For release on delivery
10:00 a.m. EDT (9:00 a.m. CDT)
October 22, 2021
The Lack of New Bank Formations is a Significant Issue for the Banking Industry
Remarks by Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
at
2021 Community Bankers Symposium: Banking on the Future
Federal Reserve Bank of Chicago
Chicago, Illinois
October 22, 2021
Good morning. I appreciate the opportunity to be part of this symposium on "Banking on
the Future," especially since the future of banking is one of the highest priorities in my work at
the Board. Today, I will focus my remarks on the importance of community banks to our
financial system and the challenges they face. In particular, I will focus on the formation of new
banks and pose two key questions concerning the recent scarcity of these "de novo" banks.1
The first question: Why have there been so few de novo bank formations over the last
decade? And second, what can be done to encourage more de novo banks? I will begin with
some background on community banks and bank formations.
The Importance of Community Banks
By serving communities, households, and businesses that may be underserved by larger
institutions, community banks play a key role in advancing diversification in the U.S. banking
system. First and foremost, community banks provide critical financial services to their
communities and to many customers who might have limited geographic access to banking
services. Because community bankers are active participants and leaders in their communities,
they typically know their customers and their needs better than a banker at a branch of a larger
institution. Community banks draw upon this knowledge and conduct "relationship" lending
versus relying on automated underwriting models that are typical in larger institutions.
Therefore, community banks are more willing to underwrite loans to creditworthy customers
based on an assessment of qualitative factors that automated models do not consider. Since
community bankers are part of the fabric of their communities, they better understand the local
market and economic conditions in the area compared to larger institutions that are not resident
within the community.
Collectively, community banks are critical in advancing the health and stability of the
U.S. economy as evidenced by their participation in the Small Business Administration's
Paycheck Protection Program (PPP). Community banks made 4.7 million PPP loans, totaling
$429 billion, which accounted for nearly 60 percent of the program's total loan amount.2 In
comparison with the banking industry as a whole, these banks provided more loans to
traditionally underserved communities and population segments: community banks provided
87 percent of total PPP loans to minority-owned businesses, 81 percent to women-owned
businesses, and 69 percent to veteran-owned businesses.3
Trends in Community Banking
Despite the local and national significance of community banks, their numbers, as well as
the number of insured banks in general, have been declining for several years.4 This erosion of
community bank charters is not just an issue in our rural communities. In urban areas, these
banks, including minority-owned banks, serve businesses and households that may also be
overlooked by larger institutions. I am concerned that the contraction of community banks could
lead to an unhealthy level of similarity in the banking system. As a result, this could limit the
ability of households and small businesses to access credit and other types of financial products
and services. The beauty of community banks is in their differences-whether in their
personality or business model. Each is unique in its mission, service delivery, and profile.
While I am troubled by the declining community bank footprint, I am not surprised that
banks are choosing to merge or to be acquired. I am well aware of the significant challenges that
smaller banks face. Since joining the Board, and increasingly over the past year, I have met with
many state member bank CEOs who share these challenges with me. These CEOs have
expressed frustrations with ever-increasing compliance burden, which distracts their attention
from prudent revenue generating activities.
As I discussed in recent remarks at the community bank research conference in late
September, public policymakers must avoid adding regulatory burden on the smallest banks,
particularly on those that maintain a more traditional business model.5 Therefore, policymakers
need to achieve a meaningful balance in our supervisory approach for community banks.
Otherwise, community banks will continue to face a regulatory and supervisory framework that
is ill-suited for a lower-risk profile and activities that are less complex than those of larger
institutions.
Why Have There Been So Few De Novo Bank Formations over the Last Decade?
The underlying question remains: why have there been so few de novo bank formations
over the last decade?
There have been only a handful of new bank charter applications over the past decade. In
fact, only 44 de novo banks have been established, which include both state and national
charters. 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.6 In contrast, the
study noted that only seven new banks were formed from 2009 to 2013. The 2014 Board study
suggests 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."7
The conclusions from a Federal Reserve Bank of Kansas City study completed this year
align with observations from the 2014 Board study. In this more recent study, the authors noted
that new bank formations tend to be cyclical, accelerating during periods of economic expansion
and slowing during recessions.8 While regulatory burden has also contributed to depressed de
novo formations, the authors pointed to the weak economy following the 2007-2009 financial
crisis and low profitability for banking as overriding factors.
A recurring theme that has surfaced through my discussions with bankers and other
industry stakeholders is the regulatory burden imposed upon de novo banks. In particular,
community bankers noted the challenges in raising the capital required to establish a new bank.
The 2014 Board study noted that the states' statutory capital requirements for a new state-
chartered bank could be as low as $10 million, but in practice could be as high as $30 million.9
Given the high initial capital requirement, a de novo bank has a small margin of error in
implementing its business strategy and meeting profit projections.
In establishing a new bank, bank executives explained the challenges in developing a
business plan and risk-management framework that addresses how the bank can generate a
sufficient profit to provide an adequate return to shareholders. For a de novo bank, the cost and
burden of starting from ground zero in establishing their risk-management and internal controls
are high. De novo banks make strategic decisions in establishing risk-management processes
and controls that may delay the launch of revenue-generating products and services. Further, a
de novo bank faces the pressure to grow quickly, which in turn, may lead to riskier lending and
other activities. Indeed, experience has shown that pronounced problems often surface in the
early years of a de novo bank's operations, which explains the elevated capital and supervisory
expectations for these banks. The Federal Reserve and the other banking agencies generally
expect a de novo bank to maintain a Tier 1 leverage ratio of at least 8 percent for the first three
years of its existence and they examine the bank on a more frequent schedule.10
For a de novo bank, there is a heightened need to hire experienced staff who are quickly
able to establish the bank and show progress in meeting the operating goals and profit
projections in the business plan. As we all know, difficulty in finding skilled workers is an issue
more broadly in the economy, but community bankers frequently tell me of their ongoing
challenges in attracting and retaining experienced staff. These challenges are even more acute
for de novo banks who require staff with experience in regulatory compliance and internal
controls.
A Kansas City Reserve Banks study echoes these anecdotes, which indicate that the
volume and complexity of regulations require specialized expertise that can be costly and
difficult to find.11
The competitive landscape for financial services and products is also a key consideration
in developing and executing a de novo bank's business plan. I often hear the perspective from
bankers that non-regulated financial entities have a competitive advantage over regulated
financial institutions in providing financial services and products. It would be helpful to
appropriately acknowledge this competitive disadvantage for banks and tailor the regulatory
framework based on the risks and complexity of their activities.
As a result, the economic, regulatory, and market realities discourage the formation of de
novo banks, as investors have many other options for entry into the financial services market.
For example, they may choose to acquire an existing bank charter and subsequently establish
branches in new markets. Further, they can acquire a branch office from an existing bank. And
finally, they may choose to establish or acquire a nonbank financial firm that is subject to less
regulation than a chartered and insured financial institution.
What Can Be Done to Encourage More De Novo Banks?
So, let's address the second question: what can be done to encourage more de novo
banks?
Simply the fact that I am speaking about this topic today should give you the sense that I
am concerned about the impact of the declining number of community banks. While the loss of
a single community bank may be inconsequential to U.S. financial stability, that loss may have
profound consequences to households and businesses in that community. This is particularly
true in rural communities and remote areas and in certain urban areas when the loss of the local
bank may leave customers in a banking desert, void of tangible, relationship-based financial
services.
But we should also be concerned about how a continued decline in the number of
community banks, in part due to the lack of de novo formations, will affect the banking and
financial services system more broadly. When banking services are limited, it is much more
difficult for people to fully participate in the economy, or to manage their finances when times
are tough. A shrinking community bank sector may lead to a weaker banking system and weaker
economy.
It is crucial to provide a balanced, transparent, and effective regulatory framework that
promotes a vibrant community bank sector. Public policymakers need to ensure that the
regulatory and supervisory framework promotes safety and soundness, while recognizing the
reduced risk of these banks' noncomplex services and activities. As large institutions and
nonregulated financial companies expand their reach into markets traditionally served by
community banks, policymakers need to ensure that the regulatory and supervisory framework
does not exacerbate this competitive disadvantage.
If we are not able to achieve an appropriate balance, I am concerned that there will
continue to be fewer de novo banks as well as a decline in the overall population of community
banks. These banks are a key segment of the industry in that they provide financial services and
products to a wide range of consumers and businesses. Looking to the future, policymakers need
to appropriately refine the regulatory and supervisory framework to minimize unnecessary
compliance costs for smaller banks and address impediments to bank formations.
Closing
In conclusion, I have raised two important questions about why there so few de novo
banks and what can be done to encourage new bank formations. It is important for us to fully
understand why we have seen the steady decline in bank formations, and to continue to explore
ways to encourage community banks in such a competitive environment. Identifying answers to
these questions should enable the federal banking agencies to identify potential regulatory and
policy constraints on the formation of new banks. To further this effort, I have asked Federal
Reserve staff to continue to study trends in community banking so that we can fully understand
the economic and regulatory factors that constrain the ability of community banks to form,
compete, and thrive.
I appreciate the opportunity to raise these questions with you. And I look forward to
further discussions about tailoring our regulatory and supervisory framework to ensure that
community banks remain an essential part of the future of the U.S. financial system.