The Future Of Banking... Once Again

Includes: IYF
by: John M. Mason


More and more banking is changing because of advancements in information.

There is now a new venture fund called Nyca which is trying to bring together people from the financial sector of New York and technical expertise from Silicon Valley.

Blackstone, the major private equity fund, is leading the field in new investments in data and technology in order to change the banking world, and make it more transparent and efficient.

From time-to-time, I write about the future of banking and how it is so closely tied up with the evolution of information technology.

Where would I advise investors to be looking for new investments? Well, one good way is to follow leaders in new investment areas.

Take a look at these news articles: "US Venture Fund Nyca Partners Seeks Fintech Edge" and "Blackstone Invests to Edge Out Wall Street."

Nyca, the name of the venture fund, is a combination of NY for New York and CA for California. The idea, states the founder Hans Morris, former Citicorp banker and president of Visa (NYSE:V), attempts to bring together the banking world of New York city and the technology world of Silicon Valley.

The reason for the initiative according to Mr. Morris is that although "There is more innovation in financial services now than ever," he claims that "none of the venture capitalists are experts in the financial system." His effort is to "bring together expertise on the financial system with lots of Silicon Valley connections."

The areas that are developing… alternative consumer credit, merchant payment solutions, and financial infrastructure software.

An example of this is Lending Club. And, who is Lending Club drawing to their circle? Well, in addition to Mr. Morris, who is on the board, there is former Treasury Secretary and Presidential advisor Larry Summers, and former Morgan Stanley chief executive John Mack.

The justification Mr. Morris gives for the emphasis on alternative consumer credit comes from his interpretation of what has happened in the bond market.

Morris states, "When I started on Wall Street in 1980 my recollection is there were about 100 companies in the world that had access to the bond market. Ten years later 100 percent of investment-grade companies had access to the bond market. Consumer credit is (going through) the same thing and the explaining variable is the declining information cost."

And, speaking about the bond market, in the second article mentioned above the emphasis is on what Blackstone is doing, how it is investing, to allow it to "bypass its traditional bankers and brokers."

Blackstone is stepping up its investments in this area in order to help it "manage its portfolio companies, communicate with its investors and safeguard its systems."

Technology is the "naturally disrupting force" in the industry and Blackstone wants to be on top of what is going on.

The problem in this area is that what Blackstone is doing is damaging to the relationship between the world's largest private equity company and Wall Street.

Blackstone is the second largest payer of fees to investment banks, only exceeded by Carlyle Group. Blackstone, in 2013 paid $882 million in fees to banks. This year, up to July 25, Blackstone has paid $546 to bankers whereas Carlyle has paid bankers $696 million.

Not only is it taking business away from traditional banks, but its actions are also impacting profit margins in the industry.

Blackstone investments in companies like iLevel have given the company and investors in the company's funds "real time data on the performance and valuation of the companies they own." Other investments have allowed Blackstone to make it easier for Blackstone to "deal directly with those who buy its debt and equity…" and "its portfolio companies" instead of using Wall Street firms to act as the agent.

In addition, Blackstone can "increasingly structure, arrange and underwrite deals themselves."

Furthermore, using these technologies, Blackstone introduces more transparency and efficiency into their customer operations. This is an area that banks have previously benefited from as they have been able to charge higher margins. This is one thing that the spread of information has traditionally accomplished… reducing margins.

But, these are all new efforts. The interesting comment made to close one of the articles is that "All Street was notorious for overspending on technology." Now, the situation is that because of the recent financial disruption and the "overspending" on legacy technology, "The banks are less able to roll the dice on new technology."

Thus, things are changing in banking.

In terms of investing in financial companies, it is going to be very important to watch where the innovators are going and where money for innovation is going.

By-the-way, did I mention that Nyca has also attracted Max Levchin, a co-founder of PayPal and chairman of Yelp (NYSE:YELP), and Brian Finn, a former president at Credit Suisse First Boston and partner at buyout group Clayton, Dubillier and Rice. Not too bad a start.

Banking… and finance is changing. If you want to develop some idea of the direction, maybe you need to look at books discussing the technology like "The Second Machine Age" by Erik Brynjolfsson and Andrew McAfee, or "The Zero Marginal Cost Society" by Jeremy Rifkin. These books are not primarily about banking, but, anything that discusses the evolution of machines that work with "zeros" and "ones" are relevant.

As I have written about before, the banking industry is shrinking, and doing so rather rapidly. This is primarily a result of the Great Recession and the financial disruption that went along with it. But, smaller banks are not going to be able to be competitive in this second machine age, the age of the zero marginal cost society. The big question is, how are the bigger banks going to respond to this spread of information technology?

It is in this environment that some really nice investment opportunities are going to be found.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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