The Quiet Financial Revolution Begins

LAGUNA BEACH – Steadily and indisputably, the financial services industry – with which we all interact, whether as borrowers, savers, investors, or regulators – has embarked on a multiyear transformation. This process, slow at first, has been driven by the combined impact of two sets of durable forces.

On one hand, top-down factors – regulatory change, unusual pricing, and what Nouriel Roubini has cleverly termed the “liquidity paradox” – are at work. Then there are disruptive influences that percolate up from below: changing customer preferences and, even more important, outside visionaries seeking to transform and modernize the industry.

Beginning at the top, the regulatory pendulum is still swinging toward tighter supervision of traditional financial institutions, particularly large banks and insurance companies deemed “systemically important.” Moreover, re-designed regulatory frameworks, phased implementation, and stepped-up supervision will gradually extend to other segments, including asset management. This will contribute to further generalized de-risking within the regulated sectors, as part of a broader financial-sector movement toward a “utilities model” that emphasizes larger capital cushions, less leverage, greater disclosure, stricter operational guidelines, and a lot more oversight.

The pricing environment compounds the impact of tighter regulation. Like utilities, established financial institutions are facing external constraints on their pricing power, though not of the traditional form. Rather than being subjected to explicit price regulations and guidelines, these institutions operate in a “financial repression” regime in which key benchmark interest rates have been held at levels below what would otherwise prevail. This erodes net interest margins, puts pressure on certain fee structures, and makes certain providers more cautious about entering into long-term financial relationships.