kenya’s M-Pesa.
Fintech firms such as Alipay are quickly moving towards markets in Africa, India and Asia. If they succeed in winning market share, this will mean lost growth opportunities for global banks such as Bank of America.
Fintech Threatens Bank of America (BAC) Stock: Tech-Savvy Competitors
We have already seen Silicon Valley shake up existing industries from retail to transportation. So far, the banks have been spared, but it looks like tech giants such as Amazon (AMZN), Alphabet (GOOG, GOOGL), Facebook (FB), and Apple (AAPL) are getting into the mobile payments game. Amazon, Apple, and Google all have rolled out mobile wallets, and Facebook added P2P payments to its Messenger app. This could end up costing banks a crucial source of big data.
Tech giants bring to the table three things: tech-savvy, including competency with Big Data and in developing and updating user-friendly interfaces; big budgets, and scale, with hundreds of millions of users. Over a billion people use Facebook, and there are over 800 million iTunes accounts. Silicon Valley firms are masters at shaking up and disrupting markets; the motto is “move fast and break things”. BAC stock owners should look at the track record of these giants, and examine the threat they pose to banking.
Fintech Doesn’t Threaten Bank of America (BAC) Stock: Not Everything Can Be Automated
Robo-advisors might be cost-effective for clients who are not wealthy, but it’s unlikely that the wealthy will be willing to entrust their fortunes to a financial algorithm. The CFA Institute’s Fintech Survey Report found that automated financial advice tools will largely replace human advisors for the Mass Affluent, but not for High Net Worth or Institutional clients. The rich probably account for the lion’s share of assets and management fees.
A Deutsche Bank report from 2014 found that “the main areas affected are less knowledge-intensive and easily standardisable financial services.” Knowledge-intensive work, such as arranging a billion-dollar bond issue or M&A, probably won’t be given to the bots just yet.
Fintech Doesn’t Threaten Bank of America (BAC) Stock: Regulatory Barriers
As fintech plays more of a role in the financial system, it will inevitably attract the attention of regulators. Banking regulations increased after 2008, and fintech will need to invest in big compliance departments if they want to get into heavily regulated areas, such as mortgage lending. A 2015 report from McKinsey & Company found that capital markets and investment banking is less likely to be affected than other activities.
Fintech Doesn’t Threaten Bank of America (BAC) Stock: Not All Can Survive
Most businesses fail after a few years, and fintech will not be any different. In 1999, there were a lot of dot-com companies, but two years later, many were out of business (remember Pets.com?). The banks will probably swallow up many of these firms; they certainly have the capital to do so.
Citi finds that “not all fintech new entrants will have a sustainable competitive advantage. Companies that are trying to solve a financial need in a different rather than simply a cheaper way are more likely to maintain their innovation edge for longer.”
Verdict
Fintech probably won’t displace banks entirely; the reality is more nuanced and there probably will be room for cooperation between the two. Banks have a large customer base and skills with managing risk and complying with regulations, which fintech lacks.
The impact of disruption on finance will probably be not different from the way it shook up retail, travel, transportation and other industries. Margins will shrink due to competition, as will opportunities for growth. 1995 to 2007 was a very profitable time for banks, and it doesn’t look like banking will return to the good old days anytime soon.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.
