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11 06 2015 | by Victor Xing | Capital Markets

What are the challenges faced by the financial industry?

The financial industry faces three main challenges – mounting regulatory pressure and industry disruptors in the form of Wealthfront and Betterment (Investment service), as well as risks to financial advisors from the great wealth transfer.

Regulatory environment

Under the current regulatory environment, trading units in investment banks are becoming more utility-like, and operating cost for loan originators and other service providers have gone up.  This eat into profits and forced many industry titans to consolidate their operations.

Despite my strong affinity toward the asset management industry, I fear for the implication of regulators labeling it “shadow banking sector, i.e. asset managers who have stepped-in to fund projects and make loans as risk averse banks retreated.

Speech–Fischer, Nonbank Financial Intermediation, Financial Stability, and the Road Forward–March 30, 2015

As you know, the nonbank financial sector in the United States is larger, and plays a more important role, than it does in most other countries. In recent years, about two-thirds of nonfinancial credit market debt has been held by nonbanks, which includes market-based funding by securitization vehicles and mutual funds as well as by institutions such as insurance companies and finance companies. Nonbanks are involved in many activities within the financial system as well, such as securities lending. The nonbank sector has produced material benefits: increased market liquidity, greater diversity of funding sources, and–it is often claimed–a more efficient allocation of risk to investors. However, threats to the stability of the overall financial system have also increased, as was evident in the recent financial crisis.

Another force for evolution in the nonbank sector is the demand for safe money-like assets. Some argue that this demand for private money creation prompted the growth in “shadow banking” prior to the crisis.  Indeed, whenever shortages develop, we might expect the nonbank financial system to create assets that appear safe but that could in certain circumstances pose systemic risks.

Sometimes when there is smoke, there is fire.  Having the 2nd most senior FED official focusing on regulating the nonbank / shadow banking sector is a warning sign of tougher regulation to come.

Industry disruptors and risks to financial advisors

Finally, robo-advisors pose a risk to the mutual fund business model.  Many mutual funds rely on a network of financial advisors to sell its funds, and sometimes that is based on advisors’ perception on these funds and their relationship and past experiences with the fund managers.  Robo-advisors are poised to take away market shares from human financial advisors, and starve many mutual funds the “pipeline” that supported their AUM.

Combining robo-advisors to the upcoming generation shift (The great wealth transfer is coming, putting advisers at risk), the venerable mutual fund / advisor model will be put to test.

financial industry
The “Great Wealth Transfer”

Next article11 03 2015 | by Victor Xing | Central Banks

Who were behind the Federal Reserve Act (1913)?