The 2000-page bill is extremely complex, and a blog post cannot do justice to all the intricacies. At a high level, the bill will curb banks' ability to profit from proprietary trading, creating complexderivatives, pushing consumers into costly products, or charging hefty fees to merchants accepting debit cards. Banks, particularly big banks, will earn far lower profits in these areas, which represent key financial services innovations from the past two decades.
But what about the financial overhaul innovation impact going forward? While it was relatively easy for banks to make money (prior to 2008) by innovating in established product lines, such as through creating seemingly infinite varieties of mortgages, there have been few new product lines emerging from large banks, nor have these institutions paid much attention to the 7.7% of unbanked or 18% of underbanked U.S. households. Instead, some of the more creative approaches have come from non-bank institutions ranging from economic development groups to hedge funds. Witness for instance the alternative to payday lending created by Kentucky's Mountain Association for Community Economic Development, which embeds a savings product into a relatively inexpensive short-term loan.
Big banks will no doubt try to cut costs from their systems, and much of their energy will focus on operational efficiency. They will also gain a short-term bump through growing non-interest revenue such as checking fees. Yet cost-cutting is not the way to satisfy the most creative staff in these institutions, who will also recognize that the exceptional compensation of years past came through growing revenues, not slashing expenses. And there are competitive and regulatory dangers in being too aggressive on fee revenue. To create growth, banks will need to look beyond their cores. This means catering to non-traditional customers, in ways other than the traditional luring of them through free checking accounts and making money on other offerings. It may also mean looking to non-traditional areas such as risk protection (let us not call this "insurance" for fear of thinking too narrowly), asset finance, and short-term investment.
Altogether, the financial overhaul's shake-up should create new pressures to innovate, for both banks and non-banks. We may no longer have 20 types of mortgages (not such a bad thing), but we will have institutions focusing on the vast non-consumption that continues to bedevil financial services of all types. This is the most promising sort of innovation for both financial institutions and consumers.
This post was written by Steve Wunker. Click for more of New Markets' thinking on financial services.