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According to the Wall Street Journal this week, the recent failure of investment bank Lehman Brothers Holdings Inc., along with the collapse and subsequent take-over of Merrill Lynch by Bank of America, represents the greatest restructuring to the banking industry since the Great Depression.  Out of all this confusion, who’s poised to come out on top?

After the dust settles, commercial banks will emerge atop the ash heap of the financial industry—according to the Journal.  This, in turn, should alter the way the banking industry goes about its business, abandoning the riskier investment banking model for the more conservative, traditional commercial banking model.  And as the pendulum swings more towards commercial banks, commercial banks, in turn, will be competing with each other for more and more customers.

Up until 1999, the Glass-Steagall Act maintained a solid wall between commercial banks and investment banks.  Glass-Steagall was a child of the Great Depression; to protect depositors, it prevented commercial banks from participating in investment banking.  So commercial banks concentrated instead on taking deposits and make loans, earning conservative returns under heavy regulation by state and federal governments.  Investment banks, meanwhile, were not subject to the same regulations as commercial banks.  And since they did not take deposits, they developed other forms of creative capital-gathering to make loans and investments.  Thus, they were more susceptible to market variations and interruptions than their commercial bank counterparts, but the profits they could reap were staggering.  In 1999, Glass-Steagall was repealed, and the wall between commercial banking and investment banking disappeared.

As commercial banks began to compete with investment banks, investment banks—lacking the deposits their commercial banks could rely upon—developed more and more creative financial products in order to keep pace in the new marketplace.  But then, the bubble burst; the housing and credit markets came tumbling back to Earth, and these creative financial products became worthless.  With no real equity to fall back upon, the investment banks were left holding the bag, and began failing.  Commercial banks, with the equity provided by their deposits, were on firmer ground.

But even as commercial banks emerge victorious in the banking industry, more and more of them will now have to compete for deposits from the same customers in order to remain competitive.  In the digital age, how can commercial banks come out on top?  Technology.

Broadband, WiFi, and mobile computing have made online retail banking not merely a nice feature, but a hardcore requirement.  Commercial banks that don’t offer their customers an engaging, holistic online banking experience, including the ability to pay bills, will soon find themselves behind in the digital age.  As more and more banks compete for customers in the digital age, the user experience of their online offerings is going to be the key to success.

Thursday, September 18th, 2008 Both comments and pings are currently closed.

By Robert Pothier