Tom Hoenig continues to be one of the biggest advocates for community banking. President of the Kansas City Federal Reserve Bank, Hoenig said the main threat to the community bank business model is bad public policy which gives advantages to the nation’s largest banks. The U.S. House of Representatives Committee on Financial Services, subcommittee on oversight and investigations, hosted a hearing in Overland, Kan., yesterday where Hoenig spoke.
“Over the past 20 years, as the banking industry has consolidated into fewer and larger banks, a perennial question has been, ‘Is the community bank model viable?’ The short answer is yes. The longer answer is yes, if they are not put at a competitive disadvantage by policies which favor and subsidize the largest financial institutions,” Hoenig said at the hearing conducted by U.S. Rep. Dennis Moore (D-Kan.).
“The community bank business model has held up well when compared with the megabank model that had to be propped up with taxpayer funding.
“Community banks will survive the crisis and recession and will continue to play their role as the economy recovers. The more lasting threat to their survival, however, concerns whether this model will continue to be placed at a competitive disadvantage to larger banks… If allowed to compete on a fair and level playing field, the community bank model is a winner.”
Read his entire testimony here.
Look for hearing coverage in the Sept. 15 print edition of NorthWestern Financial Review magazine.
I have been a fan of Ben Crabtree for many years; he is an analyst who has following the banking industry for decades. He currently works with Oak Ridge Financial Services Group. He is kind enough to send me is month analysis, and his July essay caught my eye. While banks might be inclined to “hunker down” given stressful economic conditions, he suggests the strongest banks will make the most of the current market.
He writes:
Given the regulatory uncertainties in this highly-regulated industry, the probability that asset quality pressures will remain quite high (though probably not increasing much) well into next year, and the prospect for no more than a muted recovery in a de-leveraging economy, it would not be surprising to see a lot of basically sound banks decide to pull back into their shells until they could look into the future with more clarity and confidence.
Ultimately, that may not prove to be the best strategy, however; the confluence of pressures on profitability and balance sheet ratios, the increase regulatory burdens, and the poor odds that the industry will get “bailed out” by a strong economic rebound should mean that the bank industry will be in a period of significant restructuring and market share shifts. Banks that are highly threatened by this environment are likely to at best stay dead in the water, and are more likely to shrink. This will mean that banks that are well positioned with strong management, capital ratios that are clearly more than adequate, a loan portfolio that has truly been scrubbed, “best practices” in all important procedures and policies, and healthy regulatory relationships can make substantial market share gains by taking customers away from weaker banks and/or actually expanding via accretive acquisitions, thereby taking advantage of the industry turmoil that will almost surely occur.
My translation: Expect increased industry consolidation in the coming year or two.
The House Judiciary Committee is conducting a hearing today on the Credit Card Fair Fee Act (H.R. 2695), a bill the banking industry strongly opposes. While so much attention is focused on industry reform, this bill would have a far more significant impact on community banks than most of the provisions in the reg reform bills. H.R. 2695 would basically make it uneconomical for smaller banks to offer credit and debit card services to local merchants. If the bill passes, that business will completely migrate to the largest players, leaving smaller players and their communities out in the cold.
Here is how Kenneth Clayton, senior vice president and general counsel for the American Bankers Association, explained it in a statement issued earlier today:
“The Credit Card Fair Fee Act represents yet another attempt by the merchant community to try, at the behest of large retailers, to get Congress to lower their cost of doing business, all to the detriment of consumers and the broader economy.
“Banks of all sizes…take on significant risks and costs when they issue both debit and credit cards. These include extensive infrastructure costs, fraud costs and the real risk of non-payment. Interchange fees compensate banks for taking on these burdens and make it possible for banks to offer consumers better services, more competitive choices, and lower prices.
“The legislation under consideration today would take away these benefits and inappropriately shift the cost burdens onto consumers…”
I encourage you to learn more about this issue. The Electronic Payments Coalition has an excellent web site providing the details.
President Obama wanted to hit the largest banks with a bailout fee; now the Congressional Budget Office has come out with a report saying consumers would end up paying that fee. Read about it here.
The president has also suggested that $30 billion in TARP funds should go to community banks to spur Main Street lending. Many bankers are lukewarm on the idea because there is such a stigma attached to TARP. Treasury is picking up on community banker reluctance and now I am hearing talk about the government giving the $30 billion to the Small Business Administration to make direct loans to small businesses. This, of course, would be a disaster. Bankers don’t need another government-sponsored competitor, and taxpayers don’t need a government lender with goals that put it at odds with safe and sound banking practices.
Many of the community bankers I interviewed last year said flight-to-safety inflows and new business from customers moving out of big banks were causing deposits to swell. Looks like they weren’t alone. This Bloomberg/Business Week analysis of Q4 earnings indicates that the top-10 banks expanded their deposit bases for the first time in four years.
“JPMorgan Chase & Co. posted an 8.1 percent rise to $938 billion, the biggest gain, led by increases in deposits from corporate clients…U.S. Bancorp said deposits rose 7.9 percent after the Minneapolis-based lender acquired $15 billion in deposits from FBOP Corp., which failed in October.”
The 40-biggest U.S. banks reported an average 8-percent rise in deposits.
Speaking of the former FBOP Corp., check out the Feb. 15 edition of NorthWestern Financial Review for firsthand testimony on that company’s complicated demise.
Yesterday’s rate-comparison announcement from the National Credit Union Administration illustrates a point I’ve heard repeatedly in reporting an upcoming story about credit unions: if CUs are having a hard time raising enough capital to keep pace with share growth, they should curb that growth by paying less in dividends/interest. In the seven CD categories tracked by the NCUA survey, credit unions paid, on average, 31 bps more than banks for deposits.
The pace of share growth at some credit unions is certainly causing capital concerns, as indicated in this December letter from NCUA chairman Debbie Matz to Congressman Barney Frank, chair of the House Financial Services Committee. In the letter Matz points out that some credit unions are reluctant to take in more deposits, which, without a corresponding rise in capital, diminish net worth and make the credit union susceptible to prompt corrective action.
“The risk of reputational damage from being branded less than ‘well capitalized’ and in need of ‘restoring’ net worth…is reportedly having a significant chilling effect on the willingness of some ‘well capitalized’ credit unions to accept new share deposits,” Matz said.
H/t to CSBS Newbytes.
The president indicated in his weekly address that it was good to see banks paying back their TARP obligations (with interest) but “not good enough.” He scolded as audacious those who say “that it’s somehow unfair, that because these firms have already returned what they borrowed directly, their obligation is fulfilled.”
Leaving aside questions of whether it’s fair to change terms after repayment, or whether banks should cover the shortfall caused by non-bank TARP recipients, there is still the question of likely effect. In his earlier post, Tom conceded “a certain intellectual appeal” in the proposed fee. Mike Moebs, principal at a Lake Bluff, Ill.-based financial services consultancy, said that “for all the wrong reasons” President Obama may be doing a good thing by taxing big banks. “If the big guys are beyond their economies of scale, why not use the price mechanism?” Moebs said.
“In Great Britain they’re taking the likes of the Royal Bank of Scotland and Barclays and saying to Royal Bank of Scotland, you’ve got to get rid of 900 branches by the end of the first quarter of this year; Barclays, you have to get rid of 1,000 branches. That’s more of a hatchet-type of approach…but Obama is stepping in and saying, I’m not going to face those social and political consequences; I’m just going to tax you guys–and I’m not going to tax the small [banks]. So your prices for your services have got to go up, and the small guys [will] have a competitive advantage. Now, if you big guys don’t bring down your cost, the small guys are going to win.”
The tax could cause big banks “to reduce [their] long-term average cost of operation, which is what the economy of scale is, and get it back down [to where} the small guys [are],” Moebs said.
Meanwhile, the president discussed additional big-bank reforms today.
Congressional policy analysts frequently debate whether to use static scoring or dynamic scoring. The debate often comes up in the context of tax revenue. If the government increases taxes, static scoring records the amount of additional anticipated income to Uncle Sam according to the new mathematical formula. Dynamic scoring can be used to analyze the same tax increase but will come up with a different result because it will figure in the effects of human behavior that will be motivated by the new tax structure. Higher taxes might mean businesses invest less, so the additional revenue to Uncle Sam is less than figured under static scoring.
It is a concept business people readily understand. For example, a magazine publisher with 100,000 subscribers cannot plan on $1 million in new revenue after raising the subscription price by $10. He has to figure in the number of people who will discontinue their subscription as a result of the higher price. If enough people drop their subscription, then the price increase yields little or no new revenue.
Financial reform legislation needs to be considered through the lens of dynamic scoring. One provision in the recently-passed House bill shifts the formula for calculating deposit insurance premiums to an asset base from the current domestic deposit base. Currently, the largest banks in the country typically pay a premium that reflects a smaller portion of their balance sheet than the nation’s community banks, which typically pay a premium that reflects almost all of their balance sheet. That’s because community banks rely on domestic deposits to fund their balance sheets much more than the largest banks, which have easier access to other sources of funding. The formula shift is intended to correct the imbalance. But I wonder what kind of research has been done to determine how such a shift would affect the behavior of the largest banks.
If you based the premium assessment solely on assets, then you remove an important expense currently related to attracting domestic deposits. To what extent do large banks currently focus on funding sources that are less expensive than domestic deposits? If you remove the insurance premium associated with domestic deposits, do those deposits then become less expensive than other sources? Would this then encourage large banks to work more aggressively to attract domestic deposits? What kind of new competition would this pose to community banks?
I haven’t seen any analysis that addresses these questions. I raised the issue with a contact at Wells Fargo, but they declined to comment, consistent with their policy of not commenting on pending legislation.
At this point, we have no idea what will happen with financial reform legislation, and whether it will include the new formula for figuring the deposit insurance premium. But I think whatever changes are proposed, corresponding changes in behavior should be considered.
Merchants have launched some timely attacks on interchange fees, saying they curb job creation and prolong the recession while raising prices on consumers who are struggling to buy holiday gifts. This news release claims that reducing interchange fees by 1 percent could create 1.3 million jobs.
Roger Claypool, chairman of the Iowa Bankers Association, gave a banker’s perspective on interchange fees at an industry meeting earlier this fall, saying interchange
“covers the credit risk component of issuing those cards and having that card base, and more importantly covers the fraud costs that go along with that…If you strip that away, we are left with a card base that we have to find a way to fund, and that will ultimately come back to the consumer. Nobody wants that.”
The Merchants Payments Association, which includes big players like the National Retail Federation, plus a couple of dozen state associations in the NorthWestern Financial Review readership area, has a different perspective.
Beside a lousy economy and a sense (if not a certainty) that they’re suffering for the excesses of their most ruthless competitors, self-described “good” banks are facing plenty of consequent headwinds. Just a few, gleaned from magazine interviews over the last few months:
- Paying for strength: the financial crisis may have drawn customers to banks with lots of capital and liquidity, but those things are expensive to maintain. Will customers continue to pay for strength? Bankers and consultants note that it’s the weak banks that have to pay up on deposits–but good banks have to compete with the weak ones for funds–and it’s not easy to sell stability over basis points.
- Guiding perception: customers and employees may be aware that your nonperforming loans and charge offs are higher. Is it beneficial to compare your results to your competitors’? If your problem loans are higher now but still noticeably lower than what your competitors are reporting, do you highlight that information?
- Maintaining morale: can employees accept that “least bad” or “relatively good” are as good as it gets in some cases? Bankers say it’s an ongoing challenge to help employees understand why they should feel good about their banks, especially when employees perceive that they could make more money at bigger–albeit more troubled–banks. As one banker said: “you need to be happy making less money if you work for a good bank; it’s a lifestyle decision.”
