The New Era For Commercial Banking

The new era for commercial banking is picking up steam.

The new era for commercial banking is going to result in a U.S. banking system that is much smaller in terms of the number of banks in the industry, but also in terms of the fact that there will be fewer and fewer small and mid-sized banks in the industry.

Technology is hitting the banking industry in so many different ways, not even accounting for what artificial intelligence is going to do to the industry, that major structural changes are going to be taking place over the next several years.

Scale is going to become even more important in the new digital world.

Here’s a change, one that will be liked by consumers and businesses, and will be hated by the banks… especially the smaller banks.

How would you like to have all your payments in the banking system available immediately… 24 hours a day… seven days a week?

Well, that will become a reality later this month.

The new system? It is called FedNow, and it will replace the current system, referred to as the Automated Clearing House system (ACH).

Moving to this system is expected to have two balance sheet results for banks. The small and mid-sized banks in the system are expected to be affected the most.

First, banks will have to keep more “cash” on hand so as to be able to handle the more rapid withdrawals of funds from banks. It is expected that the small and mid-sized banks will have to ramp up their cash positions further than the larger banks because of the management problem.

Second, regulators are expected to require tougher capital rules for commercial banks in the near future.

Higher capital requirements will result in a decline in the return on equity. Again, the thinking is that higher capital requirements will reduce the returns on small and mid-sized banks more than it will hurt the larger banks.

And, these changes are coming at a time when the banking system is being hit with higher and higher interest costs due to the Federal Reserve’s fight against inflation.

Again, the feeling is that this tends to hurt the small and mid-sized banks more than it does the larger banks.

And, although there will be some positive aspects of the changes for the commercial banks, the “net” impact will not be good.

Ethan M. Heisler, editor-in-chief of The Bank Treasury Newsletter, is quoted in the Wall Street Journal as saying,

The bottom line is that banks will need to sit on a lot more cash than they are used to.”

The larger banks are expected to do this more effectively.

The Changes Coming

The introduction of FedNow is just one of the changes coming to the banking industry in the near future.

Finance is just information.

Information is nothing more than zeros and ones.

The digital world is made for the financial industry… or, vice versa.

We see in the FedNow scenario that the move further into this world is not going to be toward the greater benefit of a large segment of the banking industry… the small and mid-sized banks.

The big banks are going to “eat up” the new environment.

The world is going to go digital. The world is going to prosper on “scale.” The technology of banking has changed. The structure of banking must change.

Some of the changes will have a larger impact on the industry than others.

We have seen this happen as the industry has moved to its current structure.

Now, however, is for the movement to accelerate.

Wait until we have Central Bank Digital Currencies (CBDC).

Investor Strategy

This environment leads one to believe that the structure of the banking industry… and the finance industry… is going to change substantially over the next five years or so.

The emphasis is going to be on incorporating more and more digital technologies into each bank and into the banking system.

Networks of banks and banking supports are going to dominate in controlling the direction and the scale of what goes on.

Investment will be centered upon who is managing the transition the best. We will be watching this closely and commenting on it regularly.

The use of technology will dominate the approach with more and more emphasis going toward what is being done in AI.

Note: it has been difficult enough for the small and mid-sized banks to try and keep up with the industry just on digital advancements. More and more, AI will play a part in the successful modern bank and this will exclude even more banks from the future structure of the industry.

The bottom line is, the industry is changing. We don’t fully know what the new structure is going to look like. It is possible that we won’t really recognize what the banking and finance of the future will look like.

This is why I think it is so important for investors to closely watch how all the changes taking place, like the move to FedNow, is going to impact the structure of the industry, not only in terms of who is doing very well, but also in terms of who should be leaving the industry.