For release on delivery
10:10 a.m. EDT (9:10 a.m. CDT)
April 2, 2024
Bank Mergers and Acquisitions, and De Novo Bank Formation:
Implications for the Future of the Banking System
Remarks by
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
at
A Workshop on the Future of Banking, Hosted by The Federal Reserve Bank of Kansas
City
Kansas City, Missouri
April 2, 2024
Good morning. Before I provide some context for today's discussions, I would
like to thank all of our participants who are here with us today in Kansas City at the
Reserve Bank, and those participating remotely. Most importantly, I'd like to thank our
host, President Schmid, and his excellent research staff, all of whom helped to organize
today's event. I especially appreciate the opportunity to highlight a few specific areas
that concern me about the currently regulatory trajectory and their effects on the future of
banking.1
Today's workshop addresses timely and important questions, including the forces
that will shape the future of the banking system, entry into the banking system, bank
mergers and acquisitions, and the state of competition including both the direct and
indirect competition banks experience and how regulators measure and assess
competition-or at least how we broadly measure it today.
The failures of Silicon Valley Bank and Signature Bank just over a year ago, and
the stress to the banking system that ensued, caused many institutions to retrench and
prompted regulators to renew their focus on bank regulatory and supervisory policy and
approach. Banks responded by enhancing their focus on fundamental risks like interest
rate and liquidity risk, adopting a more conservative posture in both risk management and
lending. This self-reflection by both industry and regulators continues today. In fact, the
long shadow of the bank failures continues to be a driving force for regulatory and
supervisory reforms, even for reform proposals that have little relationship to the events
surrounding the bank failures and ensuing banking system stress.
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As I have noted in the past, the regulatory reform agenda, and the less visible but
no less important changes to the supervisory process, touch on a wide range of topics that
directly and indirectly affect banks of all sizes.2 The sheer volume of changes presents
challenges to regulated institutions. Outside of the largest banks, how does bank
management review and provide meaningful comment on voluminous regulatory
changes? When those changes are finalized, how does a bank's management reallocate
resources to ensure a capability to comply with revised regulations? Are banks,
especially small banks, able to locate and retain qualified staff to understand and
implement these increasingly complex and burdensome rules? How does a bank's
management and compliance officer adjust to supervisory standards and expectations that
may be significantly different from exam to exam or regulator to regulator?
The 2023 bank failures and circumstances leading up to those failures continue to
warrant review, self-reflection, and appropriately targeted changes to identified issues or
failures in regulation and supervision. But we should ask whether the volume of reforms
that have been proposed, recently finalized, or that are in the pipeline, reflect appropriate
prioritization. Or instead, do they suggest that we have lost our focus on furthering the
primary goal of prudential bank regulation and supervision-promoting a safe and sound
banking system and fostering a thriving banking industry that effectively supports local
and regional economies. I am concerned that the broad-based and insufficiently focused
reform agenda has become a growing source of risk to the banking system, particularly
due to the rushed nature of these reform efforts and the lack of research and
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understanding of the intended and unintended consequences of these proposals.3 This
reform agenda, for both regulation and supervision, is the backdrop for today's panel
discussions.
Regulatory Approvals in the Banking System
I have previously spoken about the regulatory dynamics shaping the future of the
banking system, from bank capital requirements to liquidity reform, significant revisions
to the Community Reinvestment Act, a regulatory attack on banks charging fees for
services (including debit card interchange fees), the trend of dialing supervision up to
"11" for banks of all sizes, increased competition from non-banks, the continued
migration of certain activities from regulated banks to non-banks outside of the banking
system, and the ongoing erosion of tailoring.4 These issues continue to shape the
contours of the banking system-including bank size, the activities in which they engage,
and where activities occur within the broader financial system. The policy decisions
3
The Federal Deposit Insurance Corporation, the Federal Reserve, and the Office of the Comptroller of the
Currency recently passed an interim final rule to extend the applicability date of certain provisions in the
recent amendments to the Community Reinvestment Act regulations. The need for these delays to
important and controversial elements of the final rule illustrates the rushed, overly complex, and unwieldy
nature of the Community Reinvestment Act rulemaking. See dissenting statement of Governor Michelle
W. Bowman, "Statement on the Interim Final Rule and Final Rule Amending the Community
Reinvestment Act Regulations" March 21, 2024,
https://www.federalreserve.gov/newsevents/pressreleases/bcreg20240321a1.htm.
4
Michelle W. Bowman, "The Path Forward for Bank Capital Reform," (speech at Protect Main Street
sponsored by the U.S. Chamber of Commerce, Washington, DC, January 17, 2024),
https://www.federalreserve.gov/newsevents/speech/files/bowman20240117a.pdf; "Reflections on the
Economy and Bank Regulation" (speech at the Florida Bankers Association Leadership Luncheon Events,
Miami, FL, February 27, 2024),
https://www.federalreserve.gov/newsevents/speech/files/bowman20240227a.pdf; "Reflections on the
Economy and Bank Regulation" (speech at the New Jersey Bankers Association Annual Economic
Leadership Forum, Somerset, NJ, March 7, 2024),
https://www.federalreserve.gov/newsevents/speech/files/bowman20240307a.pdf; "Tailoring, Fidelity to the
Rule of Law, and Unintended Consequences," (speech at the Harvard Law School Faculty Club,
Cambridge, MA, March 5, 2024),
https://www.federalreserve.gov/newsevents/speech/files/bowman20240305a.pdf.
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embedded in these regulatory reforms, even if only in the form of a proposal, have
already begun shaping the U.S. banking system.
Revisions to the regulatory and supervisory framework reflect policy decisions
about not only the risk tolerance of regulators, but also the role of banks in the banking
system and the broader U.S. economy. These policy decisions create incentives and
impacts that we must acknowledge and understand. When policymakers flatten and
standardize regulations and supervisory expectations, we create strong incentives for
banks to achieve greater economies of scale through merger and make it harder for new
banks to successfully compete with existing banks.
When we "raise the bar" for banks to engage in certain activities in a way that is
disproportionate to the risk of those activities, we create incentives for those activities to
migrate to non-banks outside of the regulatory perimeter. We must understand whether
the policy decisions embedded in the regulatory and supervisory framework are effective
and complementary. If they are not, we must acknowledge the consequences of
knowingly implementing conflicting policy choices.
De Novo Bank Formation
I continue to be concerned about the decline in the number of banks in the U.S.
As I have noted in the past, there are several indications that there is an unmet demand
for new bank creation indicated by the ongoing preference for "charter strip"
acquisitions, the ongoing shift of activities out of the banking system, and the rising
demand for banking-as-a-service partnerships.5
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For the past decade, de novo bank formation has been largely stagnant, even as
the banking industry has rapidly evolved over the same time period. Many factors
influence the pursuit of de novo bank charters, including the interest rate environment,
business opportunities, the intense competition for qualified bank management and staff,
and potentially less onerous alternatives for financial services providers to operate
outside of the regulated banking system.
The decision to form a de novo bank is also informed by normal business
considerations including identifying investors, establishing a viable business plan, and
ensuring the ability to navigate the "start-up" phase of a new bank and manage upfront
operational costs, all while being subjected to intense supervisory oversight over the first
several years of de novo bank operation. Yet, perhaps the most important factor that
influences de novo bank formation is the regulatory and supervisory framework, which
includes the application process and receipt of regulatory approval.
The application process can be a significant obstacle to de novo bank formation.
Applications often experience significant delays between the initial charter application
filing with the chartering authority and the Federal Deposit Insurance Corporation
(FDIC) application for deposit insurance. The timeframe for receiving all of the required
regulatory approvals to open for business often takes well in excess of a year. Of course,
this uncertainty must be endured after initial capital has been raised, shareholders
identified, and a management team ready to begin work. As one can imagine, these
delays can present unique challenges for de novo founders including incurring more start-
up expenses than anticipated, having difficulty recruiting and retaining qualified
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management to obtain approval, and experiencing challenges raising additional start-up
capital investment.
Some of the uncertainty surrounding the de novo process flows from supervisory
perceptions of this proposed business model. For example, a de novo business plan that
focuses on providing banking-as-a-service outside of a defined geographic footprint
presents different risks than a business model that focuses on retail banking in an
underserved market. It stands to reason that the regulatory expectations for each business
model, including capital levels, risk management, and compliance, will vary. Even
controlling for the variability in business model, the standards and expectations for a de
novo application that will be viewed and treated favorably are opaque and may shift
significantly over time, even between and among the regulators.
The absence of de novo bank formation over the long run will create a void in the
banking system, a void that may contribute to a decline in the availability of reliable and
fairly priced credit, the absence of financial services in underserved markets, and the
continued shift of banking activities beyond the regulatory perimeter.
Bank Mergers and Acquisitions
A more immediate concerning influence is the dramatically evolving approach to
bank mergers and acquisitions (M&A) by some prudential regulators. It is helpful to
consider bank M&A broadly, to include not only bank-to-bank mergers subject to
approval under the Bank Merger Act, but also the broader set of business combinations
contemplated under sections 3 and 4 of the Bank Holding Company Act, and under
section 10 of the Home Owners' Loan Act.6
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These M&A transactions allow banks to thrive in our dynamic banking system,
and help to promote the long-term health and viability of banks. M&A also ensures that
some institutions have a meaningful path to transitioning bank ownership. In the absence
of a viable M&A framework, we increase the potential for additional risks including
limited opportunities for succession planning, especially in smaller or rural communities
and zombie banks that continue to exist but have no competitive viability or exit strategy.
M&A reform is currently a popular topic on the banking agency regulatory
agenda with the process and standards regulators employ to review and approve
transactions under intense scrutiny. Recently some of the federal banking regulators have
proposed or described new M&A policy approaches, with the Department of Justice
currently reviewing how it enforces section 7 of the Clayton Act.7
As regulators revisit the evaluation standards for bank M&A transactions under
the statutory framework, we should consider whether the regulatory review process is
fair, transparent, and consistent with applicable statutes. This should begin with an
important threshold question-what are the identified shortcomings with the current
process or standards, and are the proposed reforms targeted and effective to address these
shortcomings?
One concern that has been raised about the M&A regulatory approval process
seems largely based on the misconception that a lack of application denials implies that
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standards are simply not rigorous enough, that the regulatory approval process has
become a rubber stamp. This view ignores the reality of the filing process. These
transactions require significant upfront and ongoing investment and commitment of
resources. At the outset, this includes finding an appropriate acquisition target,
conducting due diligence, and negotiating the terms of the transaction. Once a target is
identified, the banks must prepare appropriate regulatory filings, engage with regulators
during the application process, and prepare for post-approval business processes
including scheduling necessary and costly systems conversions and customer transition.
This is an expensive and reputationally risky process that bankers take extremely
seriously. They do not make the decision to file an application lightly. Even for those
institutions that decide to proceed with an application, success is not guaranteed, even in
the absence of a regulatory denial. The Federal Reserve's most recent report on banking
applications activity identifies a significant portion of bank M&A transactions in which
applications have been withdrawn.8
In its recent proposal, one agency suggested that if an applicant withdraws a
filing, that agency's board may release a statement regarding the concerns with the
application in the interest of creating transparency for future applicants.9 I have observed
that applicants may withdraw a filing for a number of reasons, including prolonged
uncertainty due to regulatory delays, expiration of contractual deadlines, and issues that
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are uncovered only during the processing of the application (for example, the issuance of
updated supervisory ratings from recently completed examinations). As a general matter,
this approach could evolve to become the expectation for all withdrawn applications, and,
if so, could put regulators in the untenable position of needing to disclose confidential
supervisory information or nonpublic business information about applicants even in the
case of a withdrawn application.
Just as in the de novo bank formation process, one of the key risks to an effective
M&A process is a lack of timely regulatory action. The consequences of delays can
significantly harm both the acquiring institution and the target, causing greater
operational risk (including the risk of a failed merger), increased expenses, reputational
risk, and staff attrition in the face of prolonged uncertainty.
Reducing the efficiency of bank M&A can be a deterrent to healthy bank
transactions-it can reduce the effectiveness of M&A activity that preserves the presence
of community banks in underserved areas, prevent institutions from pursuing prudent
growth strategies, and actually undermine competition by preventing firms from growing
to a larger scale, effectively creating a "protected class" of larger institutions.
Given all of these considerations, it seems reasonable to assume that the
uncertainty of the M&A process itself may act as a deterrent to de novo bank formation,
as potential bank founders stay on the sidelines knowing that future exit strategies-like
the strategic acquisition of a de novo bank by a larger peer-may face long odds of
success. We must not foreclose bank merger activities that are permitted by law and that
are necessary to maintain a healthy banking system.
Instead, we should focus on ensuring that we can improve the speed and
timeliness of regulatory decisionmaking, applying review standards that are reasonable
and consistent with the statutory framework. Too often it seems that regulators discount
the fact that these organizations do not simply hit the pause button during the merger
review process. We must remember that these organizations are businesses that continue
to operate and must do so in a way that supports their ongoing business operations and
future growth.
Unfortunately, the past year has shown that regulatory attention is increasingly
focused on other issues, with the timeliness of regulatory action appearing to be lower on
the list of priorities. These efforts have not improved the outlook for the bank merger
process. Pending reform efforts may actually exacerbate the existing problems, resulting
in an increase in the already significant delays in processing times for some applications.
Uncertainty in the standards for an application review can drive delays. A federal
agency recently indicated that it may deviate from the longstanding approach to
evaluating competitive effects of a merger using a deposit-based analysis. While this
analysis could be retained as an initial screen, that agency would "evaluate the
competitive effects of a proposed merger in a manner that is most relevant to each
transaction," and "may consider concentrations in any specific products or customer
segments...."10 I imagine bankers contemplating merger transactions will have little
capacity to evaluate whether a merger would raise regulatory issues in advance under this
open-ended standard.
That proposal also includes revisions to the convenience and needs analysis that
may frustrate banks' ability not only to receive regulatory approval, but to manage their
businesses going forward. Specifically, the proposal notes that applicants should be
"prepared to make commitments regarding future retail banking services in the
community to be served for at least three years following consummation of the
merger."11 The proposal also suggests that the resulting bank would be expected to
"better" meet the convenience and needs of the community to be served than it would
absent the merger.12 As is the current expectation, a bank should expect to provide
information on their plans for activities and branches as part of the application process.
But we should acknowledge that those plans may change over time as conditions evolve.
A bank's future activities, whether banking or branching, are subject to regulatory
requirements, and oversight through ongoing supervision activities. We need not operate
like the applications process is the only tool available to address policy concerns. I
expect this proposal would greatly benefit from public input.
Even reported data on current merger processing times may understate the
broader application processing timeline. This process often includes preliminary
discussions and pre-filings with regulators, and delays between the time an application is
filed and when it is "accepted" by the regulator triggering the regulatory processing
clock.13
Finally, the M&A process can be inappropriately influenced when regulators
make demands on firms that are not squarely grounded in statutory approval requirements
or based on safety and soundness considerations. During the application deliberation
process, regulators can impose limitations or restrictions to address specific supervisory
or policy concerns in the form of "conditions" or "commitments" on the approval. While
this can be an important tool, it should not be used to replace rulemaking or existing
regulations and statutes that guide regulatory action; we should not engage in "regulation
by application." Conditions or commitments that impose obligations that are inconsistent
with our existing regulatory framework raise issues of significant concern.14 In these
circumstances, our existing rules and regulations are the most appropriate and effective
tools to address concerns.
Closing Thoughts
Policymakers continue to play an important role in shaping the future of the
banking system, not only through policy choices on substantive regulations and
supervisory approaches, but also through their role in bank formations, mergers, and
acquisitions. We currently have a dynamic banking system, but these individual pieces
of the bank regulatory framework do not function independently. The policy choices
embodied in current regulation and supervision, and in proposed reforms, aggregate to
influence the future of the banking system, often in ways that are unpredictable, and at
times in ways that are in conflict and internally inconsistent.
I hope that today's discussions provide an opportunity to have frank conversations
about the dynamics shaping the future of the banking system. And throughout, that we
identify opportunities to rationalize regulatory approaches, and ensure that the values
regulators say they support-like the importance of a broad and diverse banking system
that includes institutions of all sizes serving all of the different market segments across
the country-are consistent with regulatory actions.
I am concerned that many of these actions may actually undermine the long-term
viability of banks. I look forward to hearing the insights of all of our participants today,
and thinking more deeply about how regulation, supervision, and ongoing reform efforts
can help to positively influence a banking system that will effectively and efficiently
serve communities of all sizes, consumers, businesses, and the broader U.S. economy
long into the future.