What Lies Ahead for Commercial Banks?

By Charles H. Green

Recovering from a financial crisis is no easy feat, with the U.S. economy experiencing a more sluggish recovery since the Great Depression in the 1930s. As the economy slowly and painstakingly gets on its feet, brace yourself for drastic changes in the banking industry, especially for very small and small banks.

After the great financial collapse of Wall Street in 2008, the bankers who didn’t sell toxic CDOs will suffer more than does who did. Main Street banks suffered financially since the Federal Reserve imposed zero interest rates and banks have lost clients due to a high unemployment rate. Add to this is the Dodd-Frank Act. When it is enforced, community banks will have to endure the new financial regulations which are more expensive to smaller banks than larger ones.

In January 2008, there were about 8,600 banks in the U.S., and currently, the number is down to 7,400. Over 2,000 of these banks have assets less than $100 million, and over 4,000 have assets less than $1 billion. These two sectors control only 10% of the U.S. banking assets. What’s interesting is that 100 banks have assets in excess of $10 billion each and they control about 80% of the country’s banking assets.

Many capitalized banks have barely weathered the storm after the financial crisis. How come the banking industry faced such calamity? Here are several factors which contributed in creating the perfect storm:

1. Low Interest Rates Made Everyone Unhappy. The Federal Reserve cut down rates more than 5% in a 13-month period from October, 2007 to November, 2009. The low rates has left most banks without cash since unhappy savers opted to withdraw their money that didn’t earn in banks.

2. Stifling Oversight + Lower Loan Demand = Cannibalized Income. Regulators are breathing down on the bank’s necks, scrutinizing most loans and inspecting most commercial real estate (CRE) secured financing. Community banks are now afraid of giving out loans.

3. Valued Below Book Value. When a bank is not earning money, regardless if it is not losing money, it equity value suffers immediately. The stock market is very sensitive to every change and it is easily reflected in the bank’s equities. Most banks now are faced with the difficulty of raising capital even if they had no problems after the financial crisis.

4. Small Business Confidence. Main Street business are now trying not to make the same mistake twice. Many have delayed growth, refusing to get loans from banks unless there is urgent demand for it. This thinking deprived Main Street banks of small business loans which is their most competitive lending target and important income-generating asset.

Most large banks were able to remain strong after the Great Recession of 2008 but they still have to face the challenge of getting revenues despite the new regulations. As the economy stabilizes, and the new banking regulations have taken place, expect small banks to just cash out instead of lose money by following the new financial rules.

This is the scenario that will most likely take place: the very small banks or those which have less than $100 million in assets will sell to small banks (assets between $100-300 million). These small banks will either merge or sell to medium-sized banks (assets of $300-700 million). The medium banks will be seen as rolling up to become large banks. Banks in the $2 billion range can now raise affordable capital to finance real growth. By 2020, it is possible that the U.S. will only have about 1000-1,500 banks.

Let’s see if our policy makers are serious on imposing a cap on the size of banks to prevent another financial crisis and to protect us, the consumers. CRE development will return and we will see fewer but high quality project returns financed by banks. Expect better CRE financing as slower inventory growth inspire more confidence to lend. There may be fewer banks in the future but we can expect a more vibrant and competitive banking industry.