What are the reasons behind the decline in new bank and credit union charter applications?

What happened

Members of the House Financial Services Financial Institutions and Consumer Credit Subcommittee considered this question at a recent hearing, "Ending the De Novo Drought: Examining the Application Process for De Novo Financial Institutions." In a memorandum released prior to the hearing, lawmakers noted that the number of new bank and credit union charters has declined to historic laws.

Between 2000 and 2008, 1,341 new banks and 75 new credit unions were chartered. But from 2010 to 2016—after the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act—only five new banks and 16 new credit union charters were approved.

Speaking on behalf of the American Bankers Association, Ken L. Burgess, Chairman of FirstCapital Bank of Texas, placed the blame squarely at the feet of the statute. "Lack of de novos has its roots in excessive regulation," he said. "If I were in the position of starting a bank under today's conditions, I would not do so."

Excessive and complex regulations that are not tailored to the risks of specific institutions are driving banks to merge and creating barriers to entry for new banks, Burgess said, noting that 1,917 banks (or 24 percent of the industry) have "disappeared" since Dodd-Frank was enacted.

While Burgess acknowledged that the Federal Deposit Insurance Corporation (FDIC) launched a concerted effort to encourage de novos, this movement cannot "address the underlying issues that create the barriers to entry: capital hurdles, unreasonable regulatory expectations on directors, funding constraints, an inflexible regulatory infrastructure, technology investments, and tax-favored competition from credit unions and the Farm Credit System."

Capital thresholds are too high, funding constraints limit asset growth, and earning assets are under stress, Burgess told lawmakers. "If it does not make economic sense, no one will start a new bank," he said. "Look no further than the lack of new charters for proof of this. Fix the underlying problems and new charters will result."

He offered several suggestions to spur the creation of de novos, including a fast track for new banks, reducing the minimum initial capital and required capital ratio for the first three years, and further reduction of the "penalty box."

Keith Stone, President and Chief Executive Officer of The Finest Federal Credit Union, testified on behalf of the National Association of Federally-Insured Credit Unions and similarly pointed the finger at Dodd-Frank.

The number of credit unions has decreased by 20 percent since the law's enactment, "largely due to the drastic increase in regulation—mostly stemming from the new [Consumer Financial Protection Bureau]—that many smaller credit unions simply can't keep up with," Stone said. "The relentless rising cost of compliance deters many would-be de novo credit unions."

For Stone, the solution involves finding ways to cut down on "burdensome and unnecessary regulatory compliance costs," particularly as lawmakers and regulators "readily agree that credit unions did not participate in the reckless activities that led to the financial crisis, so they shouldn't be caught in the crosshairs of regulations aimed at those entities that did."

Testifying on behalf of the Subchapter S Bank Association, attorney Patrick J. Kennedy, Jr. spoke about his decades of experience representing community banks, their shareholders, directors, officers, and related entities, including working on more than 30 de novo charter groups.

"Many banks exited the mortgage loan business because of the complexity and uncertainty resulting from Dodd-Frank, the CFPB, and related rulemaking," he told the legislators. "The costs are significant and it is generally known in the industry that the cost of making a loan of less than $100,000 is not covered by the interest earned, including the cost of capital and loan reserves required to support such a loan, unless the bank has some very unique processes that can be employed to lower costs."

Kennedy disagreed with regulators who have explained the lack of new charters on low interest rates. Noting "widespread skepticism" throughout the industry that increasing de novo charters is a top priority for the FDIC, he said the lack of new banks can be traced to "the seven year business plan and compliance period as well as the significant increase in regulation."

Closing out the testimony, Sarah Edelman, the Director of Housing Policy at the Center for American Progress, presented a difference perspective. The decline in de novo charters "is largely the result of macroeconomic factors, including historically low interest rates reducing the profitability of new banks, as well as investors being able to purchase failing banks at a discount following the financial crisis," she said.

Also playing a role: the "severely damaged" FDIC insurance fund as a result of the financial crisis and the decline in total number of banks dating back to 1985, she added, predating the compliance costs of Dodd-Frank. "[M]ost of the obstacles facing new small bank entrants are not related to the FDIC application process or bank regulations," she testified. "Thus, gutting FDIC oversight is not likely to address the shortage of new bank applications."

To read the memorandum, view a webcast of the hearing, and read the prepared testimony of the witnesses, click here.

Why it matters

Three of the four witnesses at the House Subcommittee's hearing traced the decline in de novo charter applications to the enactment of Dodd-Frank, citing increased regulatory costs and capital hurdles among the barriers to entry in the market. Whether lawmakers act on these concerns remains to be seen.