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Wake-Up Call for Community Banks
Blaming new regulations for lack of growth is easy, but successful community banks will need to adjust to the new realities of the market. by DAVID KERSTEIN
Jan 26, 2011  |  0 Comments

I was struck by a recent quote from the chief credit officer of $210 million-asset Valley Community Bank in Pleasanton, Calif.: “The general consensus for a community bank now is you have to be over $1 billion in total assets going forward. That’s going to be the minimum you need to survive because of the amount of regulations that are coming down. Banks under that size just can’t generate enough profits due to the new overhead.”

If this were true, we’re really in for a decade of consolidation since 91% of the roughly 7,700 federally-insured financial institutions have less than $1 billion in assets! But hyperbole aside, the statement does reflect the frustration many bankers feel in dealing with the new environment.

Consider the litany of problems: Compliance costs have increased. Revenue has decreased due to restrictions on deposit fees and other income streams. Despite general improvement, we’re not out of the woods yet on asset quality. The slow pace of recovery has depressed loan demand, and deposits cannot be easily reinvested into high yielding assets. Increased capital requirements decrease leverage and suppress return on equity. But let’s face reality: Dodd-Frank may be modified but it isn’t going away.

Rep. Spencer Bachus (R-Ala.), the new Republican head of the House Financial Services Committee told CNBC recently that “we’ll go piece by piece” through Dodd-Frank but total repeal was not on the table. And there will be tough opposition in the Senate, where Senate Majority Whip Dick Durbin (D-Ill.), author of the “Durbin Amendment” limiting debit card interchange fees, will use his position to block an overhaul of Dodd-Frank.

Even community banks are not united in favor of total repeal. Rusty Cloutier, chief executive officer of Lafayette, La.-based MidSouth Bancorp and former Chair of the Independent Community Bankers of America (ICBA), recently said he could support some changes to Dodd-Frank, but not a complete repeal. With over 20% of all Federal Insurance Corp. (FDIC)-insured institutions unprofitable and 860 problem institutions at the end of the last quarter, the pressure from regulators is unlikely to subside.

The real problem community banks face is lack of growth. Many are in communities that are losing population. Consumers and businesses are changing the way they use banks and are more willing to do business remotely. Remote Deposit Capture (RDC), for example, is creating opportunities for competitors to service relationships in markets where they do not have branches, resulting in increased competition. The big banks, meanwhile, are getting bigger and more powerful. Bank of America Corp., for example, has relationships with 50% of U.S. households through its banking, mortgage, credit card and investment arms. BofA is not focused as much on garnering new customers as it is on consolidating deeper share of wallet and increasing relationship profitability.

We know the problems, but what are the solutions? When we look at the success stories – the community banks that have maintained growth and revenue in these difficult times – we see three strategies that have enabled them to succeed.

First, they have found incremental revenue opportunities by identifying and focusing on a few specific target segments and customers. Even in small communities, there are opportunities for growth – it only takes a relatively small number of additional profitable relationships to offset the loss of revenue from increased regulation. “Best practice” banks have taken a highly disciplined approach, with name-by-name targeting of new prospects (or prospects for expanded relationships) combined with a detailed action plan and management process that will ensure success.

Second, all banks, not just community banks, need to focus on expense reduction and re-direction into activities that generate a higher return on investment. The industry is changing and customers don’t write as many checks or use the same channels as they did before, yet branch and back office processes and staffing remain relatively unchanged. We need to adjust our infrastructure to reflect a changed reality.

The average community bank of $500 million or less has an efficiency ratio of 77%. It is simply not realistic to expect that a bank can only earn 23 cents on every $1 of revenue and succeed. The challenge most community banks face is limited economies of scale; it takes a minimum number of people to open the doors, so identifying opportunities for savings is hard. But our experience has shown that there are multiple opportunities for efficiency improvement in branch management, deposit and loan back office, marketing management, and vendor costs that can have significant impact on the bottom line.

Finally, community banks lack good peer and industry “best practice” benchmarking to help them identify specific, implementable opportunities. Larger institutions have excellent access to industry wide data – or they have sufficient breadth within their own organization to identify best practices. But smaller institutions are usually stuck with more generic peer comparisons from the FDIC or the Federal Reserve. Essentially, the data is there but the “information” is limited.

Fortunately, as we are constantly reminded in the press, we live in the Information Age, and access to quality insight that directly points to more successful strategies and action plans is available if you know where to look for it. I’m optimistic that community banks that are forward thinking can not only succeed, but thrive, in the “new normal” if they heed the market’s current wake-up call. In order to succeed, community banks need to recognize that the environment has permanently changed and conducting business as they did in the past is not a formula for success.

Mr. Kerstein is president of Austin, Tex.-based Peak Performance Consulting Group. He can be reached at dkerstein@peakconsultinggroup.com.


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