It's not enough to fix the de novo application process

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In the wake of the 2008 financial crisis, new bank applications all but dried up under unfavorable economic conditions — until now.

The Federal Deposit Insurance Corp., which approves the deposit insurance for startup banks, has more than 40 de novo applications filed since the start of 2017, according to its website. Though far below pre-recession numbers, that represents a significant uptick from the early part of this decade.

In addition to better economic conditions, the head of the FDIC is also actively trying to encourage new banks.

“The FDIC wants to see more de novo banks, and we are hard at work on making this a reality,” FDIC Chairman Jelena McWilliams said in a statement last year.

Over the last couple of years, the agency has reduced the de novo supervisory period for newly established banks — from three to seven years — and published a handbook for de novo applicants.

It also issued a request for comment last year to gain feedback on how to improve the application process. Lastly, it created a new voluntary process that allows parties looking to file a new bank application to submit a draft proposal to the FDIC. This allows them to receive feedback on the application before officially filing it.

Despite these efforts by the FDIC, applying and gaining approval for a new bank can still be difficult. Among more than 40 bank applications filed since the start of 2017, roughly a dozen have been withdrawn and only about half have been approved.

Although the FDIC has tried to streamline the process, experts say applicants should expect at least nine months to pass from filing their application to opening doors for business. Applications with issues that require more scrutiny can take longer.

Besides these issues, new banks also have to contend with raising capital to meet requirements. This can be challenging given low interest rates and an overall competitive landscape that has not been favorable for smaller banks in recent years.

Though 15 de novo banks have been established since the start of 2017, 449 banks have been acquired, per S&P Global Market Intelligence, as smaller banks consolidate in search of greater scale. Community banks are struggling to keep up with larger financial institutions that can devote far more resources to digital products and services. In such a challenging environment, it can take several years for investors to earn their money back.

Furthermore, the FDIC expects new banks to have the necessary capital upfront, and the amount that a new bank must raise is a moving target. The FDIC evaluates and sets capital requirements for each new bank application independently based on its unique business proposal, which must cover financial projections for the bank’s first three years of business during de novo supervision.

There’s no minimum capital requirements that can serve as a guidepost, although most recent applications have proposed to raise at least $15-20 million. Banks that have gained approval so far this year varied widely in terms of capital raised. Triad Business Bank (in organization) in North Carolina has targeted about $65 million; while Grasshopper Bank in New York raised $131 million; and Ohio State Bank raised nearly $44 million.

Those applying and looking to improve their chances for approval can start by carefully crafting a sound business plan. That includes taking into account factors like local market dynamics and competition, the bank’s business and operating model, and the anticipated size and complexity of the organization.

Investors must set aside enough to give the bank a reasonable chance of success based on all of these factors, which the FDIC will also take into account when determining capital requirements and final approval. Any novel aspects to the bank’s business plan that could expose it to higher risk of failure will likely mean a higher capital requirement.

The other critical factor to success is the experience and qualifications of the new institution’s board of directors and management team. These individuals should have experience directly related to the products and services that the bank will offer, as well as the markets it will operate in.

Such experience is critical to bolstering the FDIC’s confidence that the bank will be able to execute its business plan, while lack thereof will raise doubts. Getting such experienced directors is more difficult now after regulatory bodies increased financial penalties and regulatory scrutiny of bank directors in response to the financial crisis.

Beyond the business plan and experience of managers and directors, applicants should keep in mind why the FDIC is trying to revive de novo banks in the first place.

The agency has stated that a pipeline of new banks is important for the communities they serve. With the recent struggles of community banks, de novo banks can help ensure access to financial services to those at risk of being left behind.

Looking for underserved customer segments, and developing a plan to serve them sustainably, can only help to improve the odds for new banks. That will require targeting well defined customer segments, with the right expertise and digital capabilities to build strong relationships with customers in those segments.

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