Wise’s Money-Transfer Business Has Inadvertently Become a ‘Narrow Bank’

By Isaac May, CFA, Analyst | March 05, 2025

With regulators in both the US and UK looking at revamping the rules around banking, now is a good time to reconsider what it even means to be a bank. Today, virtually every bank in the world is a “fractional reserve bank.” In broad strokes, fractional reserve banks take depositors’ money and promise to give it back whenever the depositor asks for it. The bank then sends that money out to their other customers either in the form of loans or securities, earning money on the difference in interest rates between what it gets from borrowers and what it pays depositors.

This is helpful to society because it allows that capital to be recycled and put to productive use by consumers and businesses. But lending borrowed money comes with several different kinds of risk. Most notably, there is credit risk, where borrowers fail to pay back loans to the bank. Duration risk comes when long-term interest rates on the loans and securities are low but short-term rates are rising; the banks therefore can sell assets only at a loss (i.e., the assets are “underwater”) and cannot afford to pay the new, higher rate of interest that depositors demand. And liquidity risk hits when a bank’s assets are still worth more than its liabilities, but the depositors want their money right now and the loans won’t be paid back for some time. In other words, the money is tied up. As George Bailey explained in the famous bank-run scene in It’s a Wonderful Life, “The money’s not here. Well your money’s in Joe’s house, that’s right next to yours, and in the Kennedy house and Mrs. Mayklin’s house and a hundred others.”

Each of these risks have sunk banks in recent years. During the 2008 financial crisis, many banks failed because of credit risk when borrowers defaulted on their mortgages. In 2023, Silicon Valley Bank, Signature Bank, and then First Republic Bank all collapsed when duration risk fears sparked bank runs (to be clear, they were not the only banks with underwater assets, they were the only banks to suffer a run). And liquidity risks often come up when there are already other problems, such as the bank run at Washington Mutual that turned long-term issues into an immediate crisis and the largest bank failure in US history.

Regulators create rules to keep banks and their management teams from taking too much risk, but it is only a partial solution. No amount of regulation can force banks to make only good loans. So, one idea that’s been getting some attention recently is that maybe banks shouldn’t make loans at all. A “narrow bank” would take in deposits and provide payment services but wouldn’t make loans or take credit risk. Instead, it would hold all the cash it brought in as deposits at the central bank or buy short-term government bonds, meaning that there is basically no credit risk. There is almost no duration risk because the assets are short term or even overnight, like the deposits. And there is no liquidity risk because the assets are cash (or as liquid as non-cash assets can be).

To my knowledge, none of the tens of thousands of banks around the world operate this way. In part, that is because the regulators who are supposed to keep the current banking system safe don’t seem to trust the idea. In February 2024, for example, the Fed rejected the application of a bank called The Narrow Bank, which had been trying to secure a banking license for nearly a decade. Indeed, some have even argued that narrow banks actually make the system less secure. Because a narrow bank would be so secure, depositors, during a panic, might move their money away from conventional, risk-taking banks to narrow banks, exacerbating the crisis.

Today, the closest company to a narrow bank anywhere in the world isn’t even a bank. Wise is a financial-services firm with more than 11 million customers that started as an international money transfer service. Wise lets customers leave their money inside of the service as a pseudo deposit, similar to keeping money in Venmo or Cash App. Many customers who travelled frequently or did a lot of international business realized it was more convenient to leave their money with Wise than constantly shift it in and out of local banks. Today, Wise holds about £16 billion in deposits on behalf of its customers, investing the money in government bonds and other low-risk assets (see chart). And in fiscal 2024, it made £360 million in net interest income on those deposits, compared to £1 billion from its main business.

For large depositors, Wise could be safer than a traditional FDIC-insured bank even though it is not one itself. A small business in the US with US$5 million deposited at a bank is insured only up to US$250,000 by the FDIC.

Unlike banks, Wise does not lend out its customers’ money but instead holds it in cash or cash-like, safe assets.

Source: Wise PLC. and Harding Loevner analysis.

The other US$4.75 million is at risk in a bank failure. So, what is really safer, a regulated bank taking on credit, duration, and liquidity risks, or a less-regulated payments company that just holds onto cash? Its customers have decided that Wise’s approach is at least good enough for them.

But Wise also highlights some of the weaknesses of narrow banks. Without taking on any risk, it is difficult to generate any kind of return. Until interest rates started rising in 2022, it made effectively no money on its deposit-taking operation. It was just for customer convenience so that Wise could make more money on fees from its other services. Commercial banks don’t rely on fees; most of them are primarily lenders that make most of their revenue from net interest income and offer some services on the side. Rates could fall to zero again, and that revenue stream of hundreds of millions of pounds per year could disappear—Wise cannot rely on it.

As ever, there are some wrinkles. Wise doesn’t claim to be a narrow bank. Someday, it could get a banking license and start making loans. And its international business adds a new currency risk because its assets do not perfectly match its liabilities’ currencies. A kibitzer could also point out that it doesn’t hold only cash at central banks and short-term government debt. Wise doesn’t disclose exactly what is in its securities portfolio, so some of it could be corporate debt. And it deposits money at commercial banks that puts them in the same fractional reserve banking system that narrow banks are supposed to avoid. But these are molehills. Ninety percent of the deposits are in US dollar, British pounds, and euros, and they are closely matched. Banks can fail, but that is much less common than borrowers failing to repay a loan, and even if there are a few corporate bonds in there, a sliver of the funds being lent to investment-grade corporate borrowers is much lower risk than any conventional commercial bank.

On the whole, Wise is the narrowest and one of the safest banks in the world. Without being a bank at all.

What did you think of this piece?

Walmex’s Run-in with Regulators Shows What Really Makes a Retailer Tick

By Sergei Pliutsinski, Analyst | February 12, 2025

Walmex caught a break in December. The Mexican retailer, majority owned by US giant Walmart, received only a minor penalty–what amounted to about a US$5 million fine as well as some new restrictions and ongoing oversight—after a four-year investigation by Mexican regulators into the company’s business practices. Walmex’s stock rose as it appeared a severe penalty in the billions of dollars had been avoided.

And yet, Walmex plans to appeal the verdict by Mexico’s antitrust watchdog, the Federal Economic Competition Commission, or Cofece. To understand why the company wasn’t happy with a minor financial burden—Walmex earned US$657 million in the third quarter of 2024 alone—you need to understand how retailers such as Walmex make their money.

The investigation began after Chedraui, the third-largest retail chain in Mexico, accused Walmex of abusing its market power, using its size to coerce suppliers into giving it better prices and terms than they could to competitors, especially smaller ones. A Reuters story amplified the claims of pressuring suppliers, finding that some of those suppliers removed their products from Amazon as a result of Walmex’s pressure. Cofece’s investigation concluded that Walmex abused its position over the course of 13 years and broke anti-monopoly laws in the process.

The common assumption with big retailers such as Walmex is that their power and profits are a result of their scale and ability to lower prices on products that will attract and keep customers. And that is true and well understood. But what is not well understood is how its scale gives the company that power. Retailers don’t make their money on consumers. They make it on suppliers.

There is an intricate game between retailers, suppliers, and customers. Customers have bargaining power with retailers, because they will go wherever prices are the best. Therefore retailers have little bargaining power with their customers—but can have a lot of bargaining power with suppliers. Successful retailers become the conduit to customers and therefore gain an advantage over their suppliers. Retailers use that bargaining power to force terms from suppliers that advantage the retailers, and offset the retailers’ weak bargaining power against fickle buyers. What Cofece concluded was that Walmex was abusing that power.

The Cofece ruling imposed a ban against some of Walmex’s practices, such as retaliating against suppliers based on their contracts with other retailers. That should raise the bargaining power of suppliers against Walmex. The impact, though, is hard to predict. If the ruling stands, it would effectively reduce Walmex’s competitive advantages, which would hurt the bottom line. That won’t be an issue if it wins on appeal, though it will likely be several years for that to play out.

In the meantime, there are two wrinkles. For one thing, Cofece, in its oversight role, will determine whether the company is violating the ruling. For example, the ruling does not appear to ban volume-based discounts. But if Walmex demands a 50% discount from a supplier on, say, 10 million units of an item, will that constitute a violation? For now, only Cofece gets to answer that question. Moreover, the ruling applies specifically and only to Walmex. In effect, Cofece is raising the bargaining power of suppliers…against Walmex only.

That is the real reason Walmex is appealing the ruling rather than just paying the small fine and moving on. Because ultimately what makes a retailer successful is the leverage it holds over its suppliers, not its customers.

What did you think of this piece?

BBVA Takes a Risk By Going Hostile

By Isaac May, CFA, Analyst, and Moon Surana, CFA, Analyst and Portfolio Manager | September 11, 2024

BBVA is Spain’s second-largest bank and wants to get bigger. Management thought a good way to do that would be to buy its rival Sabadell, Spain’s fourth-largest bank. The resulting firm would be Spain’s second-largest bank, with a roughly US$70 billion market cap, 100 million customers around the world, and US$1 trillion in assets. Sabadell’s management, however, was not so taken with the idea, and rejected the offer.

After being rebuffed on its US$12.9 billion “friendly” offer at the beginning of May—a 30% premium to Sabadell’s market cap at the time—BBVA came back with a US$13.1 billion offer that it plans to present directly to Sabadell shareholders, bypassing management. This kind of hostile merger is a rarity among banks. Mergers are risky enough on their own. Hostile mergers amplify those risks, and hostile mergers in the highly regulated world of banking amplify them even further.

Analyst Isaac May presents a few of the biggest reasons why hostile mergers for banks can be risky, and portfolio manager Moon Surana presents counterarguments for why BBVA might be able to overcome those risks.

The Regulators

May

The challenge: Spain’s stock-market supervisor, the National Securities Market Commission, began its review of the proposal in June. BBVA will have to convince regulators of the deal’s merits before it can bring it to Sabadell’s shareholders. That could be tough. The Spanish government has already come out against the deal, and an acquisition would also require the approval of Spain’s antitrust watchdog, the CNMC, as well as the European Central Bank and even regulators in the UK and Mexico, where the banks have operations.

Those hurdles illustrate the first problem with a bank trying to orchestrate a hostile merger. Every industry is regulated, but banking is more regulated than most, and those government overseers have a lot of leverage. The regulator can block the deal outright or add conditions that make the deal very expensive. Regulators have a lot of power that they can use to discourage actions they don’t strictly have control over.

Surana

The answer: BBVA needs regulatory approval before it can take the tender offer to Sabadell shareholders (its own shareholders have already approved the offer). The offer has been authorized by the ECB and several other countries, but not yet by Spanish regulators. And there is a chance that it gets approval from both companies’ shareholders and regulators, but is still blocked by the Spanish government. In that scenario, the parent company would own two banks but couldn’t combine them, leaving them to nominally compete against each other.

BBVA management claimed the deal would be worth doing even if it has to operate the banks separately, though it would be a very unusual construction that makes it harder to realize the originally expected cost savings. Ultimately, though, the downside risk seems limited. If Sabadell shareholders reject the offer, or if regulators block it, BBVA moves on. There is little damage for BBVA at this point in making one last attempt to get a deal done. Even in the worst-case scenario the upside—BBVA gets bigger in its home market—still outweighs the downside.

The Employees

May

The challenge: One of the common reasons to merge companies is so managements can cut costs, which generally means employees. Therefore, every merger affects the staff at both the acquirer and the target to some degree. Hostile mergers by their nature can amplify the very natural resentment some employees might feel after an acquisition. But within the world of banking, issues with a company’s employees can have a more pronounced effect.

In a bank, many employees are important contacts with the customers, and in some cases they can leave and take the customers with them. Think of wealth managers who generate fee income and have personal relationships with clients. If senior managers leave, normal business may get disrupted. Loans stop getting processed, new sales leads go quiet. Even tellers leaving can be a problem that helps push customers to a competitor.

Many of these kinds of problems can be partially solved with money, but it can cost a lot, and isn’t sustainable. A takeover’s economics often depend on layoffs or branch closures, so employees know that their job security is under threat. If the acquirer has to give some employees a big raise to keep them at the job and happy, it likely exacerbates whatever the company had to overpay by going hostile in the first place.

Surana

The answer: The deal is actually less hostile than it seems. In its announcement of the offer, BBVA pledged to keep “the best talent and culture of both entities.” And BBVA made “friendly” offers, such as having an integration committee with members from both banks, keeping the management team at Sabadell’s SME (small and medium enterprises) business, and maintaining the Sabadell brand. BBVA also has a track record of successfully integrating companies through mergers across geographies. That experience should help here.

The Loan Book

May

The challenge: When two banks negotiate a friendly merger, at some point the acquiring bank will get to look at the loan book of the target bank. If not the entire book, they will at least see some of the bigger loans. This is critical, because it tells the acquirer if there are problems looming that wouldn’t be visible to an outside party. In a hostile merger, the acquiring bank is an outside party. It will not get that inside look at the bank’s true balance sheet. If there are any problematic loans or brewing issues, the acquirer will find out about them only after it has bought the company.

Surana

The answer: These companies are already very familiar with each other. BBVA held merger talks with Sabadell in 2020 and has long mulled the benefits of integrating the two companies. They were close to a friendly deal in 2020, and close this year, too, until the merger talks leaked.

Taking a merger offer hostile adds extra risks to what is already an inherently risky maneuver. Add up all the extra costs that come with a hostile transaction and the odds of it adding value for shareholders get very long. BBVA has enough levers and cushions to offset those risks and still make this deal work, if it can maintain its discipline on price and focus on execution.

What did you think of this piece?

Nigerian Banks Look for Inflection Point

By Bryan Lloyd, CFA, Analyst and Babatunde Ojo, CFA, Analyst and Portfolio Manager | June 18, 2024

Nigeria offers frontier and emerging-market investors enticing opportunities. It is a resource-rich nation with Africa’s largest population and fourth-largest economy. But when a country has gone through as many ups and downs as Nigeria has, signs of progress should be looked at cautiously.

Since last year’s election of former Lagos governor Bola Tinubu to the presidency, Nigeria has implemented a series of economic reforms designed to stabilize the country after a decade of mismanagement and allow it to profit from its own potential. What we as investors are looking for is the proverbial inflection point, a time when the reforms start producing tangible economic benefits. That would be good for the nation in general, and it would also be particularly good for Zenith Bank, Guaranty Trust Bank, and other large, high-quality Nigerian banks.

Tinubu had success turning around the economy in Lagos as its governor, and he wasted no time in tackling the country’s sclerotic economy. On the day of his inauguration, he abruptly ended a decades-old subsidy paid to oil companies to keep fuel prices low that cost the government US$10 billion a year, more than it spent on education or health care. He reorganized the county’s foreign-exchange system and abandoned the naira’s currency peg—it has fallen about 70% against the dollar since—and took other steps geared toward improving the economy and boosting tax revenue.

Since ending the subsidy, the price of oil (which is a strong source of revenue in Nigeria) has stabilized and credit-quality issues that plagued the energy sector have improved. Credit trends, for now at least, are stable. Two currency devaluations have removed a lot of the concerns about the previous monetary regime. So far, the reforms seem to be well received by outside observers. In early May, the ratings agency Fitch upgraded the country’s outlook to positive from stable, based on the initial success of Tinubu’s reform package.

There is good reason for investors to pay attention. Nigeria’s demographics are compelling: it has the sixth-largest global population, one that is young and fast-growing. Demographic tailwinds can be powerful over longer periods of time as penetration of banking and insurance services naturally expand as countries develop. Even amid the travails of recent years the country’s high-quality banks have fared well. Zenith and Guaranty Trust consistently post a return on assets north of 3%, compared to the more typical 1-2% earned by most banks around the globe.

Recent earnings might seem to indicate the hoped-for inflection point has arrived, and investors may also be enticed by the fact that Zenith and Guaranty Trust trade well below book value. But the earnings are somewhat misleading since both banks posted large and unsustainable hedging gains due to the naira devaluation. Nevertheless, their operating performance demonstrates their relative stability amid the volatility induced by the reform package.

A larger argument against the idea that an inflection point’s been reached is the reality that unwinding the mistakes of the past 8 to 10 years is going to be extremely difficult. Tinubu’s reforms, while necessary, have caused lots of pain and economic hardship. The currency devaluation feeds straight into inflation, which is running north of 30%. That, combined with the removal of the fuel subsidy and later an electricity subsidy as well, was too hard a pill for the majority of the mostly poor population to swallow. It seems likely that the next couple of years will be rocky and there may be credit-quality issues for the banks since credit stresses typically lag economic shocks.

Whatever the short-term pain, though, we do believe that the long-term picture is still positive, which is why we remain resolutely interested in Nigerian companies, not just the banks. The policy changes this new government has made will hopefully put the economy on a better growth trajectory and make the society more prosperous. In fact, we’d go so far as to say that Nigeria is lucky to have elected President Tinubu at this critical time. He appears to be the right man to have taken over the country given its precarious economic state. After his success in Lagos, it’s reasonable to have hope for his administration’s ability to turn the country around. But the path to better days ahead will likely be turbulent.

What did you think of this piece?

Out of Our Minds

Wise’s Money-Transfer Business Has Inadvertently Become a ‘Narrow Bank’

Unlike banks, Wise does not lend out its customers’ money but instead holds it in cash or cash-like, safe assets.

Source: Wise PLC. and Harding Loevner analysis.

Walmex’s Run-in with Regulators Shows What Really Makes a Retailer Tick

BBVA Takes a Risk By Going Hostile

Nigerian Banks Look for Inflection Point

Disclosures