The Incredible Shrinking Banking Industry

Knowledge @ Wharton ran an article recently called The Shrinking U.S. Banking Sector: On Balance, Who Benefits? Interesting read. I’ve got some thoughts regarding some of the points made in the article.


K@W: Many experts expect consolidation to continue, and predict that the trend will leave the banking system better off in the long run. “We don’t really need as many banks as we used to,” says Jack Guttentag, a finance emeritus professor at Wharton and former economist at the Federal Reserve Bank of New York. “Banks now have the power to [set up branches] wherever they want to, so what really matters is how many options a customer has in a certain market.”

My take: Huh? The options that a customer has in any particular market is hardly determined by how many banks establish a branch (or branches) in that market. Has Mr. Guttentag not been on the Internet? You can open a checking account, put money in a savings account, apply for loans, etc. with any number of providers. Although the absolute number of financial institutions might be declining, thanks to the Internet, the effective number of providers that any one customer can do business with has increased.


K@W: A market, such as the one in the U.S., that is “over-banked,” with a supply of banking services exceeding demand, is generally good for consumers because it results in lower prices — i.e., lower loan rates, loan/deposit fees and higher deposit rates — and higher output [in terms of] more varied and innovative products. Some may argue that ‘over-competition’ [or over-banking] could drive weaker banks out of business — as happened to Washington Mutual in 2008 — but then someone else comes in and replaces them, yet may reduce the number of offices and amount of services.

My take: There are two points to respond to here. First, regarding the US as being “over-banked” because the “supply of services exceeds demand.” What does that mean?

In a market of physical goods, it’s possible for supply and demand to be out of alignment — that is, too much or too little supply relative to the demand. But banking products are virtual products. There is no “physical” supply. How can anyone determine that the supply exceeds demand?

Theoretically, the entire demand for all checking accounts in the US could be met by a single bank, if it had enough computing power to handle the load. The concept of “service capacity” in the world of banking is not analogous the the concept of “manufacturing capacity” in physical product industries.  

Second, if you believe that “over-competition” drove Washington Mutual out of business, I hope you’ll share some of that wacky weed you’re smoking with me.


K@W: The institutions that will likely be hardest hit by all this activity will be the community banks. For many of them, the arrival of the recent Dodd-Frank Wall Street Reform and Consumer Protection Act was a death knell.Tougher controls involving capital, liquidity and leverage, and a surge in regulatory red tape, have left such banks struggling, particularly those with less than $500 million of assets. “Many small banks feel that they are being pushed out of existence by new regulations,” Thomas states.

My take: Amen, brother.


K@W: “Even if the number of banks shrinks from 6,000 to 100, if those 100 are operating in all market segments and if consumers have many options, there is no reason for concern,” Guttentag says.

My take: This is a tricky statement. On one hand, there is some truth to it — if a customer truly has 100 providers to choose from, you’d have a tough time convincing me that that wasn’t sufficient choice.

But what concerns me is the part that says “if those 100 are operating in all market segments.” For an FI to operate in all market segments, it would have to be a pretty big firm, no? Do we really want 100 mega-banks in the industry?

Here’s the bigger problem: I bet that when Mr. Guttentag refers to market segments, he’s referring to geographic segments. But geography is irrelevant in a market for virtual products and services. Customer segments are far more relevant. The challenge, however, is that while geographies are — more or less — well defined, customer segments aren’t. So it’s very unlikely that 100 firms could possibly serve all segments. 


In its description of the 1957 movie The Incredible Shrinking Man, Wikipedia says:

Robert Scott Carey is a businessman who is on vacation on a boat, off the Californian coast, when he suddenly is contaminated by a radioactive cloud. Six months later, Scott notices that his shirt seems too big. He blames it on the cleaners. His wedding ring falls off his finger. As this trend continues, Scott believes he is shrinking. Scott visits a  research lab and learns that exposure to the radioactive mist caused his cells to shrink. He is told that he will never return to his former size, unless a cure is found, and that the antidote will only arrest the shrinking. The film’s ending  implies Scott will eventually shrink to atomic size; but, no matter how small he shrinks, Scott concludes he will still matter in the universe and this thought gives him comfort and ends his fears of the future.

Sounds like the banking industry, no? Shrinking, told it will never return to its former size, but comforted in believing that it still matters in the universe.

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