“Adapt or perish, now as ever, is nature's inexorable imperative” - H.G Wells.

The idea of burning one's own boat as a strategic or symbolic gesture has been depicted in various historical contexts across different cultures and captivating the people's imagination for centuries. While it has often been associated with the Vikings, its occurrence is actually debated among historians, and there isn't definitive evidence to support it as a widespread Viking practice.

Nonetheless there is one documented experience which didn't happen in Europe but actually in South America with Hernán Cortés, the Spanish conquistador, during the Spanish conquest of the Aztec Empire in the early 16th century. Upon arriving in Mexico in 1519, Cortés ordered the burning of his own ships, an act meant to motivate his men and eliminate any thought of retreat. By destroying the ships, he symbolically conveyed to his soldiers that there was no turning back and that their only option was to succeed in their mission or face defeat.

Time to Burn the Net Interest Margin (NIM) Boat!

One way for banks to generate revenue is by using their customer deposits, pay a low interest rate on it, then lend the same funds to borrowers at a higher rate and capture the spread in between. The Net Interest Margin or NIM is the difference between the rate at which banks lend and the rate at which they borrow funds (via deposits). 

This business model is all great and well in an environment where the duration of deposits matches the duration of their loans which has been very much the case for the last centuries. This dynamic was in place because in the past the lack of technology made it very difficult to move money, open bank accounts and so bank deposits were considered very sticky. But in a digital world where the velocity of money movement increases (and gets further compounded by social media) - gone are the days of sleepy and sticky deposits .

Further proof of this evolution can be seen in the speed of bank runs over the last 15 years. In 2008 it took 19 days for Wachovia to collapse while for SVB it only took 1 day (Source: Understanding the Speed and Size of Bank Runs in Historical Comparison). Banks simply can’t rely on sticky deposits to generate revenue anymore.

John Meynard Keynes, the famous economist, once said “When fact changes, I change my mind”. For banks, deposit facts have now changed which means that they should now revise some assumptions around which they operate. This means making a difficult decision to move away from centering their business model around NIM monetization and make the hard choice to actually burn their NIM boat in order to thrive and succeed in this new environment. 

NIM Doesn’t Correlate with Profitability

A further reason to move away from NIM is that empirically there is actually very little to no correlation between NIM and bank profitability. A good measure of profitability is the Return On Equity which is the ratio of net income divided by shareholder equity. The higher the ratio the better a company is at generating profit for its shareholders. If you look at publicly traded banks (small and large), the relationship between their NIM and Return on Equity (ROE) is very weak (the correlation is close to 0). So paradoxically a strategy which solely relies on NIM maximization doesn't seem to have much impact on the ultimate goal of profit maximization.

Source: Bloomberg, Data Q4 2023

Less (Opex) Is More

The natural question is then if NIM doesn’t correlate with profitability (and cannot be a long term strategy) what strategy could banks deploy to thrive? If we look at the data one factor which stands out in order to drive profitability is minimizing Opex (i.e. cost). As the chart below shows we notice the higher the Opex (normalized by revenue) the less efficient a bank is in terms of ROE. While it might sound like a pure sophism that minimizing Opex leads to more profit, the direct implication for banks is to leverage technology to reduce their operating expenses. This is an area where Fintech can help many banks; given how efficient fintech is at scaling and replacing manual processes

Source: Bloomberg, Data Q4 2023

Bank on Non-Interest Income 

Instead of focusing on NIM, another factor which can improve bank profitability is maximizing non-interest income (i.e. fee generating business). Ultimately the real value of a bank is via the sheer number of customers it supports. Banks should be thinking about the myriad of ways they could be providing (financial) services to their customers. Banks have already acquired customers which are using their product on a daily basis, they should be thinking about ways to expand those services and thus revenue they can derive from them. As the chart below shows the ratio of non interest to interest income can positively affect profitability.

Source: Bloomberg (and removing financial institutions with Non Interest Income greater than interest income). Data Q4 2024

Conclusion: Fintech To The Rescue

Instead of relying on an old NIM playbook which is getting outdated by the day as tech increases its grasp on the economy, banks should be embracing changes and the opportunity they provide. It is time for banks to burn the NIM boat and leverage Fintech to not only decrease their Opex but also provide more and better financial services to delight their customers (such as for example some treasury and investments offerings). This will not only lead to better user experience but it will also improve banks future and financial situation. Adapt or perish.

Ben Verschuere

Co-Founder and Chief Investment Officer, Treasure Financial.

The information provided is for informational purposes only and should not be construed as investment, financial, legal, or tax advice. This material should not be considered an offer or recommendation to buy or sell a security, or a recommendation of any specific investment or strategy. You should consult your own financial, legal, and tax advisors before engaging in any transaction. While information and sources are believed to be accurate, Treasure does not guarantee the accuracy or completeness of any information or source provided herein and is under no obligation to update this information. For more information about Treasure, please visit treasurefi.com.

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