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Despite the emergence of new fintech firms hoping to disrupt the financial services industry, big banks like Bank of America (BAC), Wells Fargo (WFC), and J.P. Morgan Chase (JPM) will continue to dominate at least one key market: the trillions of dollars in deposits Americans park into savings and checking accounts each year.
Such deposits are heavily regulated, which is why banks have invested considerable resources into complying with a myriad of state and federal rules that govern the industry. For example, banks must buy insurance to cover the deposits in case of insolvency or a broader financial crisis.
Robinhood, an online brokerage firm in San Francisco, recently rolled out plans to offer savings and checking accounts with an eye-popping interest rate of 3 percent, more than triple the rate of traditional banks.
Pundits quickly proclaimed that Robinhood’s move spelled big trouble for traditional banks.
Only one problem: those deposits don’t come cheap. I’m not referring to just interest rates banks must pay to lure deposits (which have been next to nothing in recent years) but rather the regulatory strings that come with that money. In order to obtain the necessary charters to operate, banks must answer to a hodgepodge of regulators like Federal Reserve, Office of the Comptroller of the Currency, and most notably, the Federal Deposit Insurance Commission (FDIC).
Robinhood ultimately pulled back because it wrongly claimed the Securities Investors Protection Corporation (SIPC), which oversees brokerages, would insure those deposits.
But the FDIC is the agency that insures savings and checking deposits, up to $250,000 per account. That means banks need to pay into that insurance pool and assume liability for those accounts.
We have seen this story played out again and again since the emergence of the Internet at the turn of the century. With superior technology and no overhead (physical branches, employees), fintech insurgents will steal lots of deposits and market share from incumbents.
But the existential threat to big banks have been overstated. For all of the talk about how upstart payment platforms like Messenger or WhatsApp from Facebook (FB), Alipay from Alibaba (BABA), or Apple Pay from (NASDAQ:AAPL) will lure deposits from traditional banks, people don’t seem to understand that these companies can’t just offer savings and checking accounts on a whim without going through the same regulatory headaches all banks must endure.
In other words, the big banks aren’t going anywhere. Ironically, the very things that big banks like to complain about (lots and lots of regulation and paperwork), are the very competitive advantages that will keep big banks relevant in this age of fintech disruption.
Savings and checking accounts finally getting some love
That doesn't mean banks should be complacent. Robinhood's thrust into savings and checking accounts suggests that fintech firms are starting to realize the enormous value of those deposits.
On the surface, savings and checking accounts are boring, especially compared to flashier products like business loans, mortgages and credit cards. With interest rates hovering at zero or near zero since the Great Recession in 2007-2009, they don’t pay depositors much and banks don’t make much money off them alone. According to a report by Bain & Co. consulting firm,
The checking and debit account components of a banking relationship are notoriously unprofitable, especially for a fee-free model aimed at younger customers who have little money to keep in the account. Most banks don’t relish serving this part of the market.
Yet those deposits are the cheap source of fuel that powers bank profits. The traditional model that underpins commercial banks is that they pay a certain interest rate to consumers and businesses for their deposits, lend out that money to other parties at a higher interest rate, and pocket the difference - a term know as net interest rate.
But banks have also been using deposits to directly invest in other assets, like U.S. Treasuries or even financial products from competing banks’ that offer attractive yields.
Federal data suggests that despite low interest rates, banks still have no trouble attracting deposits.
In 2017, FDIC-insured commercial banks boasted domestic deposits of $11.1 trillion, compared to $5.75 trillion a decade ago. Apparently, the financial crisis did not discourage people from banks. One possible reason is that Americans really don’t know what else to do with their cash other than deposit it in a bank.
This ever-expanding pool of money also explains why banks continue to open physical branches even as Internet use becomes more common. Last year, banks operated 162,457 branches and officers across the United States, a relatively small decline from 2007, when they operated 164,486 locations, according to FDIC data.
A report from research firm Celent said that while large banks will cut branches as part of regular attrition, half of banks surveyed said they will open new locations over the next few years.
Deposits form the basic relationship between bank and customer and most people, including Millennials, seem to still prefer talking to an actual human at a physical branch about how to manage their money.
Just 6 percent of all adults said they prefer fully digital interactions, the Celent report said. Two out of five said they usually bank digitally but prefer some matters be handled in-person. However, 55 percent prefer in-person interactions, with 77 percent saying they will visit branches to discuss more complex financial matters.
Other firms want in
Nevertheless, the $11 trillion in cheap deposits banks currently hold make this pool of money an appetizing target for tech firms, both large and small.
Robinhood presumably hopes customers who open savings and checking accounts with them will thus use its core mobile brokerage platform more frequently to buy and sell stocks. Amazon might want deposits to make it easier for Prime customers to pay for its products and services. Per the Bain report:
Amazon might generate revenue through fees and royalties from the bank partner, though the more valuable financial benefit will likely be the savings Amazon realizes from direct access to customers’ checking accounts. Amazon could make it easy for customers to pay right from that account instead of with their credit cards, which impose an average 2% interchange fee for most transactions on Amazon or its third-party merchants.
Bain estimates that Amazon could avoid more than $250 million in annual interchange fees in the United States alone.
Armed with large market shares and a sophisticated regulatory/compliance infrastructure, traditional commercial banks will likely to continue dominate deposits for the foreseeable future. Companies like Amazon and Robinhood, however, will make the contest more interesting.
Investors therefore should keep an eye on deposit numbers banks post in their earnings reports. They should especially pay attention to the number of new savings and checking accounts banks open, especially as the Federal Reserve starts to raise interest rates and makes those products more attractive.
Savings and checking accounts may not be sexy but they are the fundamental blocks from which banks support their business models. Banks need to protect them at all costs.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.