The Real Reason Why There Are Too Many Banks

When I read Matt Yglesias’ article in Slate on America’s Microbank Problem, it took me a minute, but I realized what it really was: A hack piece of journalism, written simply to call attention to the author and publication.

Yglesia’s case to support his contentions was poorly argued. American Banker easily tore through the arguments in a well written piece.

Another AB editorial, What Matthew Yglesias Should Have Said About Small Banks, posited that the disparity of operating performance across smaller banks is the reason there are too many banks. Well, at least, I think that’s what the gist of the article is. I’ve read the article a few times, and I’m still not sure exactly what the author thinks Yglesias should have said.

According to the article:

“There are currently over 900 publicly traded banks and thrifts with a market capitalization over $10 million. Twenty percent of those 900 or so institutions have returns on average tangible common equity over 12.3%. Five percent are over 17.2%. The bottom 30% post returns below 5.7%. Is 5.7% acceptable? Perhaps it doesn’t look horrible in absolute terms in today’s ultra-low interest rate environment, but it is horrible any way you cut it.”

I’m not quite sure how the variability of average tangible common equity in 900 banks proves that 7,000 banks is too large a number.

There could be any number of reasons why a particular bank’s ATCE is below 5.7%. And probably any number of ways that a bank could increase the ATCE to 17.2%. Should we just eliminate all banks with an ATCE below a certain level? I’m left confused as to what argument the author is making that somehow Yglesias should have used to justify the euthanasia of community banks.

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There is one argument I can see making to justify the claim that there are too many banks in the US:

Supply outstrips demand.

It’s become somewhat popular in the past few years for social media morons and clueless Gen Yers to claim that everything about the past is dead, and that the rules of economics has “fundamentally changed.”

Nonsense. Nothing is as timeless, and relevant, as the interaction between the supply of products/services in a market, and the demand for those products/services.

If the long-term demand for a particular market’s products and services is less than the current capacity the existing set of providers can provide, then something has to give. Existing providers can:

  1. Reduce production capacity;
  2. Go out of business; and/or
  3. Find a way to increase demand.

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Over the past five years, the combination of a weak economy and the regulatory changes made by the current administration have depressed demand for financial services.

By demand, I’m referring indiscriminately to both unit volume and total revenue. The number of mortgages and credit cards needed by the market declined as a result of the recession. But the overall level of revenue generated by FIs has also been suppressed by the pricing limitations (on credit card interest, on overdraft fees, etc.) imposed by regulations.

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If the reduced level of demand for financial services is systemic and persistent, then an argument can be made that there are too many banks (and credit unions). 

Yglesias’ arguments about difficulty to regulate and poor management are ridiculous, and not valid reasons to support the notion there are too many banks.

Lots of restaurants are poorly managed (and there are plenty of health regulations regarding the delivery of food). Many go out of business. But others are created, because the demand for food services is there.  

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If the reduced level of demand for financial services is systemic and persistent, the number of banks and credit unions doesn’t necessarily have to decrease. 

FIs could shrink down through layoffs. But if the aggregate demand — across financial products/services — is significantly lower than it was in the past, this is unlikely to be a successful strategy, and the number of FIs will have to decrease. 

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So that leaves us with 3. Find a way to increase demand.

You might be inclined to argue that the demand for financial services/products is actually there, but not being adequately captured by FIs. 

The rise (albeit, still small) of the Debanked, who are abandoning traditional banks (and banking accounts) for alternatives like Simple and Moven are a good example. But I’d be hard pressed to say that Simple and Moven have put a lot of banks out of business. 

You might be inclined to argue that banks could increase “demand” by capturing the P2P lending volume that’s occurring. But you’d be wrong, and you’d be misinterpreting the definition of supply and demand. 

If I say I want a Maserati, does that constitute “demand” for a Maserati? There’s no way I can afford a Maserati (well, maybe I could, but good luck getting my wife to spend all of our retirement savings). For Maserati to capture that “demand,” it would have to lower the price of the car to point at which it wouldn’t be profitable to them.

It’s an analogous situation with banks and P2p lending. Banks have lending guidelines. The “demand” for loans constitutes the demand that fits those guidelines. One way of increasing “demand” for loans is to loosen the guidelines. Basically, credit card issuers have done that to increase “demand” for cards.

But as long as FIs maintain lending guidelines — i.e., maintain profitable pricing levels — that exclude certain consumers, P2P borrowers won’t constitute demand.

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If FIs’ attempts to increase market demand is limited to finding new ways to sell existing products and services, they’re screwed unless: 1) the economy heats up, and/or 2) new generations produce significantly new numbers of customers. 

If either of these things happen, it just proves that the current reduced level of demand is not systemic and persistent. 

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The other way the existing number of FIs can remain stable is if FIs develop new products and services to sell that grow the overall level of demand.

The current track record among FIs isn’t bright. 

Banks give away PFM and online bill pay for free. P2P payments has failed to generate much additional revenue. 

The innovations that the market seems to get excited about — things like Coin, Loop, or other mobile payment-related stuff — don’t generate revenue (demand) for FIs. 

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Please note that “mobile” isn’t the cause for banks going out of business. It’s about the reduced level of demand for financial products and services. 

Mobile has helped to create alternative suppliers to the existing level of demand, but that’s just one factor chipping away at the number of banks.

And mobile offers as much opportunity to banks to find ways to create new demand by leveraging the technology to create new products and services.  

Bottom line: The real reason why there are too many banks — or, more accurately, why there may be too many banks — is about supply and demand. And not any of that stuff that Yglesias and Slate mumbled about.

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