A recent speech given by Governor Michelle Bowman at the Community Banking Research conference, suggests that there’s data to support the contention that Community Banking has some fundamental problems. Since the passing of the Dodd-Frank Act in 2013 and in the wake of the financial crisis, the Federal Reserve, the FDIC, and the conference of State Bank supervisors created a research conference based on the understanding that research plays a vital role in shaping the nation’s supervisory and regulatory policy. The national survey of Community Banks provides data and insights into the community banking sector that was previously unavailable as well as shines light on the new landscape for banking competition.
Struggles with regulatory compliance
The survey provides data on the costs of regular Regulatory Compliance and the trend data on products and services being offered, and, in some cases, discontinued by Community Banks. This is something that is a concern for a lot of the smaller banks as increasing regulations make it expensive for banks to remain compliant. This is a general principle not only restricted to banking but to other industries as well.
The greater the compliance requirements, the less able smaller businesses can compete. It costs them more to provide the regulators with the information that is required to stay compliant.
Increase in Competitors
One of the more interesting findings from the CSBS survey has been how community banks have reported changes in competition for both deposits and loans. So, although the majority of community banks report that other community banks are still their primary competitors, the majority have steadily declined in each year of the survey as credit unions and larger banks have become the dominant competitors for deposits in an increasing number of markets.
Each year, a larger percentage of community banks report fintech firms as their primary competitors for consumer loans, the farm credit system as a primary competitor for agricultural loans, and non-banks as a primary competitors for mortgage loans. The more specialized entities come in and sweep out Community Banks.
Mergers and Survivors
This has given rise to a discussion around changing the bank merger act or the regulations around bank mergers. This can help smaller community banks that cannot compete with specialized entities.
The decisions on whether a merger should happen would depend on the product mix and the bank’s geographic location. This would help to prevent monopolies and positively affect the declining number of bank charters. Since the 2009 financial crisis, there was also a decline in the number of branches each year. In the last 10 years, the number of branches has decreased by 20%, and it is most prevalent amongst banks with total assets of less than $250 million.
During the recent pandemic, more than 3,200 branches closed. This is an indication that the smaller banks are unable to profitably run those branches and provide the services and products to their customers.
The competition in the banking market is measured largely on the basis of a Supreme Court decision in 1963, to assess whether a merger should be allowed to happen. The Federal Reserve analyses the relevant product market in terms of the cluster of products and services that constitute commercial banking in each banking market.
They have two key inputs that they use to evaluate the merger based on the geographical definition of the banking market and a regional basis. The Federal Reserve defines the different products and services that are provided to these individual markets.
Historically, they’ve used the bank’s share of deposits in a market as a proxy for market power in the broader cluster of commercial banking products and services. The idea is that both consumers and small businesses often access commercial banking products through their deposit relationships.
There’s currently no way to comprehensively measure the full cluster of commercial banking products and services in a given market, which is why they use the share of deposits of a specific bank within a market as a sort of proxy. This makes sense as the average person or small business is looking for convenience. They won’t go shopping for loans amongst hundreds of different banks, but rather use the bank at which they have a pre-existing deposit relationship.
The Screening of Mergers and CASSIDI
In 1995, to speed the competitive review process and reduce the regulatory burden on the banking industry, the Department of Justice and federal banking agencies developed a series of screening tests to identify any possible adverse effects on competition which reduced the need for a significant review of any merger.
The “CASSIDI” tool, which stands for the Competitive Analysis and Structure Source Instrument for Depository Institutions, was developed to facilitate the analysis of potential banking mergers. It measures the monopoly power of a specific entity, where a score on the Herfindahl-Hirschman index (HHI) of 10,000 is a perfect monopoly and a score of zero indicates a perfectly competitive market.
Under these screens, any merger that results in an HHI not exceeding 1,800 post-merger or increases the market HHI by less than 200 would likely not require any further review. The federal reserve website reveals a lot of press releases for bank mergers where they reference these figures. More than 60% of banking markets in the United States are above this threshold. That means that roughly 550 banking markets fall outside this figure and thus do not require further review.
The above picture of an example pro forma from the CASSDI tool showing what it would look like if JP Morgan Chase & Co tried to buy out and merge with Bank of America in the NY city metro area. As can be seen in the second table, the HHI when weighted for the amount of deposits would move from 1473 up to 2038, a delta of 565. Breaking both metrics that the Fed uses to evaluate mergers. This can also be seen in the footnote at the bottom ” The potential transaction exceeds the criteria for delegated action by a Federal Reserve Bank in this market.” All in all, this is a really need tool to play with and I will link it again HERE.
The Rise of Credit Unions
They don’t just look at banks anymore, but entities such as credit unions. Historically, they weren’t in competition with banks as they offered fewer lending products with a limited customer base. For this reason, credit union deposits were not factored into the initial competitive screens at all under the Bank merger guidelines.
However, the field of membership has broadened to take in entire geographical areas. They are also expanding their products, which makes them harder to distinguish, from a consumer point of view, from a bank, as they’re offering very similar products and functionality.
They’re insured through the National Credit Union Administration (NCUA) rather than the FDIC, and there’s not much of a difference as they have the same quarter of a million-dollar limit for their insurance on deposits.
Credit unions are becoming more of a competitor in the small business loan arena, with 94% of credit unions, with $500 million in assets, offering small business loans.
Other Competitors in the New Landscape for Banking Competition
The next competitor is online deposits, which have grown significantly with the trend toward online banking. The data shows that time deposits at brick-and-mortar branches grew by just over 21% and online deposits grew by 62% from 2019 to 2020.
Since we know that deposit relationships generally lead to consumers developing other types of banking relationships, a comprehensive analysis of competition needs to account for the ubiquity of out-of-market banks with a strong national presence.
So, it is not so much breaking up the individual banks, but in terms of the online portion, clients are no longer landlocked in terms of whom they can bank with.
Also, today we are seeing mortgage companies not only compete, but dominate the market for residential mortgage loans, meaning non-bank fintech firms have become viable competitors for nearly all types of traditional community bank loan products, but most prominently, consumer loans, small business loans, and student loans.
For more on the Monetary System check out the links below:
https://jamesdforsythe.com/category/monetary-system/banking-system/
More on the Repo Market (HERE)
More on the Shadow Banking system (HERE)
