tldr; Banks suck because of a history of structural issues and a lack of market incentives to improve. A new kind of bank, one that doesn’t rely on fees but rather investments is now possible because the Volker rule was changed on June 25th, 2020.
The top 15 US banks have a combined $12 trillion in assets and capturing a small percentage of the US banking sector would make a $100 billion-dollar company. Banking was created in the 11th century, and the first merchant banks didn’t have walls, they were just a table and a paper ledger set up in the trading centers, this was before the advent of paper money so they charged a fee so that their customers didn’t have to lug around coins. Fees have been apart of banking since the very beginning, and now we are seeing a return to banking without walls with JP Morgan’s reporting that 81% of their customers preferring to bank online. The average age of investment banks in the US is 173 years old. Barclays was created in 1896, JPMorgan Chase & Co has the highest market cap of any bank in the world and has a history that dates back to 1799. J.P. Morgan is so old it was split into investment and a retail bank by the Glass-Steagall act of 1935, and then allowed to merge back together with the Graham-Leach-Bliley act of 1999. Before the Graham-Leach-Bliley act, Universal Banks that bridge both retail and investment banking were prohibited, but now this legal barrier no longer exists.
The kinds of securities that an investment bank can manage have undergone radical changes. The JOBs act of 2012 made it so that any company can issue up to $50 million dollars securities to the public, whether it be debt or equity, or even a cryptocurrency. The SEC S-1 filing needed to go public was the legal gatekeeper for JP Morgan and other Investment Banks to issue stock, and this was the process that every company had to go through to become publicly traded. The 21st century gives Americans access to something we have never had before; we now have the A+ filing that allows small and medium-sized businesses to go public and raise millions. But currently, no major investment bank will be an underwriter for these assets, and no commonly-available exchange will facilitate the trade of the issued securities. The successive liberalization of securities law has created space for a new kind of bank — A universal bank much like JP Morgan, but a business built from the ground up to take advantage of the new regulatory environment. A new universal bank can be created that provides both retail banking and investment banking to small and medium-sized businesses and to individuals. There is substantial synergy here, by being a bank account trusted by small business — you then are in the best position to issue shares for that company with an SEC A+ filing and to manage the 401k and stock issuance to their employees. Small and medium-sized businesses can now issue stock to the public and their employees, but they need a bank to manage these assets.
Large institutions are slow to react and do not reflect how radically different our laws have become. Right now, with the JOBs act and the SEC A+ filing in place. Why can’t the pizza shop around the corner go public? The car wash down the street could sell shares in its company to anyone, not just accredited investors. Issuing shares could allow these businesses to grow, and spread to new markets, or allow the owners to cash out and business to consolidate. Access to financial markets for trading publicly issued securities for small businesses with a micro-sized market capitalization is now possible, what is missing is an Investment Bank to facilitate this market. The same ladder that allows unicorn-sized companies to raise capital and grow, can be scaled down for much smaller companies. Small and medium-sized businesses are the workhorses of our economy contributing to 44% of the United States GDP, making this an underserved market that is starving potential growth. An investment bank profits by being the bridge between people who want to purchase securities, and the businesses that are authorized to issue these investments. If we have radically changed who can issue securities with the JOBs act, then it follows we should change the institutions that issue these securities to bridge this new gap.
The retail banking side of our business is very important. Traditional banks incentivize each arm of the business to be as profitable as possible. Due to a history of successive splits and mergers, these two arms of the business were once their own entities and now they are still managed as if they were separate from each other. As a result, JP Morgan and Wells Fargo incentivize their retail bank to generate revenue however they can — regardless of how it impacts the business as a whole. This creates a perverse incentive and is the reason why we see these banks providing products to their users which are essentially asset traps, and even incentives to engage in outright fraud. In 2016 over 5,300 Wells Fargo employees were caught engaging in a fraudulent sales practice of signing up over 1,300,000 users up for products that they did not agree to and Wells Fargo was forced to pay $3 billion in damages to the SEC. This wide-spread activity is the product of misaligned incentives in Wells Fargo’s business model. This misalignment of incentives is the product of a structural flaw that manifests itself as high fees, asset traps, and a business model that relies upon “Calculated Misery.” These same structural problems exist in industries that are dominated by a few players that lack market pressure to provide good services; airlines, telcos, ISPs, and even hospitals to name a few examples. To correct this problem, retail banking can be disrupted by forbidding the collection of fees and treating retail as a loss leader, where all profits are generated through the reinvestment of FDIC insured accounts. This kind of banking practice is only possible after the repeal of the Glass-Stegal act, and also the 2017–2018 amendments to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). The Volcker Rule is intended to limit the investment exposure of banks so that there cannot be a systemic risk within the financial industry which is reflected by the EGRRCPA. However, as of June 25th, 2020, the EGRRCPA now allows banks that have less than $10 billion in assets to be exempt from all restrictions imposed by the Volcker Rule. This means that a bank that has less than $10 billion in assets is allowed to fully utilize the fractional-reserve banking requirements and issue $9.70 in debt for every $1 deposited in a checking or savings account, and leverage these federally backed funds as they see fit. It is now possible for a quantitative hedge fund to be capitalized from the federally-insured debt issued by the activities of a retail bank. This liberalization of the legal framework for banks makes it possible for a business to run a retail bank as a loss leader which will greatly encourage the creation of new deposit accounts — so that these funds can be reinvested. This combination of banking policies will not only be more profitable but also provide a better service to the everyday user. Profits no longer have to be extracted from the public, which keeps the business incentives better-aligned with the public interest. It also follows that there is no economic incentive for a bank that isn’t bound by the Volcker Rule to issue low-interest loans to the everyday user, but rather all debt issuances should be invested with a balanced Sharpe Ratio that maximizes returns while balancing exposure to risk.
