Weekly Briefing No. 155 | The biggest threat to banks is…

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Welcome to The FR. Where we boldly march into the unknown.

In this edition:

  • What is the biggest fear for banks?

  • It’s beginning to smell like a (crypto) bull market.

  • Is there true security in the digital age?

  • Not all “smart cities” are created equal.

  • A tipping point for passive investing.

NEWS ANALYSIS

The biggest threat to banks is…

For the past decade or so, there’s been a lot of talk about what the biggest threat to institutional banks is. First it was the fintechs that were going to “disintermediate” banks, but that threat has largely dissipated, and indeed many banks are partnering with or even outright acquiring fintechs these days.  

In more recent times, it’s big tech that’s been a bogeyman for banks. There’s been a spate of studies released with the “millennials trust Apple/Amazon/Google etc. more than banks” theme. Many have opined and wondered what would happen if one of these behemoths decided to become a bank. But for now, it seems these tech giants have designs more on controlling the world rather than simply becoming banks.

But an interesting recent op-ed in American Banker (SUBSCRIPTION) posits that the biggest threat to banks is banks, or more specifically one bank, that being J.P. Morgan Chase. The piece talks about the bank’s aggressive branch expansion strategy into areas where they have no presence (a strategy that is only starting in earnest now due to a decision made by regulators behind closed doors to halt the bank’s growth for the better part of this decade, only made public a few months ago.) Chase has also been rapidly building up its digital capabilities; last year it launched a digital-only bank targeted to millennials called Finn by Chase. It’s also invested heavily in its own internal innovation capabilities.

To paraphrase FDR, could it be that the only thing banks have to fear is a bank itself?

It’s beginning to smell like a bull market.

No, no, not for stocks. To us, the up days feel more like vicious short-covering spasms than real buying. Conversely, the down days seem like a foreboding acknowledgement of the coming trouble emanating from our nation’s capital. The bull market we’re talking about is in crypto.

Last year’s violent declines caused many believers to abandon their dreams of owning a fleet of Aventadors and Huracáns. Now, many of the Lambo-less, Ford Fiesta-driving crypto bandwagoners are dusting off their resumes and mumbling something about grad school or a “real job.” But even if you believe that all crypto is eventually going to zero, such a pervasive amount of dejection filling the air should grab your attention. Indeed, there are enough true believers still lurking out there, waiting to pile back in the moment an exchange, regulator or community makes the right move.

A positive catalyst in January just feels right to us. It also seems to align with Michael Novogratz, who disclosed this week that he purchased an additional C$7,422,918 of his crypto fund, Galaxy Digital Holdings.

Is there such a thing as security in the digital age?

Ever since people started buying products and services online and through digital channels, banks, payments processors, retailers and others have been trying to figure out how to best secure those transactions. One thing everyone agrees upon is that the password-and-username system is easily hackable and basically broken at this point.

But what authentication method should be used to replace it? Biometrics have been perhaps the most frequently touted solution, the notion being that “something you are” is much harder for fraudsters to replicate than “something you have.” And since Apple developed its Touch ID technology for iPhones several years ago, most consumers have generally become comfortable with the idea of non-password forms of biometric authentication.

But it turns out that even biometrics may not be as foolproof as once thought. Researchers have now revealed that they can produce “artificial fingerprints” that could hack into millions of smartphones. According to a CNBC report, the authors of a new paper from New York University and Michigan State University successfully generated what they call "DeepMasterPrints" earlier this year. These are machine-learning methods that act as a kind of "masterkey" which, the researchers claim, have the potential to unlock around one in three fingerprint-protected smartphones.

A cybersecurity executive once described to us the battle between hackers and security experts as a “cat-and-mouse game.” Basically, when security people successfully repel one type of attack, fraudsters just create new ones. It remains to be seen whether a truly foolproof digital security measure can ever be created.

TROVE

What if a city is too dumb to be a smart city?

We haven’t been shy in expressing our view that Amazon’s recent sweepstakes was more about collecting data on most American cities and regions than it led on. Still, there’s an upside for the losing cities that brought their A game to the competition: muscle memory.  

As The New York Times piece below illustrates, one such place is Kansas City, Missouri, which failed to make Amazon’s shortlist despite a $2.4 billion incentive package and its pole position as the first metropolitan area to roll out Google Fiber. However, KC, which has worked alongside Sprint and Cisco for a years to reinvent itself as a “smart city,” is now primed for battle in the quest to lure other big tech companies to the area. But other cities eager to attract a tech workforce may not have the know-how to get the job done.

According to Lee Tien of the Electronic Frontier Foundation, some cities don’t know enough about data, privacy or security to successfully morph into a smart city hub. “Local governments bear the brunt of so many duties — and in a lot of these cases, they are often too stupid or too lazy to talk to people who know,” he said.

A tipping point for passive investing?

We’ve witnessed the rise in popularity of so-called “passive” investing in recent years, and the debate between passive versus active isn’t set to end anytime soon. However, ETFs and index funds are set for a milestone of sorts next year, as they’ll hold 50 percent of assets in 2019 if current trends hold, according to Morningstar. Currently, 48 percent of assets are passively managed.

"I'd expect the trend from active to passive to continue," Benjamin Phillips, a consultant with Casey Quirk, told Investment News in an article published this week. "It's not simply investors grabbing the tail of the bull — it's a secular shift in how advisers are building portfolios.”

Meanwhile, an excerpt from a recently issued study by AQR entitled The Illusion of Active Fixed Income Alpha, which we read over the holidays, had this to say: “Our analysis finds that passive exposures to traditional risk premia — primarily term risk, corporate credit risk, emerging markets risk, and volatility risk — explain a majority of FI manager active returns. There is largely no outperformance at the category level after controlling for exposures to well-known traditional risk premia. The implication for asset owners is clear: Traditional discretionary active FI strategies offer little in the way of true alpha.”

We suspect that champions of active investing in fixed income will take exception to AQR’s analysis, and we look forward to continuing to monitor this debate as it unfolds.

Quote of the Week

“So, first of all, let me assert my firm belief that the only thing we have to fear is...fear itself.”

--Franklin Delano Roosevelt