Banking on Digital Destruction?

Crikey, that was an awful dose of George (g)Lee on the radio this morning. The intrepid RTE correspondent for Science is building quite the reputation for gleeful gloom. Yes, the pandemic data is stubbornly flatlining but to opine that the critical R-rate “must be over 1.0” ventures into emotional bias territory rather than the realm of science and analysis. Perhaps he will be right but the more immediate benefit of George’s latest BULLetin was to prompt some self-reflection. Do I exhibit similar emotional bias in certain areas? I often wonder if I am too gloomy on the prospects of the banking industry so this might be a good week to introduce some balance. And, it has been a good week for banks.

Banking is about the provision of debt capital – more on that later – but it was other areas of the capital markets where the good news was to be found. Thanks to positive vaccine news bank share prices have been on a tear. AIB’s share price has rocketed up over 50% in the last 8 weeks. However, that 8 week period referenced hints at more than just vaccine relief. Whisper it quietly but inflation or reflation is working its way into market forecasts and that helps the banks.

It also helps when there is a general rotation into VALUE stocks which is typical when investor confidence in economic growth picks up rapidly. Investors have not been too picky and a basic trading strategy of buying the most depressed share prices has worked very well. Oil and banking shares are very much in that depressed cohort and are enjoying much needed buying activity. Like George, investors could be correct but such affirmation could depend on one’s time horizon. You have read about a “Great Rotation” out of the pandemic stars in technology and healthcare. The less polite might refer to the investor switch as a “flight to sh*te”. Both descriptions tend to suggest investor enthusiasm is brief and lacking any real fundamental conviction. However, there is market activity elsewhere which illustrates greater conviction.

Spanish banking giant, BBVA, has just announced the sale of its US franchise to the top 5 US player, PNC. The American purchaser is making an interesting strategic move and the value of the deal at $11.6 billion is the largest banking transaction since Lehmans collapsed. Particularly striking is that PNC have funded the deal with the sale of their stake in fund management behemoth, Blackrock. Please note strategic shifts out of fund management into traditional banking are as rare as evidence of fraudulent voting in the US these days. Other merger activity is happening in Spain with Bankia/Caixa and BBVA/Sabadell tie-ups plus the intriguing rumours of a monster Swiss deal between UBS and Credit Suisse. These are not short-term ‘rotations’ or trades. They are big long-term management calls which require confidence. However, they could also be described as “defensive” moves and news closer to home does trigger a bit of George in me.

Ulster Bank’s Dublin HQ not only sits on George’s Quay but could in a matter of years be empty. Ulster’s parent, Nat West, has acknowledged the future of the bank is “under review”. One of the less desired options is that the bank is put in run-off mode if it fails to attract a buyer for its Irish operations. Just to remind readers, run-off is the modus operandi of a “bad bank” like the IBRC successor to the Anglo-Irish casino. What is remarkable is that Ulster Bank is not a bad bank and currently sits on €22 billion of deposits and a loan book of more than €20 billion. I have read wise commentators elsewhere describe this as the biggest banking news in Europe for years. In effect, it is a bank deciding its traditional banking business model is capital destructive ie its cost of capital exceeds its returns on that capital. You do wonder what was the straw that broke the camel’s back?

Banking is tough these days. Even tougher with a pandemic setting your loan book on fire but that’s a cyclical/one-off(?) challenge. The triple whammy of structural challenges from ultra-low interest rates, soaring regulatory costs and technology catch-up/competition are well documented and long-term. This writer’s personal view is that technology is the big one, the asteroid. These banking beasts are manifestly ill-equipped to develop technologies and compete with digital platforms unburdened by legacy businesses and IT infrastructure.
The truth is that, even if the banks catch up on current technologies, the pace of change is too hot and remains a potential extinction event if capital is exhausted to merely survive the first hit. First, you ask? Well, we are not great as a species on the forecasting front but it might be worth noting the words of Bank Of England’s chief economist, Andy Haldane, this week. Whether you are looking for an Ulster Bank final straw or straws in the wind, the Bank of England has floated the prospect of ditching cash and replacing it with a digital currency. Haldane sees it as a necessary tool to facilitate negative interest rates; and feasible thanks to the emergence of blockchain technologies and cryptocurrencies.

So, no surprise to see Bitcoin’s price roar past $18,000 this week , a three year high. Joy for crypto traders but no such glee for bank executives still pouring billions into digital transition projects. Imagine throwing a digital currency into the technology mix!! Now, what are the chances Nat West’s management got wind of Bank of England thinking and moved into extreme defence mode? We just don’t know… which is what we wish George would say more often.

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