Why Consumer Banking Could Now Change Forever

Everybody knows rising interest rates benefit banks…

Well, almost everybody.

You see, when it comes to banks, the idea of interest can get complicated. That’s because the word itself does double duty for these institutions…

When banks loan out money, interest is an important revenue source. And when banks pay depositors, interest is an important expense.

In the end, “net interest income” is all about profits. It’s just revenue minus expenses.

Like all other companies, a bank’s income and margins expand when its revenue rises faster than its expenses. And the opposite occurs if a bank’s revenue comes in below its expenses.

When interest rates rise, interest revenue goes up. But of course, interest expenses go up as well.

So far, so good. That’s basic logic. But here’s where things can get complicated…

When interest rates rise, interest revenue rises faster than interest expenses.

That last sentence isn’t basic logic. It’s a custom that has developed over time.

But depositors at the now-infamous and now-failed SVB Financial (SIVB) – which did business as Silicon Valley Bank – didn’t honor that custom. They didn’t play by the rules.

As a result, interest income and margins for banks might never be the same again. And the same thing goes for the supposed “bullish” case for banks when interest rates rise…

In a legal sense, SVB was just another bank. But as its trade name of Silicon Valley Bank suggests, it was much different in reality…

SVB had an unusually wealthy, sophisticated, and demanding client base.

These folks didn’t just sit back, watch interest rates rise, and continue to settle for lowball deposit rates. They knew how to find better deals with just a click of the mouse.

So as rates rose, they pulled a lot of money away from SVB to chase better deals. And naturally, SVB had to come up with the cash to meet the influx of withdrawal demands…

SVB had a large portion of its assets invested in U.S. Treasurys. And as we all know, these securities’ market values plummeted as the Federal Reserve raised interest rates.

Now, a pullback like that can be tolerable. Many institutional holders of fixed-income portfolios can hold these securities until they eventually mature at 100 cents to the dollar.

SVB was different. Its yield-seeking clients requested so many withdrawals so fast that the bank had no choice. It had to immediately sell a lot of its depressed U.S. Treasurys.

Paper losses guaranteed to vanish at maturity are one thing. Immediate real-money losses are a whole new ballgame.

This sort of liquidity crunch can cause failure. That’s exactly what happened to SVB.

Now, almost everyone with any type of platform is talking about SVB’s failure. And that’s critical for the future of consumer banking…

All this news coverage about SVB’s clients refusing to play the old ballgame of just letting banks benefit from rising loan rates while leaving depositors behind could create a snowball effect. It could inspire John and Jane Average to start taking their money elsewhere.

We’re no longer living in the 20th century, when banks were often legally restricted to operating within a single state. We’re not even living at the turn of the 21st century, when many folks still cherished the convenience and occasional need to go to a physical branch.

Today, we can use mobile devices to shop for better rates wherever we can find them…

Free web portals like NerdWallet (NRDS) and Bankrate help everyday folks get better rates. It’s similar to how Expedia (EXPE) and other websites help folks shop for flights and hotels.

Banks are eager to offer easy online account setup and transfer in order to poach clients from other banks. (Others poach from them, too. But that’s life – and just business.)

Consumer banking won’t change overnight. Nothing does. After all, it took years or even decades for many people to get comfortable buying stocks or shopping online.

More people need to get comfortable with the idea of mobile check deposits, looking at account fees in addition to rates, and more. Until then, the custom won’t change.

But as we’ve seen over and over, the world evolves. Once change is set in motion, it doesn’t stop.

So the custom of “everybody knows rising interest rates benefit banks” looks to be on a very short leash.

Good investing,

Marc Gerstein

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