At a time of high inflation and global rises in interest rates by Central Banks, we are facing a global reduction in the availability and willingness of banks to provide loans. The cost of capital is higher than ever and the incentive to deposit funds with the Central Bank is now higher.
This crisis environment highlights the trend that banks over the years adjust their business models and today more than ever they are focused on providing a trustworthy custodian of deposits of their clients whilst managing such funds most conservatively. This is not wrong nor even a desire to be different.
But more than ever, banks are saving the funds of their clients and charging for the service. On the private banking or even investment banking side, where it’s well known to assist more wealthy clients in their business, the banks move to a system where the major goal is to charge for Assets Under Management, place, and charge for trade, and provide secure loans against those assets as and when clients’ needs arise.
This movement has a trend of centralizing the market into large players.
The world has changed, and globalization brought to the financial industry more compliance risks than ever. Today most large banks need first and foremost to focus on compliance and be compliant, secondly, not to lose funds of their clients and when possible, invest and make profits.
This is in no way a criticism of the financial system but an approach to where the banking system is moving towards.
These movements opened up the space for new types of investment firms to appear and take the risks that banks were not interested in taking. Private Equity firms, Venture Capital, Angel Investors, or simple family offices entered into lending activity as ghost banks. Due to their business model where they take more control in investments than banks do, they can invest in riskier projects and transactions.
With the most recent failure of small banks in the USA or large banks such as Credit Suisse, the movement of clients to these nonbanking institutions will increase and they will assume a more relevant position in the worldwide economy. The financial system development is critical in the development of countries and this movement needs to be well performed with the alignment of regulation and governments to guarantee its success.
What is the future of finance?
Naturally, the future of finance will pass by these nonbanking institutions where clients can find better conditions than at banks because the opportunity cost to them is different. But to provide such conditions these entities require from clients a certain level of control. Not only shareholder control but sometimes even operational control.
Nevertheless, these entities will face great challenges. First, because regulation will increase for these entities, they will not be able to avoid it. In the end, they have a fiduciary duty to their investments like banks’ obligations.
Secondly, because the market will have a movement where each day more entities will take some space in this financial industry and more competition will make the life of these entities more difficult.
The last but not least challenge is the fact that clients always will prefer to have autonomy, instead of losing it. This will make entities seek investors that can provide them with more autonomy.
To provide autonomy and good conditions magic cannot be done. And investment firms need to be able to find ways to not stay exposed to operational and macroeconomic risk. If that doesn’t happen, different conditions cannot be provided.
The approach to be taken
Naturally, we could say that this is the ‘Colombo egg’ and that it is impossible to achieve such results – conditions of financing attractive with autonomy. But in fact, if investment firms can mitigate and migrate part of the operational and macroeconomic risk to a different type of risk than they can manage independently that can be the key.
Collateral such as shares have their value directly negatively correlated with the risks of default (operational and macroeconomic risk). Real estate or fixed assets that are not managed properly by investment firms are mandatory to be left behind.
Investment firms need to seek independent collaterals, manageable such as financial or bank guarantees that are liquid immediately and not dependent on the performance of the company’s operations.
Investment firms that can perform investment in this way, rather than manage funds of third parties, will mitigate their macroeconomic and operational exposure and their exposure to new regulation will reduce. This will allow these firms to absorb the demand that is being left behind by the banks and will absorb the full market share for financing.
All industries across the globe face evolutions and revolutions in the last decades. The unique industry that remains similar in the business model for more than a century is the financial industry. This is enough to understand that something is not right. The financial system is the foundation of any economy and if all industries change, the financial industry needs to follow the changes and guarantee that they can drive this era of fast modifications.
Different results cannot be achieved with the same inputs. Different conditions cannot be delivered with the same risks behind the investments. Separation of the operational risks and macroeconomic risks that investments are exposed to and migrate them for more manageable risks such as to the banking/financial system is the trend that will guarantee the sustainability of an industry