The Decline of De Novos

During the recent financial crisis, one class of banks that suffered failure at a disproportionately high rate was that of the de novo (newly chartered) banks. Newly chartered institutions, from the mid-1990s through the time that the crisis hit, did not fare well. Indiana, however, was an exception. Thanks to solid, conservative leadership of the Indiana Department of Financial Institutions ‒ which continues to this day ‒ de novo applications in Indiana were screened properly. This was not the case in many other states, for example Georgia and Florida, that did a poor job of screening applications. It seemed that nearly anyone who could raise $15 million in capital could obtain a charter, regardless of the quality of the business plan. Shame on those directly responsible for their lack of due diligence, and shame on the Federal Deposit Insurance Corp. for insuring those deposits without adequate review.

The result of these poor decisions is that all of the diligent banks and state departments lost billions of dollars, plus felt the sting of eroded public confidence and tarnished reputations. This is a cause-and-effect that has never been thoroughly studied or reported, which I find baffling.

Regardless, we now find ourselves subject to a pendulum that has swung too far the other way. The story of de novo banks during the past 20 years is truly a tale of two extremes. From 1996 through 2007, the United States averaged 129 de novo banks annually. Undoubtedly this was too many, since so many of them failed. In 2008, when the crisis fully unfolded, the number of de novos dropped to 73. In retrospect, few of those should have been chartered. In 2009 there were only 20 de novos. Most recently, during the six-year period from 2010 through 2015, there have only been four new charters granted throughout the nation.

What might be the reasons for this drastic pendulum swing? I suspect there are several. First, the banking regulators have been beaten up by Congress over the financial crisis so badly that they are afraid to make any decisions that could be criticized later. Second, Congress has passed a litany of laws, including the Dodd-Frank Act, that have increased the regulatory burden to where it is extremely difficult for any bank to make a profit that will attract investors in the capital markets. This particularly affects small community banks ‒ which is how all banks start out. Third, anyone who is willing to start a bank today has to have a very good, specific reason for doing so. Otherwise, why would anyone subject themselves to this level of scrutiny for such a small return?

The United States is unique in the world because of our diversified financial services industry. We have banks that serve small communities, we have banks that serve midsized regions, we have banks that serve entire states, we have banks that serve the country, and we have banks that serve internationally. Since the financial crisis, many banks have failed, and many more have merged. The outcome is that banks are getting bigger, and there are fewer of them. Consequently many communities are no longer served by a locally owned bank, and some communities are no longer served by any bank. Sadly, those communities are dying.

The only hope of retaining our unique financial services structure, which has made the United States the most financially powerful country ever on earth and the envy of the world, is to roll back the regulatory burden so that small banks can survive, and so that regulators can find the right formula to allow de novo banks to once again be chartered regularly. Let’s hope that message reaches the powerful people in Washington, D.C., before it is too late.

– S. Joe DeHaven

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