Why Do I Need a Commercial Bank?

There is really no reason for me to be a customer of a commercial bank. 

Full disclosure: I am not the customer of a commercial bank. 

There is really little or no reason for many people…and businesses…and non-for-profit organizations…to be a customer of a commercial bank.

Here again, however, we are getting a bifurcation of the society. 

The world is splitting into those people, people with even a modest amount of wealth and some financial sophistication, who do not really need a bank and other people, who need only the very basic products and services offered by some kind of a banking organization.  And, in the latter case, a credit union is often the best place they could go to get the kind of products and services that they need.

Pushing this split along is…of course…the regulators. 

Allan Meltzer, in his delightful little book “Why Capitalism?”(Oxford University Press: 2012)   presents his two laws of regulation.  His first law of regulation: “Lawyers and bureaucrats regulate. Markets circumvent regulation.  His second law of regulation: “Regulations are static.  Markets are dynamic.  If circumvention does not occur at first it will occur later.”  The regulators, in their attempt to prevent a recurrence of 2008, are pushing the financial system well beyond what it once was.

Furthermore, advances in information technology are making circumvention easier and easier every day.  If finance is just information…which it is…and information can be presented in any form that can be useful, then financial information can be “sliced and diced” in any way that can serve the needs of a person or an organization.  And, it can be done almost instantenously.  This certainly will contribute to the ability of financial institutions to “circumvent regulation”.

The Financial Times devotes two pages in its April 10, 2012 issue to “shadow banking.”  To include the scope of this area, the Financial Times lists “alternative forms of finance.”  These alternative forms include leveraged finance, broker-dealers, hedge funds, money market funds, insurers, blue-chip lenders, mortgage servicing, peer-to-peer lenders, and governments. 

The paper even has a case study of what Siemens is doing to protect its money and to provide credit to suppliers as well as customers.  And, Siemens operation has been expanding over the past five years, rather than shrinking like many other “banking” organizations and now has a presence in such emerging markets as China, India, and Russia. 

Even Vikram Pandit, the chief executive officer of Citigroup, a form hedge fund manager, has stated that “One of the many unintended consequences of the brutal regulatory crackdown on banks is that there is now a massive incentive to be a shadow bank.”

But, there has also been a massive shift in terms of what is available to individuals and families on the financial front.  If you would have told be a few years ago that I would have no need of a commercial bank I would have said that you were delusional.  Now, as I said above, I do not do my “banking business” with a commercial bank. 

And, the situation is becoming even more desperate for the commercial banking industry.  The American Bankers Association is frantically fighting legislative bill S. 2231 which contains legislation that would allow credit unions to more than double the amount of business loans they could keep on their books.  The ABA argues that a vote for this legislation is a “vote against your community banks.”  ABA material goes on to say that “This special-interest bill allows aggressive credit unions to leverage their tax advantage to steal loans from community banks.”

It could be noted that credit unions are not taxed because they are mutual organizations…like mutual savings banks and savings and loan associations before them…but also have a lower cost structure that adds to their ability to attract business. 

The financial industry is changing and is changing dramatically.  Technology is speeding this change along, but so is regulation.  It is obvious that the press is now very aware of the innovations that are taking place.  More and more we see articles on mobile banking, new financial instruments being formed, products and services being offered in a different way, and global organizations penetrating more and more into regional and local banking markets. 

More and more people I talk with do not keep their business at a commercial bank any more.  Most of the young people (in their teens) I know are so sophisticated technologically that it is ridiculous to think that they will have anything to do with commercial banks.  And, if that is true, what will the case be for their brothers and sisters that are only five, let alone ten, years younger than they are?

The American Bankers Association admits that “Community banks account for a little more than 10 percent of the banking assets in our country….”  I cannot envision a scenario in which this percentage will increase…even if the credit union legislation mentioned above is defeated. 

In fact, I cannot envision a scenario in which the larger financial organizations do not become more and more like “shadow banks” rather than commercial banks.  Global competition will demand it.      

Larger Banks Are Changing the Banking Landscape

In a recent New York Times op-ed piece, the finance blogger at Reuters, Felix Salmon, wrote about the higher fees being charged customers at larger commercial banks in the United States. 

Salmon states, “As bank fees have moved from being invisible to being visible, the inefficiency and greed of the big banks has become ever more obvious.  The result is heartening: In 2011, more than 1.3 million Americans opened a new account at a credit union.

In part that’s because smaller banks and credit unions are a better fit for the average consumer.  They don’t have the huge branch networks to support, they pay their executives mush less and they don’t generally feel the need to be enormously profitable in the first place…

So, rather than kvetch about monthly checking-account fees, let’s celebrate them.  With any luck they’ll be just the thing we need to finally get around to closing our accounts at Citibank or Wells Fargo or Bank of America or Chase, and opening a new account at a better, friendlier—and cheaper—bank.” (http://www.nytimes.com/2012/03/11/opinion/sunday/higher-bank-fees-are-a-good-sign.html?_r=1&scp=3&sq=felix%20salmon&st=cse)

This reminds me of the time I was sitting in the executive quarters of a large savings bank in Philadelphia in the late 1970s.  I was talking with several of the senior people on the retail side of the bank.  They were ecstatic about the fact that their bank had just picked up more than 5,000 new accounts over the past month or so from a commercial bank that had recently started charging depositors explicit fees on their checking accounts as well as on some other transactions related products. 

This scene was ironic to me because about a week before, I was talking with some senior executives from the commercial bank that had raised its fees and they were very, very excited about all the accounts they were losing because of the new charges.  They were excited because the accounts they were losing were generally low balance, high transactions accounts…in other words, very costly accounts…and this had been one of the objectives they had hoped to achieve with the imposition of the higher fees.

Note: the savings bank failed while the commercial bank remained healthy and was ultimately acquired by a larger, national organization that was diversifying geographically.

This story came back to me in reading the New York Times article because I see some of the fee activity of the larger banks as an effort to encourage certain bank customers to leave these larger banks and take their accounts to the smaller commercial banks or credit unions. As with the commercial bank I described above, by raising certain fees and charges, these larger banks were allowing their customers to “self select” and take their business elsewhere. 

Of course, some of these larger banks presented their new fees in such a way that they got a lot of unfavorable publicity that they didn’t really want and so they immediately backed off.  And, this news played into the “Occupy” movement and helped its cause. 

But, I would say, the larger banks got what they wanted.  According to Saxon, 1.3 million Americans opened a new account at a credit union.  And, even more opened accounts at “smaller” commercial banks.

What’s going on here?

Well, this is a part of the new, evolving financial system. 

Are the larger banks really unhappy about this movement?  I don’t think so.  The larger commercial banks are getting larger.  The share of banking assets going to the smaller banks is declining.  In February 2012, the largest 25 domestically chartered commercial banks in the United States made up just about 66 percent of the total assets of all domestically chartered banks.  In February 2008, just before the financial crisis took place, the largest 25 banks in the United States held less than 65 percent of the total assets. 

Note: total assets at all domestically chartered commercial banks were just about 13 percent larger in February 2012 than they were in February 2008.

Furthermore, at the end of the year 2011 there were 6,290 commercial banks in the banking system, almost 1,000 fewer than existed at the end of the year 2007 when there were 7,284 commercial banks in existence.  The shrinkage came in the number of “smaller” banks.

But, Salmon writes: “From a consumer’s point of view, this trend (the movement of deposits to smaller commercial banks and credit unions) will create a virtuous cycle.  As deposits leave the big banks for smaller competitors, the too-big-to-fail crew will inevitably lose political clout—and eventually, start shrinking.”

What am I missing here that Salmon sees?

I agree that things are changing, but I see them changing in a different way.  Less wealthy individuals and businesses will move to smaller banks and credit unions.  These people will prosper at not-for-profit, low overhead organizations.  These financial institutions will offer more basic banking products and services and will thrive.  And, their customer base will be very happy. (http://seekingalpha.com/article/420741-commercial-banks-can-t-get-a-break)

Wealthier customers and larger businesses will work with the newly re-structured larger banks.  We see this taking place already as JPMorgan Chase and Citigroup, Bank of America and Wells Fargo are creating new relationships, new branches, and new lounges to attract a more affluent customer.  This new target is the “mass affluent”.   These are people with assets in the “hundreds of millions.” 

This, however, is not just about “banking” but about mutual funds, stocks and retirement advice and so on and so forth.  This approach is providing the customer with complete, timely, fluid, low cost management of the “customers’” wealth.  These banks are not going after the top 1%, but they are going after the top 10%.

Not only are these accounts more lucrative, they “also face less of a pinch under new government regulations than do those of ordinary savers.” (http://www.nytimes.com/2012/03/11/business/to-increase-revenue-banks-go-after-affluent.html?scp=6&sq=nelson%20schwartz&st=cse)

And, what kinds of managers are being brought into these banks by the Board of Directors?  Not just commercial bankers, oh, no!  Commercial bankers are just “debt” guys…people that only understand advancing money if there is adequate collateral and don’t get all agitated if the borrowers credit rating is not the best.  They understand loan classifications like business loans, mortgages, consumer loans, and commercial real estate loans.     

No, the recent trend…although it is not absolute…is to bring in investment bankers at or near the top.  Investment bankers are “equity” guys…they understand ownership…and, they understand risk management.  And, they understand asset classes and portfolios of assets. (http://www.ft.com/intl/cms/s/0/0e80a8c6-6c6c-11e1-b00f-00144feab49a.html#axzz1p1BAmhf3)

So, we should celebrate, with Felix Salmon, the movement of small deposit accounts to the smaller banks and credit unions.  However, I am not sure that I am celebrating this movement for the same reason that he is.   

Commercial Banks Can't Get a Break!

Commercial banks, other than the very largest, just cannot get a break these days.  With their numbers shrinking and numerous loan problems still to be faced, “main street” bankers are facing more and more competition from another group of interlopers…credit unions. 

The commercial banking industry got rid of another bunch of competitors…thrift institutions…and now they are challenged by another not-for-profit upstart. 

In the 1950s and 1960s commercial banks were threatened by the “mutual” savings and loan associations and the mutual savings banks, but the government created credit inflation pushed the thrift industry towards insolvency as interest rates rose along with inflationary expectations. 

The thrift industry was “saved” as numerous savings and loan associations and mutual savings banks converted to “stock” institutions…as it turned out the best thing that could have happened for the commercial banking industry.

Full disclosure: I led the mutual savings bank Wilmington Savings Fund Society (WSFS) into a stock conversion and initial public offering as CFO in the 1980s and I was the President and CEO of a “converted” savings and loan association, First American Savings, into the early 1990s.

The thrift industry, with many of its institutions converted to “stock”, with expanded capabilities of lending and non-bank subsidiaries, basically self-destructed in the thrift crisis of the early 1990s.  The industry never recovered and essentially went out of business in 2011.

Full disclosure: Wilmington Savings Fund Society is still in existence and healthy; First American Savings…or at that time, Flagship Financial Corp…was a healthy institution acquired by PNC bank of Philadelphia in 1991.

Now, the commercial banking industry is being attacked from another angle.  Not only has the credit union industry changed dramatically over the past ten years, but it is healthy and growing.  Some credit unions have been able to shed their very narrow “field of membership” and now have become a significant “banking” force within their local region. 

To re-emphasize…credit unions are non-profit organizations and are tax-exempt institutions. 

They have been very local in orientation and have been very customer orientated.  Many credit unions have specialized memberships either associated with specific organizations…churches, police departments, and schools…or restricted geographical markets.  Also, there are many credit unions that bear a “low income” designation and work closely with local communities in an effort to encourage financial knowledge within the community.

But, some of the credit unions are getting a little pushing.  Now, credit unions are asking for Congress to raise the member business-lending cap for a few of the larger credit unions from 12.25 percent of total assets to 27.5 percent.  And, guess what…the legislation is actually bi-partisan being introduced by the Democratic Senator from Colorado, Mark Udall, and House Representatives Ed Royce, a Republican from California, and Carolyn McCarthy, a Democrat from New York!

The American Bankers Association is against this legislation!  Surprise!

As a backup, however, the American Bankers Association, also signed by 50 state bankers associations, has sent a letter to all House and Senate members arguing that any credit union that obtains increased business-lending authority should pay taxes.

Well, you have to be prepared if you lose the first battle. 

What’s going on here?

Banking is changing.  The big banks are getting bigger and are moving more and more into electronic payments.  JPMorgan Chase & Co., Capital One Financial Corp., and Barclays PLC have moved to let customers use a mobile-payments service. (Wal-Mart Stores, Inc. and Target Corp. along with about two dozen other retailers are working together to develop a mobile-payments system to compete with similar efforts of Google, Inc. and big cellphone companies.)

Note that the banking communities in the developed world seem to be behind those in the emerging nations when it comes to mobile banking. (See “The End of Money” by David Wolman)  One of the leaders in this effort for the less-developed world is the Bill and Melinda Gates Foundation.  Lots of “stuff” is happening here.  And, the technology is there.   

Mobile banking in emerging nations is bringing banking services to the poor and less serviced population in these countries.  But, one of the secrets to this effort is economies of scale.  Mobile banking works best where a “service” has millions of customers, not tens of thousands.

My point is that the smaller banks cannot create such systems.  Furthermore, for the poor or disadvantaged, “commercial, for profit” institutions are perhaps not cost effective.  “Commercial, for-profit” banking institutions are not economically feasible

As we move into the new banking world with the new regulations, I see the industry bifurcating more and more into community organizations that deal with individuals that do not have large asset holdings and primarily need transaction services and places to build up individual/family savings, and larger institutions that are almost totally internet-based that provide a multitude of products and services and allow their customers to transfer funds between classes of assets easily and in real-time.

“Commercial banks” may not be the economically effective way to serve this the former population.  Here, credit unions, mutually owned, may fill in this gap.  The latter market, however, will be served by bigger institutions that allow their customers to manage their portfolios on-line and not work with independent deposits and assets classes, as is now the case.  (There is one question about these larger institutions…will we be calling them “banks”?) 

There will be a third player in this area…the provider of mobile banking services.  These service providers may or may not be owned by a bank but may work with banks much as the credit card companies have.

This is just a simple view of the possibilities for the future.  The fact is that this future is being created right now.  Commercial banks, especially all the ones below the largest twenty-five or so, are under a severe threat.  As in the 1970s and 1980s when the structure of the depository institutions industry was threatened by credit inflation and changes in information technology, the structure of the industry now finds itself under attack from what remains of the financial crisis of the past several years and the changes in information technology. 

Looking back to the 1960s and 1970s who would have ever thought that the thrift industry would disappear?  Now, I believe, we are facing another huge change to the structure of financial firms.  It will be interesting to see what results.