This is a great high level summary of why banks make money. The metaphor of a moat is used to describe how Banks can control their marketspace, and exclude interlopers.
The question becomes, whether the moat can be crossed, or avoided.
… nearly all banks have a sustainable competitive advantage–an economic moat. Warren Buffet and Charlie Munger were surprised, too. Buffett once remarked, “Charlie and I have been surprised at how much profitability banks have, given that it seems like a commodity business.
To review some fundamentals, an economic moat represents a company’s ability to earn returns above its cost of capital and defend its ability to do so over time. After confirming that a company’s historical returns on invested capital exceed its cost of capital–the easier task–one must assess the likelihood of those surplus returns persisting in the future, and here’s where mistakes can be made.
Source: Canadian Banks & Insurance
The article goes on to support the moat theory with examples:
- The Beauty of the Deposit-Gathering Business
- The Advantage of Regulation
- Switching Costs
- Conclusion: Banks are good businesses because of their fundamental design
One argument against the moat theory is that someone can set up a new market outside your moat. If they can avoid the regulation, then In that situation your moat actually hinders you from attacking the new market. The moat works against you. Examples would be Paypal, Zopa, & Prosper.
To continue the metaphor ( I love metaphors) another group would be those that build small bridges across your moat behind the castle, away from the main drawbridge. These small bridges are used to take small positions of strength, which in themselves are large for those interlopers yet small enough that the main castle doesn’t get too worried (The Long Tail). They can do that because its impossible to defend an entire circumference successfully, against an increasingly adaptive and creative enemy. The resources required for that defense are too great.
Relevance to Bankwatch:
Banks must never think they are invincible!
tags: business+model, bank+strategy
Bankwatch 