When my kids were young, they sometimes asked me what I do for a living. This ex-dark side banker will say that I am a magician. I create something out of nothing. There is basically very little economic value to what I do except to take a spread/commission out of every transaction. This could run into millions of dollars in revenue. Going into my 2nd halftime life journey, I try to redeem myself with positive Jedi energy now 😉
A number of banks have been failing in recent times and the question of whether traditional banking has become obsolete. Can non-banks take over the banks’ iron rice bowls now? I wrote about it in my previous blog. Today, let’s do a deep dive into this topic and its likely future implications with a past example and a new Apple threat that happened this week.
A few days ago, the biggest local bank announced a great financial quarter result. Its NIM (Net Interest Margin – difference between the average cost of funds and the deployed lending rate) had improved by 66 bps (0.66%) quarter on quarter from Q1 2023 versus 2022 to more than 2.60%. This came on the back of aggressive rate hikes last year by central banks after almost 15 years of low to zero interest rates because of the 2008 GFC (Global Financial Crisis) saga. The US Fed had raised rates by a total of 500 bps (5.00%) since early 2022 to try to tame raging inflation, thanks to the Ukraine war and returning to normal post-Covid.
At this point, I would like all readers to check their personal bank accounts (CASA – Current and Savings Accounts). How much interest are you earning at the moment? Is it zero or just 0.25%? This, my friends, is the free lunch which banks have been creaming off from everyone for years. Banks get low-interest loans from sticky depositors and deploy the funds at higher rates to juice up their profit margins. It is now even more apparent because of the rapid interest rate increases by the central banks in the last 12 months.
Aren’t depositors going to rebel and vote with their feet to move funds away? Most of us are either too lazy or have had few alternative options previously. But with technological advancement and recent default examples like SVB, it has been proven that money can move out in real-time instantaneously to cripple a badly managed bank.
Let’s take a step back in time now to look at an example of a giant bank killer who managed to upset the bloated banks and took their free lunch from under their noses. This was 10 years ago in China. The aggressor was Yu’e Bao from Alibaba.
Back then, Chinese authorities were in a cosy relationship with the state banks. Regulators ruled that the banks can pay depositors 3% or less while they can lend out the funds at 6% or higher. This 3% difference effectively became a free lunch for the banks to earn easy revenue without lifting a finger. This easy money support for the banks was to provide them with a buffer so that they can have the resources to build and expand the underdeveloped banking landscape in China. It was also to encourage them to support the funding of grand infrastructure projects of state institutions.
Alibaba, a very good corporate tech name by 2013, effectively was at the mercy of the banks. It can only get funding that was higher than 6%. Alibaba also had to fight for banking facilities against the various state project initiatives. Credit was scarce and hard to come by.
At that time, many citizens were already using Alibaba’s platform to buy and sell products online and had accounts set up for the settlement of transactions. Many had idle funds in them, just like the spare cash you have in a metro city card nowadays. It was free float funding for Alibaba as it did not need to pay the customers any interest on these idle funds. While Alibaba needed to borrow more aggressively for its business expansion, it also already had a banking network set up for payments with many local Chinese banks.
The light bulb moment happened instinctively within the company. Why can’t we tap on this and turbocharge it to 100x for a win-win result for everyone? And to screw the banks along the way by destroying their free lunch fat 3% margin while getting a new and reliable stream of funding at a lower cost too.
And so the Yu’e Bao (Chinese for “leftover treasures”) product was created. Alibaba immediately offered all its clients a 6% interest deposit rate which they can transfer their idle cash into within seconds from their mobiles. Clients began to pull out their deposits from traditional banks earning less than 3% into their Yu’e Bao accounts to have an instant 3+% pickup. Alibaba is now able to bypass the banks to access new funding at a much better rate than what banks can offer. It was a brilliant win-win move that caught all the banks with their pants down.
Very soon, Yu’e Bao became the largest money market fund in China. This fantastic success story will forever be remembered as a David conquering Goliath story for others trying to break into the banking cartel to emulate. How one can conquer an unfair banking disadvantage to break it open with an innovative tech solution.
It was good for Alibaba while it lasted. The sad outcome of the Yu’e Bao success story was that it spawned a whole industry of wannabes high-risk yield-enhancement wealth products that spiralled out of control in China. The authorities were always behind the curve and finally cracked down after billions of RMB were lost by retail clients who were chasing higher yields from risky fly-by-night operators. Only after mass protests did the government step in to clamp it down in the last few years.
Since then, many fintech firms have tried the Yu’e Bao method to collect funding by paying up to attract new depositors. That was basically the strategy of new digital Neo banks around the world. They needed to bulk up their depositors’ base in order to finance their lending program. Their digital banking strategy required the leveraging of their capital via new depositors to make their financial numbers work.
Sadly, most of them hit a brick wall soon after as many clients do not really trust low-capitalized new digital banks without any track record compared to traditional banks. As studies later show, most new digital bank clients would not place more than $50k in them, regardless of their parentage.
But in recent times, big American companies have tried to muscle in on this game. Apple has just launched its new high-yield savings account offering an amazing 4.15% interest a few weeks ago. Behind this product is Goldman Sachs, the financial firm that is providing Apple with the banking platform. Within less than 5 days, it has attracted $1 Billion of new funds.
Apple is the largest company in the world with a market capitalization in excess of $ 2.7 Trillion. It is a well-known brand with an embedded ecosystem of millions of iPhone users around the world. Who wouldn’t want to bank with Apple to earn a higher rate of return with their idle funds?
This move will be the monster hit that will put banks on high alert. Banking confidence has fallen with recent bank failures. Consumers have had enough of getting screwed by greedy banks and are pissed. Will this be the future of banking? Only time will tell…
Meanwhile, Musk over at Twitter Land is trying to create a super app, following the examples of Alipay and WeChat. There are talks that he has registered X.com to revive the strategy he had during his early 2000s PayPal CEO days. There are also rumours of him wanting to buy eToro to combine with Twitter to form a super one-stop financial app.
These are interesting times as the American banking landscape is ripe for possible innovative solutions to pay higher interest after recent bank failure turmoils. It is also the awakening of customers questioning why they are being paid peanuts in interest while bank CEOs earn fat bonuses.
There is a realization from strong tech names that the banks’ fat margins in deposits can be eaten by non-banks. The accumulated simmering anger of long-suffering and frustrated loyal depositors is the perfect storm where many new Yu’e Baos will rise in America and other parts of the world soon. We live in interesting times…
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