Dearth of Start-Up Banks Is an Unsettling Indicator

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.