Banking: Can small beat big?

By Felix Salmon
July 20, 2010
Matt Goldstein has a big story today about the large number of private-equity shops and other financial investor chomping at the bit to acquire small banks -- and the way in which they're so far being rebuffed by the FDIC and other regulators.

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Whither small banks? Matt Goldstein has a big story today about the large number of private-equity shops and other financial investor chomping at the bit to acquire small banks — and the way in which they’re so far being rebuffed by the FDIC and other regulators.

Matt’s story appears on the same day that the WSJ runs a dispatch from Orlando, Florida, all about the way in which America’s largest banks are squeezing out any attempt at competition from smaller fry:

Fortified by infusions of taxpayer capital and takeovers of other large institutions killed or wounded in the crisis, a handful of hulking banks is emerging from the mess to dominate everything from mortgages to checking accounts to small-business loans…

The three huge banks made 57% of all home mortgages in the first quarter, up from 28% in 2008, according to Inside Mortgage Finance, an industry newsletter…

Measured in loans and other assets, Citigroup Inc. and the three other giants had $7.7 trillion as of March 31, up 56% since the end of 2007. Their combined assets are nearly twice as big as the assets of the next 46 biggest banks…

By providing more branches, ATMs and features like free online bill payment, the newly consolidated banks have made many basic services more convenient and cheaper for customers. The banking giants often offer lower mortgage rates and other types of loans than smaller players…

Bank of America, J.P. Morgan and Wells Fargo “can make money beyond belief” because of their low costs and volumes of scale, and “there is no chance of anyone challenging them,” says Arnold Danielson, a bank analyst in Bethesda, Md.

I’m not convinced: I suspect that the private-equity guys are right, and the people saying that the banking industry is doomed to being dominated by the big four banks are wrong. I’ve seen no evidence that there are economies of scale, in banking, once assets exceed $10 billion or so; and I’ve seen real evidence that consumers are shopping around for the best banking deals like they never have before. As the Accenture report says:

Customers tell us that they are much more willing than in the past to buy products from multiple providers. This volatility is a key factor in customer behavior post-crisis… Customers had the tools to shop around before the crisis, in fact the banks had put them into their hands via direct channels, and the aggregators and informal blogs simplified the comparison process further, but the crisis has accelerated their willingness to use them. This key trend was described by retail banking senior executives Accenture interviewed, but has also been confirmed by recent market research amongst consumers.

This volatility is closely associated with a loss of trust in the banks. Two thirds of global senior executives surveyed identified shopping around, decreased loyalty and price sensitivity as the key changes they are observing in customer behavior. Importantly, more than half of the senior executives Accenture spoke to had seen customer trust drop in banking brands.

This says to me that there’s a big opportunity right now for smaller banks to capitalize on the unhappiness that the big banks’ customers are feeling. (Not many holders of WaMu checking accounts are exactly overjoyed right now to be banking with Chase.) And as free checking slowly disappears, there will surely be a move to consolidate the many different accounts that people are now opening into one relationship institution. While there are reasons to use a big bank for such purposes, there are also reasons to use someone more local, where they know you personally, and where you’re not at the mercy of some balky computer.

One of the things I’m looking forward to finding out about BankSimple is the degree to which they’ll interact with their customers personally, over the phone, via email, and via Twitter and Facebook, applying human intelligence on a case-by-case basis. It’s high-touch, but also high-reward, if customers end up essentially giving them all their money as a result. What’s more, that kind of thing very hard to scale to a monster organization, the hiring of Frank Eliason by Citi notwithstanding. Small banks can be nimbler and more responsive, and can become very profitable for their owners in that sweet spot between say $1 billion and $10 billion in assets.

To put those numbers in perspective, Citibank has $1.5 billion of deposits at its 120 Broadway branch alone. Small can work; big won’t necessarily always win.


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I work for a community credit union, so I sure as hell hope you’re right.

Still, I can’t help but think that the reality has failed to match the rhetoric for most small institutions. We talk a big game about taking on the big banks, but every data point available – from customer growth to deposits to loan assets – show a clear trend of large banks growing larger.

True, most of this has been aquisition based, and maybe there’s a sweet spot where we get to grab huge market share among bank-assumed customers, but that’s a big if.

And what’s worse, I don’t see a lot of small institutions willing to embrace an alternate pricing model that would really differentiate themselves from the big banks. There were credit unions, for example, that didn’t charge the amount of overdraft fees that the biggest banks did, but there weren’t any who said, “Providing overdraft services is generally bad for our customers, and shouldn’t be an important part of our income model.” If they did, I’d like to hear about it.

Posted by strawman | Report as abusive

Mine! The Lower East Side People’s Federal Credit Union said EXACTLY that.

Posted by FelixSalmon | Report as abusive

You know, I had a private suspicion that you were going to say exactly that.

And I think that’s a great model – in fact, I think it’s the only model that could successfully differentiate small institutions from big banks. But I feel a frustrating amount of inertia in the banking sector. Most banks are content to offer lip service to customer-orientated banking, but never really question their fee income or business model.

I think you saw that through the way the NCUA mobilized against interchange fees. That would have been a great moment to say, “Hey, these fees are regressive, and hide the true cost of electronic transactions from our members.” Instead, lobbying and a fair degree of misinformation.

Taking on the market share of the big banks is going to require a pretty big commitment to changing the way banks and credit unions approach consumer finances. Otherwise, I worry it’s just going to be a few brave institutions battling away at the edges.

Posted by strawman | Report as abusive

While I have an account with one of the big boys that I share with my wife, I have had a relationship with the best bank in the US (USAA) in terms of customer service for years and keep it almost for nostalgia, and the best insurance prices I can find. I love their customer service and am happy that they are now available to more than just the military.

Posted by EorrFU | Report as abusive

I would like to read the Accenture report – any idea how I can get it – is it free or does Accenture charge for it? SOunds interesting. Thanks

Posted by Clive1953 | Report as abusive