Wednesday, September 3, 2014

Why Your Credit Union and Bank Are Walking Dead!

Chances are your credit union or bank is walking dead! To understand why, it is important to retrace U.S. banking history and regulatory change that occurred in 1994.

Throughout the history of the U.S. much of the world has deployed a banking system that is different than ours. Until the late 1900s the U.S. banking system was primarily an agrarian unit bank system, while a branch banking system was deployed throughout Canada, United Kingdom and Europe. In fact branch banking was not legal in many states until as late as 1993 and was highly discouraged by many other states through onerous regulation.  It was not until 1994 when most interstate banking prohibitions were repealed by the Riegle-Neal Interstate Banking and Branching Efficiency Act, paving the way for a nationwide branch banking model.

The “stated” goal of The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (IBBEA) was the return to a balance between the benefits of a state bank charter versus a federal bank charter.  Among other notable changes, the Act stipulated that a federally chartered bank wishing to expand must first undergo a review of its Community Reinvestment Act (CRA) compliance. 

We can debate the real purpose of the IBBEA, but my opinion is it was to replace unit banking with branch banking, to pave the way for the creation of a limited number of mega banks and to help redistribute wealth in a stealth and politically palatable manner. IBBEA enabled the very thing Americans fought for over two centuries, the concentration of banking and political power by a limited number of people or institutions.  

Why you ask would politicians want to enact branch banking? Three reasons:
  1. Unit banking compared to branch banking is a highly unstable banking system that creates unnecessary risk 
  2. Allowed for wealth redistribution through the Community Reinvestment Act (CRA)
  3. The creation of mega banks to compete in a global economy 
Why is unit banking unstable? Instability of unit banks is caused by their inability to effectively manage resources in two major areas:
  1. Diversification - Portfolio across a multiple local or regional economies and market conditions
  2. Economies of scale - Operational and technology costs

IBBEA created the opportunity for wide open intrastate and interstate banking, resulting in bank mergers, acquisitions and the creation of mega banks, “banks too big to fail”. So what does this have to do with why your credit union or bank is walking dead?

First, the U.S. banking system has moved from a unit bank to a branch bank system. Virtually all credit unions and community banks still follow the unit banking model. Oh sure, you may have a few branches and some of them may even cross state lines, but the fact remains, virtually all credit unions and community banks have a very difficult challenge managing their loan and deposit portfolio. For example:
  • Inability to move high liquidity from one geographical region to a high growth geographical area that needs the liquidity to lend and generate profit
  • Diversification against economic downturn in in one geographical area offset, but high growth in other areas

Nationwide branch banking and the creation of the mega bank eliminates these problems, which results in an opportunity to create a much more stable banking system. A banking system the politicians and regulators seek to embrace.

The second reason virtually all credit unions and community banks are walking dead is because of a cost structure that is inherent in a unit banking system. A major motivation of bank acquisitions and mergers was to achieve economies of scale, both from a technology and operational standpoint. 

As we all acknowledge technology is a critical to the growth and survival of all financial institutions. As the pace of change accelerates the costs associated with buying and maintaining technology solutions grows. What was your IT budget 10 years ago compared to today? Back office processes and operations while important; add little to help financial institutions grow and are also a big expense to the bottom-line. Economies of scale cannot be accomplished by unit or small banks and credit unions, especially compared to the economies of scale achieved by mega and large regional banks.

As the U.S. banking environment shifted from a unit banking model to a branch banking model in the late 1990s, how is your credit union or bank adjusting to the new realities of the market? Added a few branches, added some “me too” technology solutions? Is that competing or is your credit union or bank walking dead?  


  1. The decline in # of banks at the same time as major deregulation of the holding companies (1992) interstate banking, which you mentioned, and Interest rates on Deposits (Reg. Q)... do you think deregulations stopped protecting the inefficient banks more or less than it empowered the aggressive banks? If it is the former then we had "walking Dead" banks on regulatory sponsored life support for generations, Your thoughts David & Eric?

    1. I think interstate and intrastate branching deregulation in the 1990's changed the banking model in the US. In my opinion, it didn't expose inefficient banks; it changed the rules to allow mass consolidation through acquisition and merger, creating nationwide intrastate branch banking. It was also a way to enact President Clinton's Third Way agenda to redistribute wealth that was acceptable to politicians on both sides of the isle.

      When the Community Reinvestment Act (CRA) was inserted into the branching deregulation, it forced banks to get high marks from community activists under the CRA, from organizations such as ACORN. That is what lead to reduced underwriting requirements, zero down no doc loans. It was to satisfy community activists like ACORN. It is estimated that the mega banks have paid over 9 billion dollars to theses community groups.

      Originally the lower underwriting and no down payment standards were intended to cover urban properties and low income borrowers, but as Fannie Mae and Freddie Mac liberalized underwriting for urban and low income borrowers they had to do it for all borrowers. That lead a housing bubble and to the bundling of toxic mortgage investments that lead to the financial crisis of 2007.

      All this to accomplish intrastate branch banking and mega banks too big to fail, and the worst part, the politicians on both sides of the aisle knew what was going on and its inevitable conclusion. As of November 10, 2011, the net cost of TARP was $29,616.4 billion dollars — (or 29 and a half trillion). That is income redistribution and politics at its best.