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Roundtable: The Future of Banking

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Last week, we talked about the biggest threat to banking. Today, we're cutting to the chase and considering the future of banking. Here's what some of our analysts think about the next decade in banking:

Morgan Housel: Sadly, I have a feeling it won't look too different than it does today. The nature of political reelections makes altering the gravy train of people who have money -- and the banking industry does -- very, very difficult. Moreover, we're already a year past the big crisis of last fall, and very little has changed. The longer time drags on, the harder it is to install reform, since people forget so quickly how dangerous the system is.

But where would I like to see it in 10 years? A few big changes:

1) Reinstate some form of Glass-Steagall, separating commercial banking from investment banking, insurance, trading, and brokerage operations. There's no excuse not to do this, and while it wouldn't solve every problem, the only people who argue otherwise are those whose incomes are dependent on it. If you want to be a commercial bank, be a commercial bank, and the FDIC will back your depositors when you fail. If you want to be a cowboy derivative trader, do so at your own risk.

2) Install a tiered capital structure. If breaking up "too-big-to-fail" banks is politically unfeasible, having a system where large banks are forced to hold proportionally more capital than smaller banks is a good alternative. Since profits would diminish with size, banks would have to prove efficiencies stemming from being huge, rather than just saying it and hoping we believe them.

3) Get rid of the absolutely insane accounting rule that lets banks count the erosion of their own debt as profit. This rule literally makes it so [that] right before a bank goes bankrupt, it turns into the most profitable bank in the world. Earlier this year, Citigroup  (NYSE: C  ) and Bank of America (NYSE: BAC  ) announced billions of dollars in "profits" thanks to widespread fear they were about to explode. It's the most absurd accounting rule I've ever heard of.

Alex Dumortier: Here are my three predictions for the banking sector, to be realized on or before 2020:

  • 500 more bank failures. In September 2008, I wrote: "Thirteen banks have failed since the beginning of the credit crisis, but I think we could see a large wave of bank failures, possibly numbering in the hundreds." With 133 bank failures to date in 2009, that possibility looks increasingly like a certainty. Another 500 failed banks would put the failure rate since the start of the current crisis at less than 10%, and that's a trifle compared to the more than 9,096 banks that failed from 1930 to the first quarter of 1933 -- approximately one in three banks.

  • Up to 30% fewer banks than precrisis. At the end of the second quarter of 2007, there were 7,281 commercial banks in the U.S. This number will fall below 6,000 by 2020, and perhaps even below 5,000. On top of bank failures, expect the sector to undergo a wave of consolidation over the next 10 years, as solid institutions snap up poorly capitalized competitors.
    While a 30% decline is probably the top of the range, a 15% to 20% reduction in the number of banks in the U.S. looks quite likely. The industry remains highly fragmented at the local and regional level; the aftermath of this crisis will accelerate consolidation. Unfortunately, this process has already taken place at the top level ... which was already too concentrated to begin with.

  • The banking industry will be as top-heavy as it is today-- or worse! At the end of the third quarter, the top four U.S. banks -- Bank of America, JPMorgan Chase (NYSE: JPM  ) , Citigroup, and Wells Fargo (NYSE: WFC  ) -- had combined assets of $7.4 trillion, which is equivalent to over half the GDP. In 2020, I expect the top 10 banks' share of total banking assets and total deposits to be equal to or higher than today's levels. There appears to be no will to reduce the size of megabanks, which is unfortunate, as there is evidence that this concentration improves bank profitability at the expense of the rest of the economy.

Matt Koppenheffer: This is kind of a funny question. If you asked me where I'd like to see banking in 10 years, I'd quickly say that I want to see true banking become boring again. That is, I'd like to see the biggest banks broken up so that institutions like JPMorgan Chase and Bank of America focus on making slow money by engaging in sober, conservative lending rather than bulking up on trading and tossing around risky instruments like credit default swaps.

And if folks like Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) want to hold onto the "bank" title that they picked up during the financial crisis, well, I'd like to see them actually engage in banking rather than just using cheap federal funds to juice their trading operations.

But where do I actually see banking going? Unfortunately, I don't see a whole lot changing.

What are your bold predictions for the banking sector? Let us know in the comments section below.

This roundtable article was compiled by Anand Chokkavelu, who owns shares of Citigroup. The Motley Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (15)

Comments from our Foolish Readers

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  • Report this Comment On December 14, 2009, at 8:11 PM, rd80 wrote:

    "Get rid of the absolutely insane accounting rule that lets banks count the erosion of their own debt as profit."

    First time I've seen someone propose getting rid of mark-to-market. :)

  • Report this Comment On December 15, 2009, at 12:51 AM, BigIsBAD5466 wrote:

    Morgan had it right. Return Glass-Stegall, but stronger. Make "too big to fail" a thing of the past. No, absolutely no, capitalist entity should get TO BIG TO FAIL where it brings down the life work of so many hardworking Americans at the financial benefit of a few bankers and the detriment of the entire country, the greatness of the American system.

    Capitalism is about making it or not. Government should not be held hostage to the greed of a few bad decisioning Financial idiots.

  • Report this Comment On December 15, 2009, at 9:57 AM, Gorm wrote:

    Without a doubt "Too big to fail" is a threat to US economic commerce and stability that MUST be eliminated.

    As was done with Standard Oil and AT&T the top 5 banks, controlling 40% of US deposits, MUST be busted up.

    As stated by many, these financial behemoths serve NO BENEFIT but to the few who manage empires and reap millions in earnings. Clearly, there is no justification in the masses supporting entities that favor so few!!

    Ditto on re-establishing Glass Steagall. There is NO economic benefit to US via a combined commercial and investment banking system. Who can argue that more competition isn't what is best for America?

  • Report this Comment On December 17, 2009, at 10:38 AM, JakilaTheHun wrote:

    I agree that some form of Glass-Steagall should be re-enacted. Failing that, I believe the solution is require the FDIC to impose abnormally large fees from the Goliath banks. The rationale being that those banks create giant systematic risks and *should* be required to pay disproportionally higher FDIC fees.

    This would create a market incentive against becoming too large. Either you stay a reasonable size or you pay huge fees for the privilege of being "too big to fail."

  • Report this Comment On December 17, 2009, at 12:29 PM, rd80 wrote:

    Reinstating Glass-Steagall is only a piece of the puzzle.

    For example, even had Glass-Steagall been in place, it wouldn't have stopped the huge risk presented by CDS. A commercial bank could still have believed it was reducing risk by purchasing CDS on some of the loan book. The balance sheet would have looked great right up until the bank's asset manager called her counterparty at AIG and discovered the money to pay the swap wasn't really there. The gov't would still have been faced with the choice of bailing out AIG or watching a number of banks collapse when protection they thought they had vaporized.

    With Glass-Steagall still in place, the situation might not have been quite as bad as what we just went through, but AIG and other counterparties' inability to honor their contracts had very little to do with investment bank vs commercial bank distinctions.

    Similarly, the poor credit underwriting that contributed to the mortgage collapse had little or nothing to do with commercial vs. investment bank.

    G-S was also a non-issue in some of the biggest failures and near failures we saw - Bear, Lehman, Fannie, Freddie, WaMu, GM, ... G-S wasn't a factor in any of them. Even with Goldman and Morgan, the distinction was only a factor because the gov't allowed those two investment banks to become bank holding companies.

    I agree commercial and investment banks should be separate entities. But I see too many talking heads pitching this as THE solution instead of one piece of the solution.

  • Report this Comment On December 17, 2009, at 12:43 PM, davejh23 wrote:

    "500 more bank failures"...before 2020.

    I wouldn't be suprised to see 500 bank failures in 2010 alone...I wouldn't be suprised to see one BIG bank fail in 2010 or 2011 either. We didn't really start seeing bank failures nearly EVERY weekend until June. The FDIC is doubling their staff, "just in case" bank failures increase...they're staffing up to be able to handle 500+ within the year...there are likely many banks that should have been shut down by now that they just haven't gotten around to. Ten banks added to the failed bank list every Friday in 2010 doesn't sound like too much of a stretch.

  • Report this Comment On December 17, 2009, at 12:51 PM, goalie37 wrote:

    My greatest wish for Congress is that they reinstate Glass- Steagall. Unfortunately the odds of this happening are about zero.

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