The film It’s a Wonderful Life invokes the feeling of the small local bank at the heart of a small town. Yet it seems like we’ve strayed far away from Bedford Falls and are living in something closer to Pottersville…
Federal Reserve Governor Michelle W. Bowman recently gave a speech called The Lack of New Bank Formations is a Significant Issue for the Banking Industry, where she asked the question:
Why have there been so few de novo bank formations over the last decade?
Per the Governor an “insured depository institution is in the de novo phase if it has been operating for three years or less.” She notes the erosion of community banks has been occurring in both urban and rural communities, stating reasons why this is bad such as less service for communities, and acknowledges the significant role banks play in the development of communities across America.
The figures don’t look good. The Governor cites that:
A 2014 study by Federal Reserve Board economists noted that from 1990 to 2008, over 2,000 new banks were formed, which on average is more than 100 per year.
But then the Great Recession happened, ending in 2009:
In contrast, the study noted that only seven new banks were formed from 2009 to 2013.
This lack of rebounding from the financial crisis over a decade ago seems strange. She cites another study which claims that:
…new bank formations tend to be cyclical, accelerating during periods of economic expansion and slowing during recessions.
The problem: Since 2009 until the latest recession is considered to be the longest US expansion in history, as CNBC announced in 2019, according to the National Bureau of Economic Research. What does it say about the mainstream understanding of banking or the tabulation of economic data when very few banks were formed during the last and greatest economic expansion ever?
The Fed Board suggest that:
…low interest rates and depressed demand for banking services—both of which depress profit for banks, and particularly new banks—may also have discouraged entry.
In addition to depressed interest rates (caused by the Federal Reserve), Governor Bowman notes:
A recurring theme that has surfaced through my discussions with bankers and other industry stakeholders is the regulatory burden imposed upon de novo banks.
According to Bowman, capital requirement for de novo banks could be as low as $10 million, “but in practice could be as high as $30 million,” which gives them a “small margin of error” to operate.
Unless one is in the banking or regulator environment, it’s difficult to fathom exactly these high costs and barriers to entry required in starting and operating a bank. However, an even older Federal Reserve study, from 1998, outlines some of these regulatory burdens such as start-up costs and on-going operating costs needed to adhere to regulation.
Opportunity cost is also noted as a regulatory burden, per the study:
For a bank, opportunity costs occur when a regulation prevents it from engaging in profitable activities. An example is the cost resulting when branching restrictions prevent a bank from taking advantage of profitable lending opportunities outside its local area…
It doesn’t require a PhD to understand that when a for-profit enterprise is restricted from engaging in profitable enterprise, in this example, a bank being restricted by geographical location, the result is that the bank suffers. Not only that, the potential customers suffer from not being able to access the bank’s services.
Why the Governor is surprised by the lack of new banks opening in America should be of no mystery. Interest rates have been held low by the Fed for well over a decade. And over two decades ago the Fed was aware of the costly regulation imposed in the banking sector, which has done nothing but become more expensive with the passage of time.
It would be nice, if perhaps somewhere in the USA, a plan to open an uninsured and full reserve bank, or some other system for investing and lending activities that circumvent the Federal Reserve could be developed to avoid burdensome regulation…. and the Federal Reserve all together.
