A few weeks ago Morningstar’s Jim Callahan asked whether banks have moats. He felt that banks have high relative switching costs and cost advantages.
Geoff Gannon presented a different take on bank moats. Gannon did not really see high switching costs establishing moats around banks. He instead thought that bank transactions had similar characteristics to Gillette razor blades. Disposable razor blades are sold over and over again at a very low price per transaction, and because the buyer will form a habit and not make much of an effort to compare prices, profits will be higher. In summary, he sees banks as “sticky” businesses. I have a different take on what gives some banks moats.
First, I do not agree with Jim Callahan’s opinion that high relative switch costs give most banks moats. My personal experience is that it is fairly easy to switch retail bank accounts. Business accounts that provide lots of services might be a different story, but personal checking and savings accounts are easy to move to another bank. The only challenge is finding your pin number to change your direct deposits from your employeer.
Second, I agree in part with Geoff Gannon that the small and frequent “costs” (lower interest rates and fees) associated with retail banking keep many consumers from shopping around. The cost of researching alternatives and the uncertainty of switching to an unfamiliar bank can seem to outweigh the benefits in many people’s minds in the short-term. However, I don’t believe that this “stickiness” alone gives a bank a moat, especial in today’s information age. One can easily go online and discover tables detailing the best banks with the highest savings rates and lowest fees.
I believe that the primary way that retail banks now gain a competitive advantage (i.e., moat) is though their networks. With modern consumer banking, there are a lot of small costs associated with straying outside of a bank’s network of branches and ATMs. I know from personal experience that I selected the largest, most widespread local bank network in order to minimize my costs associated with making deposits and withdrawals. I love the ability to make a free ATM withdrawal almost anywhere in my metropolitan area. If my bank dramatically cut back on the number of branches and ATMs, I would start looking for another bank real soon.
I believe that the network effect of geographic access to a banking network also is important to small businesses. Being able to safely, quickly, and conveniently make large cash deposits is likely to be an important feature that many small businesses that handle cash require. In addition, companies with several business locations likely want to use the same bank for deposits in each of their locations. This likely attracts them to large regional and national banks.
In a similar fashion, I believe that internet banking has a similar characteristic. Convenient access and better rates due to cost advantages have attracted me to online savings accounts like Emigrant Direct and INGDIRECT. I believe in the future, as cash transactions continue to decline, that internet banking will have an increasing competitive advantage over brick and mortar banks.
Traditional large physical banking networks will likely face declining competitive advantages over time as the economy continues to increasingly shift to electronic transactions. In the meantime, however, I believe that the network effect of geographic access to banking networks helps some consumer banks get a competitive edge.