It used to be easy to start a local bank: Find investors. Get a charter. Hire staff and appoint a board of directors. Off you go.
A confluence of factors spawned by the Great Recession have combined to decimate the number of bank start-ups.
Regulatory compliance is more expensive. Bank approvals have slowed to a crawl. Low interest rates have sapped profit margins. Loan demand has dropped.
“It’s almost impossible to start a bank because you have to hire so many people to get it started,” said Bernard H. Clineburg, chairman and chief executive of McLean, Va.-based Cardinal Bank, which has $3.5 billion in assets and launched 15 years ago. “It’s not like when you get a charter, get your deposit and make a loan. The fun is gone. We used to help people succeed. It’s very hard now. The bottom line is it’s regulatory.”
The number of independent commercial banks nationally dropped by 14 percent, or more than 800 institutions, from 2007 to 2013, “driven by an unprecedented collapse in new bank entry,” according to a report by the Federal Reserve Bank of Richmond.
Some banks and financial institutions disappeared through gigantic mergers during the financial crisis, when JPMorgan Chase took over the assets of Washington Mutual, Wells Fargo absorbed Wachovia, and Bank of America swallowed Merrill Lynch.
But the mergers aren’t the whole story. The number of newly formed banks has fallen from an average of about 100 a year since 1990 to three a year in the past five years. Most of that is because of the lack of new community banks, which generally start with less than $50 million in assets. (JPMorgan Chase, by comparison, has $2.5 trillion in assets.)
The drop could have far-
reaching consequences for local businesses, many of which rely on small community banks for money.
Clineburg was one of several Washington-area bank executives who discussed the lousy market for new banks. Several said we are on the downside of a typical economic cycle, which should reverse when conditions change. Others said the new regulations are justified.
“Regulators have raised the bar,” said Shaza L. Andersen, chief executive of Reston-based WashingtonFirst Bank, which has 17 branches and $1.3 billion in assets. “Banks have hit a little bit of a bump, and regulators wanted to ensure that any bank that starts is bound to succeed.”
Andersen said new bank formation will increase as the down cycle runs its course and demand picks up for more banking.
“A lot of people think they can raise money and, ‘poof,’ they can open a bank,” she said. “But it takes a lot of expertise. I had to go through a lot of interviews and through a lot of screening before I got my charter in April 2004.”
Banks have been closely regulated since the early days of U.S. commerce. Until the 1970s, they were barred from opening branches other than in their home states. And sometimes they were restricted even within a state. In Illinois, big banks such as First Chicago had to stay in Chicago, unable to open a branch in the suburbs, much less downstate.
Restrictions were loosened in the 1970s, and the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 opened up banking across state lines.
The changes put local banks in competition with big national brands. And the number of independent banks fell from about 13,000 in 1960 to less than half that number before the financial crisis.
Then the Great Recession hit.
From 2009 through 2013, according to the Richmond Federal Reserve Bank report, new bank entries fell to almost zero.
The Richmond report attributed the collapse of new banks entering the system to several factors, including the slim net interest margins. That margin is the revenue banks earn on the spread between how much it pays for deposits and how much it charges in interest.
“When you combine that with a meaningful increase in the cost of doing business, more lawyers, cost of compliance, et cetera, it’s a difficult combination,” said Lee Sachs, co-founder and chairman of Chevy Chase-based Alliance Partners, a cooperative of community banks that finds and evaluates midsize business and corporate loans for its members. “Is it worth going through the effort of starting up a bank in this environment to get sub-optimal returns?”
Chain Bridge Bank founder Peter G. Fitzgerald, a former U.S. senator from Illinois whose father helped pioneer branch banking in that state, said the answer is no.
“Let’s say you are opening a new bank and have $20 million in capital,” he said. “The first day your bank opens, all you have is $20 million in capital. No deposits and no loans.
“So you are going to invest that in safe, short-term instruments such as U.S. Treasury Bonds. If you go back a number of years, that $20 million would earn 6 percent annually and that would provide you with $1.25 million in revenue. So the first day you buy T-Bills and you already have $1.25 million in earnings and haven’t taken any risk.”
At recent Treasury rates, that $20 million would earn about $45,800 in annual revenue.
“With zero interest rates, opening a new bank doesn’t work,” said Fitzgerald, whose bank was one of the last to open before the financial crisis hit. “It’s the laws of humble arithmetic.”
Community banks tend to give more personal service — especially to smaller, local businesses that want to work with a person who understands their company, their management abilities and what they are trying to accomplish.
Small businesses want more from a banker than someone checking boxes based on some computer printout of their financials.
“There needs to be a story” to those businesses, said Joseph S. Bracewell, chairman of Washington First Bankshares. “Maybe the business is relatively new and maybe to finance the business, you need to take a lien on the owners’ loan.
“If you have a small- to medium-size business that requires financing for real estate or working capital or whatever,” he said, “a smaller, community bank will of necessity be equipped because their lifeblood is dealing with smaller businesses.”
Sachs said Alliance Partners and its cooperative of community banks help fill some gaps created by the evolution in banking.
“As a hypothetical example, 20 years ago, if you were a farmer in Kansas and wanted to buy a tractor, you would walk into a Kansas savings bank and ask for a $25,000 loan,” he said. “Today, you walk into a John Deere store and they say, ‘Here is your tractor and here is your loan.’ The Kansas savings bank has been cut out of the tractor lending business. But the treasurer of John Deere has to borrow money to make those loans. He borrows hundreds of millions of dollars. He can do business with us, and we can effectively get our banks back in that business.”
Either way, the long-term trend toward fewer banks may not reverse itself, which Bracewell said is not a bad thing.
“Fifteen thousand banks in the 1970s was too many,” he said. They had difficulty distinguishing themselves. Some merged or failed as technology made face-to-face banking less important. Even so, Bracewell considers himself an old-fashioned banker.
As he put it: “At 68, I still like to go to the bank and hand my deposit to a teller.”