Mark W. Olson: “What is the Future of Community Banking?”
What is the Future of Community Banking?
A seasoned industry observer offers his perspective on what’s ahead for community banks.
By Mark W. Olson
for Community Banker
January 2010
In our current economic climate, and in light of the tumult of the past year and the successive waves of mergers and consolidations that have washed over the financial services industry over the past 25 years, many are asking whether there is a future for community banks. As we look forward to 2010 and try to anticipate what lies ahead, it is useful to re-examine the relevance and utility of the community bank charter. Is it possible for small banks to survive and prosper?
To put the current situation in perspective, it is useful to consider the number of banks that currently exist in the United States and compare it to the rest of the world.
As of June 30, 2008, there were just over 8,000 banks and thrifts in the United States. It is not an exaggeration to say that no other nation in the world has anywhere near the number of banks we have in the United States. In light of the incomparably large number of financial institutions in this country, two obvious questions emerge. The first is: Do we have bank overcapacity in the United States? A related but more important question is: Do we have too many banks? Although the answer to the first question is yes; the answer to the second question is no. To fully understand the banking environment in the U.S., we need to further examine these two thoughts.
First, there is the issue of bank overcapacity. Although overcapacity currently exists in the financial services sector, it is also present – to a greater or lesser degree – in virtually every other sector of our economy. It is not just banks that we have a rich abundance of – it is other businesses as well, such as restaurants, hotels, etc. The United States is known for its vibrant economy and entrepreneurial spirit. It therefore attracts numerous participants into many industries, including banking. This is true even for foreign companies seeking to participate in our economy. There are over 300 branches and agencies of foreign banks in the United States which are allowed to conduct limited banking services. In addition, around 60 commercial banks are owned by foreign banks that have established bank holding companies in the U.S. allowing them to own full service banks.
The second question, which addresses the issue of whether there are too many banks, is more complex. For a long time the inexorable trend toward consolidation appeared to suggest the belief by many that “bigger is better” because bigger offered better economies and took advantage of business line synergies. For a time it looked like the future might lie in a smaller number of larger banks. This is not the case. The reasons we have been experiencing unprecedented consolidation activity are more tied to the statutory and regulatory history of banking in the United States than the obsolescence of the community bank model.
Over the past 15 years, we have experienced significant consolidation among financial institutions. As mentioned earlier, we now have just over 8,000 banks and thrifts in the U.S. In 1995 that number was just over 12,000. What caused banks to consolidate?
A major factor was that established state and federal barriers to consolidation were dropped. Going all the way back to the 1920′s, federal legislation under the McFadden Act of 1927 provided that national banks could open branches only in the state in which they were based. In addition, state law controlled the extent to which banks within a given state were allowed to open branches.
The 1950′s brought some slight easing of restrictions, but major barriers remained. The Douglas Amendment to the Bank Holding Company Act of 1956 allowed interstate ownership of banks, but only in circumstances in which the interstate bank acquisition or ownership was specifically and expressly authorized by state statute. In practice, this meant that banks could only establish a new bank or own branches in another state if they were invited by the state to do so. These restrictions severely limited the growth options of banks during this period. A handful of bank holding companies had established an interstate presence prior to 1955 and were allowed to continue – but not expand – their existing footprints. These institutions included First Bank System, based in Minneapolis, Minnesota, now U.S. Bancorp, and Northwestern National Bank, also based in Minneapolis at the time, now Wells Fargo, currently based in San Francisco, California.
That scenario remained the status quo until the 1980′s. The bank/thrift crisis in the mid to late 1980s, fueled by the high inflation of the prior decade resulted in many banks experiencing severe loan quality and liquidity problems. Many banks were in trouble and needed more capital, and states began to feel the pressure. One by one, acting in accordance with requirements set forth in the Douglas Amendment, states began inviting banks to “cross state lines,” usually through reciprocity arrangements among neighboring states. Banks took advantage of the changes in state laws, and began merging with and acquiring banks in other states. The Southeastern states were among the first to “open their doors.” State legislatures, recognizing the potential impact on job creation in their states, began allowing banks from out of state to either merge with in-state or to enter denovo. As a result, both “inter” and “intra” state bank consolidations began in earnest.
But while bank charters were being consolidated quite aggressively, the number of bank branch offices was not. To the contrary, while total bank/thrift charters declined further from 12,000 in 1995 to just over 8,000 in 2009, the total number of bank/thrift offices increased from just over 80,000 to almost 100,000. This increase excludes stand alone ATM machines (many more time the number of branches) and is evidence of the perceived value of branch locations for banks.
The net effect of this is interesting. In the 1970′s, for example, my home county in Minnesota had some 12 communities with a total of 15 banks. Today, there are some 18 communities with banks with a total of 25 banking locations – but fewer bank charters.
The nature of community banking continues to change and the future of community banking is bright. There are at least three reasons why:
Accessibility: In 2004, Roger W. Ferguson, Jr., former Vice Chairman of the Board of Governors of the Federal Reserve System, chaired an international study on bank consumer behavior. The research showed that the number 1 criterion for customers selecting a bank was accessibility to their residence for core services such as their primary checking account. This alone bodes well for the future of community banking. My own feeling is that many consumers and businesses still find that their community bank is more likely to take an interest in and support their financial needs.
Technology: The availability of technology also bodes well for community banking. Today, a smaller newly-chartered financial institution is able to offer immediate, real-time online financial services options to its customers, in most cases, at no cost to the consumer. The prevalence of cost-effective technology also allows these banks to make loan determinations and perform other transactions in a matter of minutes. Finally, community banks can take advantage of outsourcing opportunities for core applications that allows them to concentrate resources on reaching and serving customers.
Capital: There is a third, critically important reason why the future of community banks is bright. Banks are still attracting capital. This is a very powerful indication that they continue to be viable. When we no longer see capital coming in – that will be the time to worry. Right now, we are seeing the opposite. Investors are seeking new opportunities and community banks are market-attractive business propositions.
Community banks will still need to monitor liquidity, asset quality, and other key management issues in this and future uncertain economic and regulatory environments. These certainly are challenging times, but community bank charters can still have a bright future.
Mark W. Olson is a former Federal Reserve Board Governor, Chairman of the PCAOB, and President of the American Bankers Association. He currently is Co-Chairman of Corporate Risk Advisors LLC, a DC-based compliance and strategic advisory firm specializing in the financial services industry. For more information about Corporate Risk Advisors, visit www.corpriskadvisors.com.
