The Next Crisis in Banking - It is Not What You Think

The Great Recession hit Banks hard. Not only were many Bank’s under-capitalized at the time, but the quality of their loan portfolios was poor and in some cases dismissal, leading to large losses that almost completely crashed the whole financial system, the economy and even the Country. Great strides have been made since the Great Recession, both in the form of tighter regulations as well as just better management practices from Boards of Directors and Bank owners, to be sure what happened in the late 2000’s never happens again. Although Banks are still at risk of having increases in problem loans and capital issues should the economy hit the skids, due to much better lending practices, more conservative loan advance rates, better loan loss reserves, and higher minimum capital ratios, Banks are much better poised to survive any future economic downturns, making the full collapse that started in 2007 much less likely in the future.

Despite the changes that have been made to key areas such as credit quality and capital, Banks are still not home-free. There continues to be one key issue facing Banks, and that issue is deposit generation. In order for Banks to make money they need to lend money, and they cannot lend money without access to deposits, the basis for all loans. Right-now small to mid-sized Banks are struggling to generate deposits, and it is starting to create a real crisis in the industry. Without access to deposits these Banks cannot expand their lending and hence struggle to grow. As the cost of complying with regulations are ever increasing, without being able to grow Banks actually become less profitable, enticing ownership to sell or make other changes, hence hurting the business community and the economy in general.

In order to understand just how challenging it has been for small to mid-sized banks to generate deposits, let’s look at a key statistic. In 1990 the top 10 banking organizations in the United States had 19% market share. At the end of 2017 that market share had increased to 51%. So in 27 years, the 10 largest Banks saw a 32% increase in market share in the United States and now control over half of the United States banking market. That is a very scary statistic on multiple levels. First, if you are concerned about a Bank being too big to fail, there are definitely multiple institutions that could send a huge ripple effect through our economy if they were to fail. But it is also scary because it means Community Banks, the true drivers of small businesses which drives a lot of the economy, are losing out on the market share they need to expand and compete. Less Community Banks means less commercial lending capital available to small business owners to expand and grow their businesses.

Why are deposits so hard for community and mid-sized Banks to generate? There are a few major factors hurting deposit origination, including the following:

  • Large Banks have invested significant capital into their deposit services and online banking platforms, making it harder for community and mid-sized Banks to keep up. Access to nationwide locations and ATM offerings, as well as such services like Chase’s Quickpay Feature, have given the large national Banks a leg up on deposit generation. Many young consumers and small business owners are flocking to these large Banks enticed by the marketing and staying for the products, services, and access to locations they believe only these large Banks can provide.
  • With the large decline in interest paid on most deposit accounts with the decline in the Fed Fund Rate following the Great Recession, many fixed income investors have had to find alternative income sources versus Bank deposit rates. This has led to many deposit accounts moving from traditional banking platforms into brokerage accounts and other platforms that technology has provided easier access to and which are paying much higher rates of return than traditional Banks. Previously investors would go directly to Banks for these services but now with all of these online platforms, investors can put their deposits anywhere.
  • For years when Banks needed to originate deposits, they would run certificate of deposit (CD) specials, and those specials would drive seniors on fixed incomes into the Banks for as little as a ten-basis point higher return on their retirement money over what a competing Bank was offering, as the seniors looked to maximize their return. However, the Baby Boomers are probably the last generation that still actively use CD’s as a way to save money, and even most of them are using other more sophisticated products. Because of this one of the core methods of Banks generating deposits via CD’s is quickly going away, likely to never return.

Although Banks can still generate deposits from other means, such as general consumer accounts, municipal accounts, and corporate accounts, the cost in generating these deposits is much higher as it costs marketing dollars and sales people to originate and close such accounts. At one time getting a commercial business account was very sticky for Banks, as these customers would rarely move their accounts. But with changes in technology and less reliance on checks and even going into the bank with the ability to deposit checks via your phone, as well as most Banks requiring commercial deposit accounts to move over with commercial loans they make, it has become much harder to keep even long-term commercial banking arrangements intact.

In order to generate the deposits Banks need to continue to grow, Banks have been acquiring other Banks that have excess deposits at an alarming rate. This has led to a shrinkage in the number of banks in the United States. In 1990 there were 15,160 Bank and Thrift Charters in the United States. At the end of 2017 that number was down to 5,670. If this trend continues, we could be looking at a shortage of banking institutions within the next ten years. Such a large decline in Banks not only hurts the owners of those banks, but also hurts business in general. With less options available, both consumers and commercial businesses will struggle to find the capital and services they need to be successful.

So what can you do about it? Although big Banks can offer very competitive pricing on loans and other services, don’t let big banks be your only option. Consider maintaining an account or two with a community Bank or mid-sized Bank. Also keep in mind that as technology has continued to advance, most Banks, including even some of the smallest ones, have access to online solutions and other products close to if not on par with those offered by the bigger Banks. If you need a loan, consider pricing the request with both a community Bank as well as a large Bank. You might be surprised at the rate the smaller Bank offers and they might be just as competitive as the big Bank. But even more importantly, community and mid-sized Banks tend to be more nimble and can often move quicker than the larger banks and be more flexible on terms and issues that might come up in the process.

Knowing what type of institution is the right fit for you or for your business can be tough to determine. Here at Commercial Lending X we are here to help you maneuver through the market and find the best solution for you and your business.