The Banking Industry: Past and Future

In honor of The Motley Fool's 25th birthday, we're taking a look back at what's changed in the banking industry over the past quarter-century and speculating a bit on what the next 25 years might have in store.

While nobody can predict the future, here's how Industry Focus: Financials host Michael Douglass and Fool contributor Matthew Frankel see things going.

A full transcript follows the video.

This video was recorded on June 25, 2018.

Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Monday, June 25th. This is the Financials show. 

We're kicking off a very special theme week. This week marks the immediate lead-up to The Motley Fool's 25th anniversary, which is Saturday, June 30th. So, we decided to celebrate by doing a theme week around the concept of 25 years. Because Motley's in the name, everyone's interpreting that a little bit differently. Some episodes may be talking about how things were in their covered industry 25 years ago, here on Industry Focus. Others will probably be predicting how things might be 25 years into the future, with the caveat that no one can really predict the future now, can they?

Matt and I are overachievers, so we decided to do both in under 25 minutes. Get your timers out, folks, because things are about to get interesting. Matt, let's start by going to the past and some of the major changes we've seen in the banking industry over the past 25 years. One of the big ones that we were talking about before we hopped on air today is, of course, consolidation.

Matt Frankel: Yeah, definitely. One of the big things that's happened over the past 25 years is that the big banks have gotten bigger. We now have what are known as the Big Four banks in the U.S. -- Citigroup, Bank of America, Wells Fargo and JPMorgan Chase. All of those have grown substantially through acquisitions, not just from the financial crisis, which saw a lot of consolidation, but beforehand. Actually, three of the four were actually acquired themselves, and the acquiring companies just decided to keep the names because they were more recognizable. 

Just to name a couple of cases: Wells Fargo picked up Wachovia along the way; JP Morgan, Bear Stearns, Washington Mutual; Bank of America picked up a bunch, U.S. Trust, Countrywide Financial, Merrill Lynch. You've heard before the financial crisis that a lot of these banks were becoming too big to fail, and it seems that they've actually become bigger as a result of the financial crisis. That's been one big trend, a lot of consolidation in the industry over the past 25 years or so.

Douglass: Yeah, and we haven't just seen that in banking and financials, to be clear. This move toward scale is something we see across healthcare, we've seen it in a lot of different industries as folks decide -- to some extent, at least -- that bigger is better. 

Of course, one of the big things that happened over the last 25 years is the extended use of the internet. As a result, internet-based companies -- some of you have probably heard of Amazon -- have really grown and hit their stride. A good example, of course, on the banking side is the online-only banks.

Frankel: Yeah, there's a few. We talk about BofI pretty often on this show.

Douglass: Constantly, yeah. [laughs] 

Frankel: Right. [laughs] But, there were a couple that actually came before, that primarily offered just savings accounts and CDs. They figured out really early on that because they had an online-only business model, they were able to save the whole expense having branches, employees, things like that, and offer better interest rates than everyone else was paying. Personally, I had an ING savings account, I think it was, in 1998 or '99. That was a big change over the past 25 years. Pretty much, if you wanted to open a savings account 1993, you went to a banking branch. There was really no other option.

Douglass: Right. Relatedly -- let's dig into that a little bit more -- there have been a number of other technological innovations that have really changed the nature of financials -- banking and banking activities. One of the big ones, of course, peer-to-peer payments. It used to be, you got your loan from, maybe your parents, maybe from a VC, maybe from a bank; not really so much from a dispersed group of people who are each kicking in $25 or $50 or however much to fund your idea.

Frankel: Yeah. If you wanted to borrow money in those days -- say you needed $20,000 to consolidate a bunch of credit card debt -- you pretty much had to go to a bank unless you had wealthy friends or something to that nature. It was really tough to find anywhere else to borrow money. And the lending process, because there was really only one option, was very lengthy, very inefficient, and very tough to get through, in many cases. 

Peer-to-peer lending has not only forced some of the banks to get on board with this whole trend of making loans a little easier, including more customers, but it's really driven down prices and increased competition. It's really been a good thing for consumers who need to borrow money. Goldman Sachs, we've talked about the Marcus platform, a lot of the big banks like that are getting in on this and seeing the value in that business model.

Douglass: Right. Related, of course, to peer-to-peer lending is also peer-to-peer payments. Nowadays, you can Venmo people money if you want to split a check, which certainly has saved me an inordinate amount of time, and usually money, because somehow, whenever a check gets split five ways, I always seem to pay more than the numbers indicate that I should be. And I'm just like, somebody figured out how to get a free meal here.

Frankel: [laughs] Definitely. I need to use Venmo one of these days so I know more of what you're talking about.

Douglass: Oh, yeah, sorry. [laughs] 

Frankel: No, but, having said that, I do use PayPal, I've used Zelle before. That's pretty much the same thing. 

Douglass: Right.

Frankel: The process in 1993 -- 25 years ago, when The Fool was born -- if you wanted to give your friend money, you pretty much had two choices: you could write them a check, then they would have to go to the bank, cash or deposit your check to get the money; or, you could go to the bank or ATM -- ATMs existed in those days -- and get the money out and physically hand it to them. Either way, there was a trip to the bank involved. Now, that's not a thing anymore. People my age or older remember this, but a lot of people 30 and younger really don't remember having to go to a bank to get money.

Douglass: Well, I remember how often my parents -- we, of course, had to go to the bank for whatever reason. They always had those really poor-quality lollipops that were still really good. Do you know what I'm talking about?

Frankel: [laughs] I remember those well.

Douglass: I remember really liking the green apple one. Anyway, that's its own long conversation. We can have a whole episode just on candy flavors and our favorites.

Speaking about technology a little bit more, too, a lot of this ties into this idea of mobile banking, internet-based banking. That really didn't exist. Online banking portals didn't even start to appear, really, until the mid-to-late 90s. And, well, let's just say they weren't terribly user-friendly. That seems to have taken off really in the last few years, to get to a good, fairly frictionless experience.

Frankel: I'm aging myself a little bit now, but the first time I became an adult was in the late 90s. I had an account at what was known as Commerce Bank, which is now part of TD. I clearly remember logging on to the online portal, I want to say early 2000s. You could pretty much check your balance. That was really the extent of its functionality.

Douglass: [laughs] Right.

Frankel: There was no such thing as mobile deposit. If you wanted to deposit, you had to go to the bank. People my age probably remember how long the bank drive-thru lines got back in those days. The lollipops Michael was just talking about were the motivation my parents had for getting us to sit through the line with them. "You'll get a lollipop at the end of this, don't worry." It's really boiled down to, banking has become so much more convenient than it used to be.

Douglass: It's interesting, because, of course, we think about fees in terms of money, but there's also the fee of time. Banks have really done a good job, in a lot of ways, of starting to lower those. I'm not saying that that's because the banks necessarily wanted to lower fees, it's just that that's where the market drove them.

Let's also talk a little bit about something that The Fool has certainly been involved in, and it's certainly been a symptom, you might say, of the broader expansion of the internet, which is this idea of fee awareness. People have become so much more aware of the fees they're paying, in part because there are sites, like fool.com -- and, of course, like a number of sites online, you can probably imagine them, dear listeners, and you probably know of plenty that I don't even know about -- that compare these fees and help you understand, "OK, here's how this works, here's what this is actually going to cost." That's really helped bring a lot of transparency and further fee reductions as people have better-understood what they're really paying for the services.

Frankel: Yeah. I'm surprised fees on things like checking accounts and things like that haven't really come down yet. But in terms of investments, there seems to always be someone who's willing to do it cheaper. Vanguard is a big example of one of the pioneers in this space, really low-cost investment products. They make almost nothing on some of their most popular ETFs. And just because of the volume, they're actually making a fair amount of money on them. 

It's just, the trend has been toward lower and lower fees, and people have become much more aware -- and want to be aware -- of the fees they're paying before they enter a relationship, which really was not the case 25 years ago. If you had a stockbroker, the commissions you paid were really, in many cases, not very transparent. Banking fees were tougher to understand because certain reforms that have been enacted between then and now didn't exist. More transparency exists because that's what customers are demanding these days. And, as we said, a general lower trend.

Douglass: Yeah. And, in the past 25 years, we should also note -- you teed this up very nicely, Matt -- regulations have changed. Gosh, it's almost like we prepare these shows beforehand a little bit, right? What a concept! [laughs] But, in the aftermath of the financial crisis -- which obviously was a big event over the past 25 years, one of the largest recessions in the United States' history -- Dodd-Frank regulations defined a systemically important financial institution, or SIFI, and also prohibited certain types of investments by a bank. Of course, as we discussed in an episode just a week or two ago, there have been some changes and some rollbacks of some of the Dodd-Frank reforms.

Frankel: Yeah. The Dodd-Frank reforms were the biggest regulatory action in the past 25 years, hands down. That 25-year period does not include the savings and loan crisis that happened just before, so these are the biggest reforms. They pretty much defined what too-big-to-fail means, and put steps in place to ensure that those institutions are not in a position where they would fail. 

This is generally a great step. It seems that they might have gone a little too far, which is why some of the rollbacks in the regulations were done a couple of weeks ago, relaxing what the systemically important financial institution standard is and letting some of the smaller banks take on a little more risk. 

But, regulation has certainly come a long way. There was no such thing as too-big-to-fail back in 1993. First of all, like I said, the four biggest banks were not nearly as big as they are right now. If one of them failed, it would just be inconceivable in 1993; whereas now, after the financial crisis, it's like, "Hey, these are actually pretty vulnerable when they're not run correctly."

Douglass: Yeah, it's highly conceivable today because we've seen it happen -- well, or, let's say, seen it get pretty close. The financial system got very close to melting down. I was a big lover of history in school, and I believe that history can tell us a lot about what our future is if we fail to heed its lessons. So, there's a lot of important stuff for us here to consider. 

That's the past 25 years, in about ten minutes. Let's turn to the next 25 years with some predictions for how financials will change. Now, I want to be clear here -- these are my personal predictions, Michael Douglass, analyst here at The Motley Fool who enjoys covering financials, and noted bank enthusiast. These are not necessarily Matt's predictions -- although, we talked about these before, and I know where he's going to disagree with me a little bit. And, they certainly don't represent the company's unified viewpoint -- as if a company with the name Motley in it could have, necessarily, one unified viewpoint on things anyway. But, just a few things that I see, looking forward, that I think will really highlight what happens in financials over the next 25 years, at least around the things that we're thinking about today.

Let's start with blockchain. I believe that blockchain will be in widespread use for its dispersed ledger capabilities. I will further add, I do not think that Fannie and Freddie will be using blockchain for mortgages because I think they're going to lag the rest of the market. But, I'm betting that, throughout the private sector, blockchain will be used for contracts, and maybe even some non-agency conforming loans might be using blockchain for validation.

Frankel: There are a ton of applications for blockchain technology. We're only starting to see this pick up a little bit. One important distinction I want to make -- and we're going to get into this in a little more detail in a minute -- blockchain does not mean Bitcoin. Blockchain does not mean any other cryptocurrency. This is a form of technology. It's just like saying, "The internet does not mean Microsoft." It's one thing that came out of internet technology.

Blockchain technology, I definitely agree with Michael on this one, is going to grow by leaps and bounds. There are so many applications, not only in finance but in fields like healthcare, for example. There are a ton of applications for blockchain in terms of record-keeping and things like that. I definitely agree with you on that one.

Douglass: Here's the one that, I don't think it's going to be too controversial between you and me, Matt, but it might be for some of our listeners -- I do not believe that any of the current major cryptocurrencies will be in widespread use for conducting business transactions. There, I said it!

They are too resource-intensive, they're just too slow, and they can't handle the volume. Now, that's not to say that they won't be used as validation. Again, I think blockchain will be. But, I don't think we're going to be regularly paying the pizza delivery guy with Bitcoin. Now, I do believe that new cryptocurrencies will emerge and may, in fact -- and probably will -- better solve the speed and cost difficulties that would plague today's cryptos at scale. But, I do not believe that any of our current -- you might think of them as first or second-generation -- cryptos will be in widespread, common use across society.

Frankel: Just to add a little more color to that, when Michael says the major cryptocurrencies, I believe you're referring to, what, the biggest dozen or two dozen that exist right now?

Douglass: Yeah, exactly.

Frankel: OK. There are 1,900 cryptocurrencies in counting right now.

Douglass: [laughs] Right!

Frankel: And there are more coming online every day. It's possible that the ones that will eventually have a big impact have already been invented. There's already third-generation cryptocurrencies being invented. But it's way too early to tell. Who knows which one of the 1,900 could eventually become what everyone thinks Bitcoin is going to become? There's no way of knowing right now. Will cryptocurrency still be a thing in the future? Absolutely. It could definitely one day -- probably not in the next 25 years -- completely replace our currency system as we know it. Will it be Bitcoin itself that does it? Probably not. And that's kind of the point there.

It is interesting to note, though, that a lot of those 1,900 cryptocurrencies utilize Bitcoin and Ethereum and the other blockchains in their technology. That's an interesting dynamic. But, will Bitcoin itself be as big as everyone thinks it's going to be in 25 years? I'm predicting no.

Douglass: Yeah. Now, here's one, actually, that we might disagree on a little bit. I believe that 99% of U.S. bank business will be online in 25 years. To give you some context here, according to a Bank of America study, in 2016, 62% of Americans reported that they primarily banked online. I believe that banks, in the quest to better compete with their low-cost, online-only competitors -- like your BofIs -- will essentially force everyone to go fully digital or pay ruinous fees on things like checking accounts; and that people, price-sensitive as they are, will increasingly head in that direction.

Now, I do think there will still be some bank branches, not a ton. I think they'll be designed, basically, to facilitate the high-touch stuff -- meetings between a bank-employed wealth advisor and high net-worth clients, that sort of thing. Think of it like the Capital One Café model, except taken to an extreme. If you Google Capital One Café, you'll get an idea of what they're starting to do. It's really cool, really interesting. I think that's where banks will ultimately go. I do not think that a lot of the daily, teller-based stuff that a lot of people are still using banks for today will be at all in widespread use in 25 years. And Matt, our difference is really one of scale, not necessarily of direction.

Frankel: I definitely agree with the trend, I just think it's going to happen a little slower than you do. I believe that, as long as the Baby Boomer generation is alive at all, first of all, branch banking won't go away. This is the same reason that personal check-writing at the grocery store hasn't gone away. There are some people who just really don't want to switch to a new technology. 

And there are a lot of, as you said, high-touch things that are not just the older Americans. For example, I have a safe deposit box at a bank, so I have to go to that whenever I need to access the box. I think the number's going to be closer to, let's say, 75-80% than 99%.

Douglass: Fair enough. And, hey, this is the fun thing about predicting things 25 years out -- who knows? 

Let's also talk about these mass-market things. I think it's very, very clear that fees for mass-market services, things like checking accounts, savings accounts, money transfers, bank wires, index funds, ETFs, etc., will collectively be very close to zero. This is one of those things where they probably won't actually be at zero, because there's still some kind of underlying fee. But I believe that banks will be finding other ways to monetize those clients. You hear about the cross-selling, for example, that a Wells Fargo has historically done -- with, as we all know, some externalities, let's just say. But, you could also see freemium models, things that are ad-supported, things like that. There are a lot of different ways that the internet is solving the fee problem, and I do believe that's going to ultimately come to banking, as well.

Frankel: Absolutely. I think, within 25 years, every bank -- big bank, small bank, whatever -- will have a free checking and savings product. It will be an absolute necessity to compete with the online banks, especially, as we both agree, more and more banking will switch to online. You just can't charge people $12 a month for a checking account when they can log onto their computer and get one that's free. That's not a long-term sustainable business model. But, other things, like money transfers -- will a wire transfer ever be $0? No. But it's not going to be $30 forever.

Douglass: [laughs] Right!

Frankel: It might be $1. Maybe something like that is the floor. But it's never going to get to zero. But, banks will offer the free checking and savings products in order to retain their customers to be able to charge them for things like that.

Index funds, ETFs will all gravitate toward zero. Index funds already are. If they want to compete with places like Schwab and Vanguard, ETFs are going to really have to lower their fees over the long run. Vanguard and Schwab's fees, I think some of them are down to 0.03% on some of their index funds, which is $3 for every $10,000 you have invested. So, it's going to gravitate in that direction. It won't actually get to zero, but pretty close.

Douglass: Very close, yeah. Relatedly, I think that robo advisors will have about 90% worldwide market share in securities markets in 25 years, with self-taught active stock pickers -- people like you and me -- and the handful of incredibly wealthy people working with hedge fund types making up the balance.

The broader world doesn't think things are heading there quite that quickly. MyPrivateBanking recently released a report in which they say that they think robo advisors will make up 10% of total market share by 2025. My personal viewpoint is that the initial forays into this have basically been slow because people have had to get used to the idea, and because they don't offer all the services yet. They're still building it out. 

But my belief is that as the robo advisors improve, and as people get increasingly used to and comfortable with the idea of an algorithm handling different parts of their life, including their finances, I think it's going to explode. Now, 90% is maybe a little bit aggressive. Maybe it's more like 80%. But I truly do believe that robo advisors are going to basically wipe up the vast, vast majority of market share in the next 25 years.

Frankel: Definitely. 90% may be aggressive, but it's definitely closer to 90% than 10%, in my opinion.

Douglass: [laughs] Right!

Frankel: That's definitely a trend that's going to take place. There will always be people like me who want to own individual stocks. Michael, I believe you're one of them, as well.

Douglass: Oh, yes.

Frankel: But that's not for everybody. You really need the time to research stocks, the knowledge to do it correctly, and the desire to do it, if you're going to buy individual stocks. I'd say about 90% of the American population doesn't have those three things. Robo advisors, as long as -- as you said -- fees keep gravitating toward zero, and these products keep getting more and more advanced, there's really going to be no reason for the average investor not to use them.

Douglass: Yeah. Relatedly, two points that I'm going to put together into one -- I believe that peer-to-peer lending will represent at least 25% of total lending spent in 25 years. Now, I only say 25%. You might be thinking, "He's been throwing out these huge numbers! Why only 25%?" For me, it's very clear that peer-to-peer lending has become a lot more widespread and a lot more feasible than it was previously. I do expect the peer-to-peer lenders -- or a bank, perhaps, who hops in -- to help solve for one of the current difficulties, which essentially is poor underwriting by some of the peer-to-peer facilitators right now, meaning that the investors who are putting the money in aren't making the kind of money that they'd hoped to -- I believe those will ultimately be solved. In fact, I could see robo advisors helping you invest in small debt tranches for exposure on the risky side of the yield curve. 

But, I only say 25% because banks have legitimately trillions of dollars to lend, and they will absolutely be looking for ways to deploy that capital effectively. So, I would expect that they will be helping facilitate a lot of these peer-to-peer loans. I believe they will be, in some cases, investing alongside. I think they will often invest in alone, and perhaps then sell it to peer-to-peer lenders for an arbitrage so that they can do it all again, sort of like you see with agency-backed mortgages. 

In fact, let me double underline that last point. Banks will probably retain a technological advantage over normal folks. They just have a lot more money to throw at problems, and they will keep gobbling up fintech companies. In the short-term, on a lot of things, they will make more money than normal folks, because they will be able to run the trade and then arbitrage it to someone else. But over the long-term, I think they'll continue to fall prey to the same failings, which usually come down to greed, or what Greenspan would call irrational exuberance, and, basically, human judgment errors. I think they're going to continue to fall to those, as they have since time immemorial.

Frankel: I think 25% is definitely a good figure there. I think within 25 years, every bank -- whether it's big, small, online, brick-and-mortar, whatever -- will have some sort of lending platform that, on its surface, at least, feels like Lending Club to the consumer, or feels like Marcus by Goldman Sachs, or one of those platforms. 25% to just peer-to-peer lenders, because it is an interesting investment product, it's a way to diversify your holdings, earn better returns than most bonds will pay. It's definitely appealing to the investor. But as you said, the banking system has trillions and trillions of dollars to lend. Over time, they're only going to get more and more efficient about how they use it. They'll acquire fintech companies, as you mentioned. 

So, 25% is definitely a good number. I could see banks actually getting much, much more competitive with peer-to-peer lenders and even maybe taking a little market share back from them. But, the disruption has been made. Peer-to-peer lending is -- at least from a customer's point of view, how it simplifies the process -- here to stay.

Douglass: Yes. Relatedly, just to bring a little bit of history back into this discussion as we're thinking about the future, it looks like there will probably be at least two full credit cycles during the next 25 years, and at least one financials-induced recession, possibly two, and two to three full recessions. For context, we had three across the last 30 years. Because I do not believe that banks have fully learned the lessons of this last recession, at least one of those recessions will probably be caused by banks repackaging something into something else, reselling it to consumers or other banks, over-trusting algorithms that they did not adequately vet, and blowing up the financial system, or at least getting close. 

To summarize this whole idea, this whole episode -- the financial system today has several problems, as it always has. One of them, fees, is solved, we think, long-term, by the invisible hand of private markets, because of technology. But the others -- irrational exuberance, shoddy betting work around algorithms, the goal of making a buck today no matter the cost next year -- will persist because they're human issues. I believe that no amount of the fanciest technology can ever really truly solve those problems, because the algorithms ultimately will look like us, to some extent. Any solution that we try to create, somebody will do something new, and that may ultimately end up undermining the entire enterprise. 

I do not think we're going to enter into a time where we perfectly know who's going to default, or when we perfectly can predict the next credit crisis, or when we can perfectly prevent the next recession, because that's just not something humanity can do. But what we can do, hopefully, is make things a little bit better, a little bit cheaper, and a little bit more transparent, and a lot more democratized. That, I think, is a future we can all be excited about.

Folks, that's it for this week's Financials show. Questions, comments, you can always reach us at [email protected]. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so, don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Michael Douglass. Thanks for listening and Fool on!