Have banks outgrown their usefulness
As investors, we love metrics because these are tools that helps us measure progress or decline in an industry, asset or organization.
I have met many investors/traders/speculators in industries as diverse as real estate, oil and gas and even bitcoin and each of them is wedded to one type of metric or performance measure and regard it as the Holy Grail or the Philosopher's stone that will unlock the secret of untold riches.
This is not really the case for two main reasons; firstly, it is the perspective from which one views an investment metric that determines what one sees from it so if I wanted to buy Apple AAPL then every dip in the price becomes a buying opportunity and not the beginning of a decline.
Secondly, in many cases, metrics becomes a self-fulfilling prophecy in that if everyone is using the same performance measures then in many cases, they will also come to the same conclusions, take the same actions and these collective actions will move the market not because of any inherent strength or weakness in that security but because of market rationality because their metrics were rational and well thought out but as I continue to see, it is market rationality and not market irrationality that is the cause of investing failure.
In fact, I will go as far as to say that irrationality is the key to investing success, the greatest investors are highly irrational but it is in effect this irrationality that allows them to see key insights that have been missed by the rational masses.
This is the fallacy of corporate finance theory and even more recently; behavioural finance as these disciplines believe in a rational market when in fact, rationality is an exception to what is in essence an irrational market made up of a teeming mass of emotional, fearful and greedy people.
These are people who pyramid losses, people who let their losses run and cut their winnings short, who say the trend is your friend and of course people who invest in banks because they will always be there and make money.
When I look at the banking industry as a whole, I see a humongous, bloated and inefficient industry. Banks are like very fat individuals who have been told to lose weight or die but rather than exercise to lose weight, they ask the doctor to prescribe them ice cream and cakes every day.
It is healthy for a business to be subject to market forces, it keeps them nimble and fit in order to innovate and grow but when there is an industry that is not really subject to market forces then the industry becomes bloated and self-serving.
In all of my years, I can count on one hand the amount of people that says that they are satisfied with their banks. How can an industry so large have so little customer satisfaction and still bring in billions in revenue every year.
The answer to this question will lead to the success or failure of the banking sector as in effect the success of banking has not been its marketing prowess, contribution to society, strong financial and strategic management capabilities but it has been that they have had a captive audience globally who has depended on them for cash to survive.
In many respects, even without any type of marketing or advertising, loan demand continued to grow every year.
Despite this, as investors, we continued to see banking like every other business even though the rules on how they operate is completely different.
We did not see that it is a significant problem when there is slow growth in the economy as this will affect the banking sector whose asset base is primarily made up of loans that may never be paid back.
The banking sector is now facing a real existential threat from the Fintech industry which has begun to pick out functions that was once the exclusive domain of banks and have added good marketing to their mix to create exceptional products that eclipses similar offerings from the banks.
These products include payments, money transfers, loans, investments services, corporate finance, trade finance and much more.
We are seeing a gutting of the banking sector from within and from the surface, it still looks healthy and its shell is well polished but beneath the glistening shell lies an industry that does not know how to compete in the market place because it has never had to do so.
They had a monopoly on intermediation of funds but now, a whole host of new companies have entered the market like Lending Club LC and many more. Furthermore, we are seeing large companies like Apple, Amazon AMZN and IBM among others encroaching on what were traditional banking territory.
As investors, we have become used to looking for external triggers and cues relating to operational and profitability challenges in banks rather than looking inwardly and using the right metrics to measure bank effectiveness.
Instead of simply using leverage ratios, ROI, ROCE and others which essentially gives us the fruits, rather we should also use metrics like overall consumer satisfaction, online engagement, ease of use, thought leadership and innovation because these are the metrics through which we judge most Fintech companies.
When we are able to do this, we will begin to see a very interesting picture take shape because traditional commercial banking is dying, the Fintech industry is also growing but the commercial banks are the dinosaurs in the industries who have not recognized that they need to change with the industry.
It is not my intention to assert that Fintech is amazing and everyone should abandon their banks and so on because as in any rapidly growing sector, it is having growing pains that has come from the burden of shoulder the responsibility to finance healthy global economic growth.
In the meantime, I will suggest that investors with holdings in ETFs like KBE that has exposure to developed markets banking sector sell their holdings and shift into safer instruments like utilities ETFs such as IDU.
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.