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Behind the Death of De Novos

In just 11 years, all banks in the U.S. will be gone. At least, that's what extrapolating the current pace of bank consolidation would suggest. Between April and August of this year, there were 79 mergers or closings and 9 failed banks, according to the Federal Deposit Insurance Corp. Guess how many banks were established during that period? None. Zero. Nada.

We understand why banks merge (to reduce expenses) and why banks fail (failed credit policies). But why has the establishment of new banks virtually stopped since the crisis?

Perhaps the most fundamental reason that investors are not rushing to start small community banks is that the returns for smaller community banks are not terribly attractive. Current low interest rates and competition from tax-exempt credit unions make it difficult to generate even reasonable returns in the small retail market.

Regulation is another big reason. Since 2008, the Dodd-Frank Act has added 14,000 pages of new rules, regulations and pending proposals. Community banks are struggling to keep up with the new requirements, and the pressure of navigating such complexity puts even the most diligent institution at risk of non-compliance-simply from a lack of manpower. Investors are weary of establishing a new institution when the Dodd-Frank regulations are still being written and the associated costs are unknowable. What prudent business manager risks a new business undertaking with such uncertainty?

Investors are also shying away from starting new, or "de novo" banks, because it is cheaper to buy a failing bank or tiny community bank that has already done all of the filing necessary for the charter. It's also faster, and in many ways, simpler.

Shadow banking and the internet are two more reasons that investors are shunning start-up banks. Small retail banks must compete against online peer-to-peer lenders such as Lending Club, Prosper and student lender SoFi. Many of the key services that made community banking so vital for so many years are now offered by companies that face a fraction of the regulation encountered by banks. The only advantages that the banking license appears to offer are the FDIC-insured deposits and access to the Federal Reserve discount window. But with rates at such low levels, the benefit of cheap deposits is minimal, while access to the discount window is offset by regulatory capital requirements. The costs associated with regulation appear to more than outweigh the benefits of the charter.

Finally, the enterprising individuals who would normally be interested in starting a bank now wonder, "Why would I assume the personal risk that goes with being a director or officer at a fledgling bank?" Since 2009, the FDIC has authorized 1,171 lawsuits specifically against bank directors and officers. An aggressive individual might be willing to take on such risks for the high returns expected from a lucrative technology start-up. But there's little advantage to risking one's personal assets for the seemingly limited potential upside at a small community bank.

I'm not seriously suggesting that there will be no banks in 12 years. But it is entirely possible that rapid consolidation will continue for the time being. Unless rates spike, returns improve and regulators relax, would-be bankers will continue choosing to take their entrepreneurial spirit to other fields of business and finance. And that could be the end of banking as we know it.

Richard Magrann-Wells is a senior vice president and the
Financial Services Practice Leader for Willis North America.


(10) Comments



Comments (10)
The average ROE for a bank is 9%, which is close to cost of equity: who in their right mind wants to make an investment like that?
Posted by cdb1 | Thursday, August 28 2014 at 10:22AM ET
"I agree, let the market determine how many banks and what types of banks we have." LOL--Where was this conviction in '08 and ever since?

Cornelius Hurley
Boston University
Posted by hurley | Friday, August 22 2014 at 9:58AM ET
I agree, let the market determine how many banks and what types of banks we have. I am concerned when it is regulation and government preference that are driving the results rather than customer preference. There is no question that unnecessary and badly tailored regulation are driving up the barriers to entry to banking. Are 300 banks too many or two few for Iowa? I don't know, and neither do you. You may have a preference, but so do millions of Iowans. Let the Iowans decide.
Posted by WayneAbernathy | Friday, August 22 2014 at 9:39AM ET
Many small bookstores have been competed out of existence. Their owners may regret this, but book buyers (the customers) have benefited. So why are we romanticizing community banks? If they can deliver valuable services, they'll survive. If not, customers will take their business elsewhere.
The point about massive consolidation of the number of US banks is simply wrong. There are just under 300 banking institutions operating in Iowa alone. Iowa! Who will buy all these little banks? No one.
Large banks are simply too large to care about all the small banks. So unless we see lots of small bank failures, or multiple rounds of mergers-of-equals that build institutions large enough to attract the attention of larger banks, we will have thousands of US banks for decades.
Posted by Harvard Winters | Friday, August 22 2014 at 9:15AM ET
If no tigers are being born, tigers will eventually become extinct. When coupled with the continued consolidation in the banking industry, the conclusion is inescapable; with no de novo activity, community banks will eventually become extinct.

I am CEO of a soon to be ten year old bank. In spite of the great recession, we are still standing and have proven we can compete for business with our larger, more established brethren.

I sadly have to agree with Rhsmith999 above; notwithstanding regulator rhetoric, the empirical evidence indicates that regulators prefer a US banking system with fewer banks and I would emphasis the "fewer" is from the smaller community bank group, especially small rural banks.

Without new de novo activity, 11 or 12 years might just prove to be optimistic.

Brad Swickey
Posted by bswickey | Wednesday, August 20 2014 at 6:18PM ET
Excellent and timely piece. Unfortunately, it has been timely for several years. It is time that these points become out of date.

There are always reasons to pause when considering starting up a new bank. But there are also powerful business reasons for going ahead. There always have been throughout our history, through thick and thin, recesssion, depression, and expansion. The last few years are the only time in U.S. history that there have been no new banks (except for those enterprising and persistent folks in Pennsylvania who opened the only de novo bank in recent memory).

Yes, a lot of de novo banks failed. A lot of new businesses fail. De novo banks tend to have a better survival rate than start up businesses generally. Our economy, remember, thrives from start up businesses, banks and other businesses. The dearth of de novo banks is not a healthy sign, no matter the challenges.
Posted by WayneAbernathy | Wednesday, August 20 2014 at 10:24AM ET
Outstanding piece by Mr. Magrann-Wells.

It's quite a distorted market we have now: the Fed's TBTF doctrine has those six banks under an acquisition moratorium; no M&A among the regionals for fear of tripping a regulatory threshold; and de novos are extinct. Where is the market discipline when the management of every bank over $50 billion has a de facto poison pill?

Among its other victims, Dodd-Frank has killed M&A save for those banks that can't cope with the regulatory nonsense.

Cornelius Hurley
Boston University
Posted by hurley | Wednesday, August 20 2014 at 10:22AM ET
The author makes great points. But to be completely fair, the history of de novo banks in the 1980s and early 1990s is littered with failures. Still, well-presented applications with qualified personnel at the top should be given a chance. Regulators seem determined to say no at the starting gate.
Posted by GMahler | Wednesday, August 20 2014 at 10:06AM ET
Well said but it seems clear that Washington has concluded that our financial system is better off with fewer banks and has in fact placed an un-written moratorium on new banks which will prove to be a great burden for small communities, cites and many who will be unable to start a small business, build offices etc.. Washington wants more control over the financial system and they have got it. Who will be the last bank standing?
Posted by Rhsmith999 | Wednesday, August 20 2014 at 9:55AM ET
These are valid points but the simpler, and only reason in a nation as large, diverse and wealthy as the United States that there are ZERO (and not just diminshed numbers) new banks (Bird in Hand aside), is to conclude that there is a de facto moratorium being effected by the FDIC. Consider what regulators are doing, not what they are saying; much of the regulatory burden is outside what is being put down on paper.
Posted by hwalker | Tuesday, August 19 2014 at 2:10PM ET
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