FYI: An Update on Emerging Issues in Banking

Bank Branching Trends and Prospects of Key Banking Sectors

July 9, 2004

Overview

This issue of FYI summarizes three reports released today that represent the fourth 

installment of the FDIC’s Future of Banking Study. The first report discusses the 

decade-long trend of bank branch growth, the reasons behind the trend, and the 

branching outlook going forward. The other two reports are focused on various 

segments of the banking industry in the United States. 

Bank Branch Growth Has Been Steady – Will It Continue?

The number of institution charters has been declining since 1984, and in the decade 

between 1994 and 2003, dropped almost 29 percent.1 At the same time, however, the 

number of physical bank offices has been steadily increasing, driven by an increase in 

branches (see Chart). In the decade between 1994 and 2003, the number of bank 

branches increased 15 percent.2

Chart 1 

Over the Long Term, the Number of Banks 

Has Declined and the Number of Branches 

Has Increased 

Year Institutions Branches Offices 

1934 14,146 0 14,146 

1935 14,125 3,112 17,237 

1936 13,973 3,261 17,234 

1937 13,797 3,381 17,178 

1938 13,661 3,412 17,073 

1939 13,538 3,456 16,994 

1940 13,442 3,489 16,931 

1941 13,430 3,517 16,947 

1942 13,347 3,555 16,902 

1943 13,274 3,744 17,018 

1944 13,268 3,875 17,143 

1945 13,302 3,896 17,198 

1946 13,359 3,928 17,287 

1947 13,403 4,096 17,499 

1948 13,419 4,283 17,702 

1949 13,436 4,530 17,966 

1950 13,446 4,832 18,278 

1951 13,455 5,157 18,612 

1952 13,439 5,486 18,925 

1953 13,432 5,855 19,287 

1954 13,323 6,346 19,669 
1955 13,237 6,965 20,202 

1956 13,218 7,639 20,857 

1957 13,165 8,267 21,432 

1958 13,124 8,955 22,079 

1959 13,114 9,732 22,846 

1960 13,126 10,556 23,682 

1961 13,115 11,436 24,551 

1962 13,124 12,421 25,545 

1963 13,291 13,581 26,872 

1964 13,493 14,699 28,192 

1965 13,544 15,872 29,416 

1966 13,538 17,029 30,567 

1967 13,514 18,079 31,593 

1968 13,487 19,183 32,670 

1969 13,473 20,379 33,852 

1970 13,511 21,839 35,350 

1971 13,612 23,336 36,948 

1972 13,733 24,829 38,562 

1973 13,976 26,673 40,649 

1974 14,230 28,651 42,881 

1975 14,384 30,205 44,589 

1976 14,410 31,344 45,754 

1977 14,411 33,108 47,519 

1978 14,391 34,791 49,182 

1979 14,364 36,791 51,155 

1980 14,434 38,738 53,172 

1981 14,414 40,786 55,200 

1982 14,451 39,783 54,234 

1983 14,469 40,853 55,322 

1984 14,496 41,799 56,295 

1985 14,417 43,293 57,710 

1986 14,210 44,392 58,602 

1987 13,723 45,357 59,080 

1988 13,137 46,381 59,518 

1989 12,715 48,005 60,720 

1990 12,347 50,406 62,753 

1991 11,927 51,969 63,896 

1992 11,466 51,935 63,401 

1993 10,960 52,868 63,828 

1994 10,452 55,145 65,597 

1995 9,942 56,512 66,454 
1996 9,530 57,789 67,319 

1997 9,143 60,325 69,468 

1998 8,774 61,957 70,731 

1999 8,581 63,684 72,265 

2000 8,315 64,079 72,394 

2001 8,080 65,564 73,644 

2002 7,887 66,185 74,072 

2003 7,769 66,775 74,544 

Source: FDIC Office Structure Information 

d

The growth in physical branches is all the more striking in that it occurred during a 

period of rapid technological advances that would appear to have diminished the need 

to use branches. These advances include a proliferation of automated teller machines, 

and the rise of the Internet and increasing broadband capacity, which have enabled 

customers to bank on line. Moreover, legal changes and financial innovations have 

intensified the competitive landscape by removing many of the traditional barriers 

between banks and other financial service companies, allowing these companies to 

offer products and services typically provided through bank offices, again seemingly 

reducing the need for physical bank branches. However, over time, bank branches 

have proven to be a highly effective and profitable distribution channel. 

The steady increase in branching is due primarily to the following three factors: 

Changes in bank branching laws led to structural shifts in branching. –

Historically, a number of states had significant restrictions on branching. Gradual 

easing of these laws occurred on a state-by-state basis from the early 1980’s until the 

1994 passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 

1994 (Riegle-Neal). Riegle-Neal removed many remaining individual state law 

restrictions on interstate branch banking. As a result, interstate branching increased 

rapidly as banks sought to simplify their structure by consolidating multi-state and 

multi-bank operations into branches and then began to expand their branch networks 

under the new, relaxed rules. 

Branching, when well executed, appears to improve performance. - Bank 

branches are costly, so noninterest costs are higher for banking organizations 

operating multiple branches versus companies with a single office. However, banking 

organizations with larger branch networks generally have much higher non-interest 

revenue, and as a result, have better efficiency ratios. Improved efficiencies are 

reflected in higher overall profitability for multi-branch banking organizations. 

Favorable economic and demographic trends encourage branching in certain 

markets. – The increase in physical branches during the past decade was not uniform 

across the country. Not surprisingly, states with the largest branch growth rates are 

those where relaxation of branching laws occurred later. However, economic vibrancy 

of a community and demographic patterns also appear to be important drivers of 

branch formation. In particular, population growth and employment growth are the 

most highly correlated economic drivers. 

To a large extent, the increase in branches has also been driven by demand, as 
consumers seem to like the convenience of bank branches. Indeed, surveys 

conducted by the Federal Reserve Board indicate that the single most important factor 

influencing a customer’s choice of banks is the location of the institution’s branches.3 It 

would be difficult to predict what consumer preferences for physical branches will be 

going forward. However, the general trends suggest that branching will continue, at 

least in some markets, particularly those with strong population and employment 

growth. Additionally, other trends in the retail banking business will have implications 

for the future pace of branching, such as deposit growth and the overall attractiveness 

of the consumer sector. 

Prospects for Key Banking Sectors 

These remaining papers address two segments of the banking industry: (1) regional 

and other mid-size banks and (2) limited-purpose banks, which specialize in relatively 

narrow lines of business. Together with previously-issued papers on community 

banks, these reports supplement the discussion in the Future of Banking Study of 

prospects for specific sectors of the industry. Although these groups of banks differ 

greatly in size and other characteristics, they also face similar challenges—intense 

competition within and from outside banking, the trend toward fewer charters, and the 

need for sophisticated risk-management techniques. How they have responded to 

these challenges provides a basis for assessing their future prospects. 

Regional and Other Midsize Banks: Recent Trends and Short-Term Prospects -

For purposes of this paper, regional and other midsize banks are defined as banking 

organizations with aggregate assets of more than $1 billion, excluding the 25 largest 

banking organizations.4 The midsize group is very diverse, with some banks operating 

as regional banking organizations across state lines and in more than one market. 

Others are concentrated in only one state or market and are closer to large community 

banks. 

During the last seven years, regional and other midsize banks have consistently 

outperformed community banks in terms of earnings and have often outperformed the 

top 25 banks. Over the same period, the number of regional and other midsize banks 

increased by 13 percent as a result of mergers and growth of community banks. 

However, in terms of market share of assets, this sector lost market share between 

1996 and 2003, largely because of the top 25 banks’ dramatic growth through mergers 

and acquisitions. This paper finds that merger activity in this sector will continue, but 

that there is an abundant supply of community banks that will enter the midsize bank 

sector via internal growth, mergers, and acquisitions. Therefore, it is likely that in the 

near future the number of midsize banks, although relatively small, will remain 

generally stable or grow slightly. 

Limited Purpose Banks: Their Specialties, Performance, and Prospects – For the 

purposes of this paper, limited purpose banks are institutions that specialize in 

relatively narrow business lines. In particular, credit card banks, sub-prime lenders, 

and internet primary banks are examined. In number, these institutions make up a 

small share of the banking industry. Yet, their unique and concentrated functions and 

product mixes have attracted considerable attention. 

As of December 2003, the average ROA for the credit card banks was more than four 

times the banking industry average. Over time, credit card banks have managed to 

offset the effects of higher credit risk with higher yields than traditional lenders, by 

successful utilization of technology, and with the benefits of scale economies. For 

these reasons, this paper concludes that credit card banks have likely found a 

permanent place in the banking sector. 
In this study, sub-prime lenders refer to insured institutions that extend credit to 

borrowers who may have had more limited borrowing opportunities due to their poor or 

weakened credit histories. Although sub-prime lenders earn interest income higher 

than the industry average, higher non-interest expense and credit losses offset a 

portion of income. Moreover, increased scrutiny from regulators on issues such as 

capital adequacy and consumer issues may have effectively eliminated the advantage 

insured institutions once enjoyed relative to other financial firms operating in the field. 

In response, sub-prime lending at banks has trailed off recently and some participants 

have withdrawn from the market. As such, this paper indicates that it is likely that bank 

participation in sub-prime lending has stabilized and may even decline.

Internet primary banks are institutions that deliver banking services mainly online. By 

eliminating physical branches and employing fewer employees, they can potentially 

provide banking services at lower cost. In reality, however, internet banks underperform “brick-and-mortar” banks. This may reflect limited consumer demand for 

internet banking services and the lack of barriers of entry for other banks to offer 

internet banking. They are also at a competitive disadvantage relative to “brick-andmortar” banks in lending to small businesses because they lack the means of building 

long-term relationships with borrowers. This paper concludes that, over time, these 

disadvantages could damage the internet primary business model. 

1 For a more complete discussion of the reasons for charter declines, refer to two 

papers issued under the FDIC’s Future of Banking series: “The Declining Number of 

U.S. Banking Organizations: Will the Trend Continue?” and “Community Banks: Their 

Recent Past, Current Performance, and Future Prospects.” 

2 The net increase in offices (decrease in main offices plus increase in branch offices) 

was 8 percent over the decade of June 1994 to June 2003. 

3 Olsen, Governor Mark W., “Remarks at the Fortieth Annual Conference on Bank 

Structure and Competition, Sponsored by the Federal Reserve Bank of Chicago, 

Chicago, Illinois.” May 6, 2004. 

4 According to this definition, assets of regional and other midsize banks at the end of 

2003 ranged from $1 billion, the top of the community bank size group, to $42 billion, 

the asset size of the smallest of the top 25 banks. 

About FYI

FYI is an electronic bulletin summarizing current information about the trends that are 

driving change in the banking industry, plus links to the wide array of other FDIC 

publications and data tools. 

Disclaimer

The views expressed in FYI are those of the authors and do not necessarily reflect 

official positions of the Federal Deposit Insurance Corporation. Some of the 

information used in the preparation of this publication was obtained from publicly 

available sources that are considered reliable. However, the use of this information 

does not constitute an endorsement of its accuracy by the Federal Deposit Insurance 

Corporation.

Last Updated 07/09/2004