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Dearth of Start-Up Banks Is an Unsettling Indicator

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Is it too early to declare that the banking industry has recovered?

Bank failure rates continue their general trajectory of improvement. It is not uncommon for a week or two to pass by without a single failure (but there's still an occasional week with three or four, so careful not to become complacent). The Federal Deposit Insurance Corp.'s Deposit Insurance Fund is nearly two years ahead of schedule in its recapitalization—all funded by premiums from the banking industry. Banks' loan delinquency rates are in decline, net earnings are improving, bank capital in relative and absolute terms is at an all-time high.

Naysayers might point to other indicators. Industry employment is rather flat, and bankers report that too many new hires are compliance officers. The growth in net earnings more closely matches the reduction in set asides for loan losses than it does increased revenue. Few if any banks can develop a meaningful business plan very far into the future, because bankers do not know what regulators (and the Dodd-Frank Act) will allow the business of banking to be very far into the future.

Closer to the point that I wish to emphasize, there is an interesting uptick in voluntary bank mergers. Anecdotes suggest that many of these, though, come from bankers eager to get out of the business, but there must be a willing buyer for each seller. Are we getting past the perception that waiting to acquire a failed bank is a better strategy than buying a troubled one? 

I would propose that the key sign, the convincing indicator that the banking industry has returned to a healthy normal will be when we witness the return of new bank charters, when the de novo charter count is significantly above zero. So far this year, it is not at all above zero, and last year there were only three.

This should not be a matter of indifference to federal bank regulators. After all, each agency was created by Congress to promote a robust banking industry. The Office of the Comptroller of the Currency was created to promote a strong system of national banks (in fact, Lincoln's Treasury Secretary, Salmon Chase, envisioned a system so strong that it would drive state charters out of business, another misguided Washington plan that fortunately turned out differently).  The Federal Reserve System was created, almost 100 years ago, to promote liquidity for banks in times of crisis, a role that the Fed performed well as recently as 2008 and 2009.  The FDIC was created to reassure depositors, forestalling panicky bank runs.

Taken together these agencies, over generations of Congresses, are testaments to the recurring recognition of the value of banking to the American economy. A key part of achieving their mission is making sure that individual weak institutions—of any size—correct their weaknesses or be allowed to fail, in an orderly way. Toleration of failure of individual firms supports the continuation of a healthy industry, allowing the better bankers and better banking practices to succeed. It is one reason why the American banking system, which has tolerated failures, has routinely outcompeted foreign banking systems that do not.

I would posit, however, that besides who needs to leave the industry is the even more important question of who wants to come in. Can the bank regulators consider their job accomplished if the industry is not attracting new entrants?

Granted, it is not easy to obtain a new charter, and for the regulators it is no small task to approve one and authorize deposit insurance. In addition to the daunting demand for significant amounts of at-risk capital, investors must enlist capable managers willing to stake their careers, with a credible business plan for the markets in which they propose to operate. None of that will happen if people do not believe in the future of the industry. When it does happen, there is no better measure of confidence in that future.

Can that be expected today, after the financial and regulatory crises? That is an open question, which the de novo market may be answering for us.

The last time that the banking industry faced such twin traumas was in the early 1990s, following the bank carnage of the 1980s and the heavy new regulation that Congress imposed in its wake. In the years 1990 through 1994, bank chartering hit bottom at 67 charters in 1993, but averaged 104 new charters per year. 

This time things are different, but is it a healthy difference?   

Wayne A. Abernathy is executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association.  Previously he served as assistant secretary of the Treasury for financial institutions and as staff director of the Senate Banking Committee.

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Comments (6)
And rarely before has there been such a need for new banks that, well capitalized, can go out after what is real bank risk and real banking, without having to carry the heavy load of all that nonsense of absolutely not risky assets, regulators allowed you to leverage up to the tilt.

Unfortunately bank regulators are so busy with the history, that they have completely forgotten about the need for a future.
Posted by Per Kurowski | Tuesday, June 26 2012 at 1:16PM ET
The author has hit the proverbial nail on its proverbial head! Every time someone has told me recently that they are happy the banking crisis is now behind us, I politely disagree with their position by pointing out that since it is now quite obvious that no one with assets to invest seems to be willing to invest those assets into a banking charter, that the market is very clearly telling us that the industry has not really recovered.

The occupy Wall Street dummies who run around dumping on the "greedy capitalist bankers" who try to commit what they consider to be the ultimate sin of trying to earn a "profit" miss the point that the banking industry is largely no longer a place where capital finds a respectable rate of return (AKA "Profits"). The over-reactive regulatory envirnment and the pending additional wave of Dodd Frank "fixes" have driven virtually every last opportunity to operate profitably, safely, and soundly out of the industry. Those folks seem to conveniently forget that it is the opportunity to be able to make a fair profit on one's investment that causes capital to flow into any industry. And a critical industry that needs to be healthy and robust if our economy is ever to recover again needs to become a place where profits again can be made and capitalists wants to go in search of profits.

When we see a lively denovo market back in play, we will know that banking is truly back again where it needs to be for the good of our country.
Posted by Walt Young | Tuesday, June 26 2012 at 3:53PM ET
Sadly, the absence of de novo charters is not just a question of increased regulatory burden, a squeeze in net interest margin and non interest fee income opportunities, or even the daunting task of diversifying a balance sheet across multiple lines of business set against the backdrop of higher capital requirements, significant technological and other start up expense, and the difficulty of recruiting top talent for executive management or board members that will embrace personal liability. I am confident is it not the absence of risk captial seeking new ways to disrupt the market with new innovative ways to serve our communities and smal businesses. At the core of the dearth of de novo charters is a policy driven from the current administration, the Department of the Treasury, administered by the chartering agencies that clearly communicates 'no need to apply'! Private and sometime public conversations include the discouraging words that make it clear that applications for de novo charters will be placed in an endless 'in process' queue, but not seriously considered. The regulatory process is happy to spend applicants start-up capital in the constant back and forth of the approval vetting process, but delegated authority to make an approval decision appears to be lost or misplaced. For well intended regulators doing the work, the incentives to say yes are gone and the incentives to delay or say no are absolute, absent political or top of the house intervention. The fact is that the current establishment has determined that they would rather deal solely with the devil they know, not the devil they don't. They seem to have accepted the idea if they keep doing what they are doing, they will get a different result and our communities and small business will somehow be better served and experience important competition for their business. I, for one, believe this is an insanity that must stop and it will take not just a pro business, but a pro banking policy to invigorate traditional banking in our communities again. It is time for bankers, small business people and all Friends of Traditional Banking to stand up and speak up.
Posted by Crawford Cragun | Tuesday, June 26 2012 at 4:28PM ET
As for the state of Ga,which is ground zero for bank failures, there were way too many charters created, with little discernment of who was coming into the industry. There were too many banks chasing too few bankable deals, and our problems ultimately were caused by poor boards and poor management, and too many rookies allowed into the industry.
Posted by diggerdog | Tuesday, June 26 2012 at 7:17PM ET
Our firm consulted on 150 bank charters from 1986 to 2007. In the 80's and early 90's most of the banks we started were in small town that had no locally owned bank or one family controlling the financial services in a rural community. Later the proliferation of new banks was driven by prices being paid for acquisition of banks trying to enter a market. I believe you will see new charters begin to surface next year in the smaller, more rural communities, where the local bank failed and the access to credit has been severely limited. The investors will not be looking for large capital gains
Posted by T Stephen Johnson | Wednesday, June 27 2012 at 4:55PM ET
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