In the economic process known as creative destruction, new technologies displace—and eventually destroy—old structures. Nowhere is this more evident in financial services than recent structural shifts in brokerage firms, largely catalyzed by the rise of free trading apps like Robinhood.
Last month, Charles Schwab announced that it would no longer charge commission fees—then $4.95 per trade—for US stocks, ETFs, and options trades. (A number of other brokerage firms followed suit.) Amid fears of revenue loss, the company’s stock fell nearly 15 percent. But in fact, Schwab added 142,000 new brokerage accounts in October. That’s 31 percent more than the month prior and seven percent more than October 2018.
Does this mean an incumbent managed to “disrupt itself”? Not quite. If you take a closer look at how Charles Schwab makes money, only 6 percent of the company’s revenue in Q3 came from commissions. Seventy percent of net revenue came from interest revenue, which includes interest that Charles Schwab collects off the cash that people leave in their accounts. Last quarter, clients left 11.4 percent of their assets in cash and Charles Schwab earned more than two percent on its interest bearing assets. The takeaway: Even if the company loses money on commissions, it can make some of it up in interest on cash. In addition, Schwab announced that it will push lending and income services more aggressively, which should drive margin expansion in the utilization of cash assets.
In doing away with commission fees, Schwab parted with a relatively small line of revenue. In a sense, the company is still making money from customer apathy and misinformation: people should be investing their cash, not stashing it in deposit accounts. (And even if they are, they should be getting paid a market rate for it.) They just don’t know it.
Revenue from lending and cash management is already being competed away, just as commission revenue was in the past. This is happening in two ways. First, net interest margins have been steadily declining over the past 15 years. While this can partially be attributed to central bank activity, the trend is increasingly being catalyzed by software. As financial automation moves consumers into the best and cheapest forms of debt, bank margins will continue to fall. Secondly, cash management accounts—and bank accounts in general—have been proliferating, driving margins to zero. Many startups see these accounts as the foundation for the future of self-driving money: whoever owns the customer’s primary bank account and paycheck will own the “router” through which all cash flow and lending automation can occur. Cash management and banking is a strategic building block in that pursuit—increasingly, incumbents and startups alike are willing to forfeit margins to get there.
If Charles Schwab and other banking incumbents can successfully navigate these changes, they may be able to out-innovate scrappy new challengers. If they fail, they may end up a footnote in the fintech revolution.