Over the past four decades the number of U.S. banks dwindled from more than 14,000 to little more than 4,000 today.
By nearly all accounts, the total will continue to drop through 2024 and in the coming years, with
At the same time,
The enduring trends beg the question: Are community banks a collective relic of the past and destined for the dustbin of history? Or will this segment of the industry, one that has long catered to small businesses and
The answer, bankers and other industry insiders say, is complicated.
The potential is there, but small lenders have to identify new niches or get even better at serving existing ones — and, in particular, those corners of the small-business universe that are underserved or overlooked by large banks.
To do this, small banks almost certainly will have to embrace and accelerate adoption of rapidly evolving technologies, notably including artificial intelligence. AI presents the possibility to develop sweeping new efficiencies that could enable community banks to compete with the scale that their larger brethren use to absorb the
"There is certainly a lot of potential, and I think a lot of need for community banks," said Jacob Thompson, managing director at Samco Capital Markets. "Some are investing and preparing for long futures, but just as many are selling and bowing out," he added, noting that more than 100 banks per year have sold this decade.
To attract new banks, the high regulatory hurdles that emerged in the wake of the crisis must be lowered to reduce the lofty costs and years-long de novo processes that discouraged entrepreneurs and investors from pursuing startups over the past 15 years, said Christopher Maher, CEO of the $13.4 billion-asset
"I really hope that happens," Maher said. "I do think we need a future with community banks that know their markets, know their customers' needs and support local economies…But it really comes down to regulatory expectations."
The great decline
To size up a path forward, Maher and other industry veterans say it is critical to understand the recent past.
As Fed analysts concluded in a series of reports, the crisis delivered a seismic blow to the U.S. banking sector, triggering a cascading decline in the number of banks. Between 2007 and 2013, more than 800 such institutions failed or were acquired, marking a 14% reduction.
This contraction primarily affected community banks.
Throughout much of U.S. history, strict regulations prevented banks from expanding beyond state lines, fostering a landscape peppered by mostly small banks. The period from 1960 to 1990 exemplified this era, with between 12,000 to 14,000 independent banks dotting the country, Fed researchers wrote. However, regulatory shifts starting in the 1970s that culminated in the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 dismantled these barriers and paved the way for consolidation. By 2000, the number of independent commercial banks had plummeted to fewer than 7,000, the researchers noted, as M&A enabled larger institutions to capitalize on economies of scale.
In the past, new entrants emerged to fill the void. But the aftermath of the financial crisis upended this trend. While overall exit rates remained steady, the dearth of new bank formations from 2009 to 2013 reached unprecedented levels, with only four de novo banks established during that span, a stark departure from the more than 100 per year seen in the preceding decade, according to Fed data.
Several factors were at play. Economic instability dampened investor appetite, while stringent regulatory frameworks, bolstered by legislation such as the Dodd-Frank Act, erected formidable barriers. The Federal Deposit Insurance Corp., for instance, extended the period of heightened capital requirements and rigorous scrutiny for newly insured institutions from three to seven years post-2009, the Fed researchers noted.
Organizers of and advisors to startup banks in recent years cited a markedly lengthier and more rigorous application process compared to prior eras
"That's the big one — the time and the costs that add up over time," Thompson said.
Looking ahead, if current trends persist, the composition of the banking sector will continue to erode. This not only impacts the availability of credit but also reshapes the foundational pillars of local economic support that community banks traditionally provide, Maher said.
"Community banks are, in many ways, the lifeblood of our economy," he said.
Regulatory roadblocks
Maher said he thinks startups could be afforded a safe harbor period to comply with myriad banking rules over time. This would allow de novos to get their businesses up and running, enabling them to generate revenue as they build teams and resources to manage regulatory compliance.
Another possibility is to take a cue from the National Credit Union Administration, which this year granted a federal charter to Tribe Federal Credit Union in Minneapolis. It is the first to receive a charter under the NCUA's provisional charter pilot initiative, which allows a credit union's organizers to obtain a federal charter and provides them one year to obtain the capital necessary to begin operations. Securing the charter clears a major hurdle and, as the thinking goes, makes it easier to attract investors needed to meet capital requirements to open.
Another idea lies in Arizona: Starting in 2015, the state allowed de novos to start raising funds before they apply with federal regulators, with a goal of reducing the overall time it takes to launch the bank. It took time for this to take root, in part because of interruptions caused by the pandemic, but several new de novos — as well as potential startups — popped up in the state to help fill holes caused by M&A and the swelling population of Phoenix.
Three de novos formed in 2022 alone, including the now $58 million-asset Scottsdale Community Bank, or SCB. Before 2022, no new banks had opened in Arizona since the $210 million-asset Gateway Commercial Bank in Mesa was established in December 2007.
When the financial crisis rocked the lending sector, there were more than 30 community banks in metro Phoenix, according to state data. In the three years before the crisis, 10 de novo banks opened in Arizona. However, by 2022, there were only four community banks based there. The dwindling numbers followed bank failures and mergers.
In an interview after forming Scottsdale Community Bank, Chairman George Weisz said SCB's founders were concerned about a dearth of local banks even as Greater Phoenix's population swelled. Major banks such as Bank of America and Wells Fargo dotted the metropolitan landscape, but local banks that catered to small businesses were scarce.
He said getting approval to launch was still a difficult process that involved a 1,000-page application that took nearly a year to work through with regulators.
"It is a tremendous amount of work to get a new bank going; no one should underestimate that," Weisz said. But, with an emphasis on efficiency, the process was manageable and ultimately not cost prohibitive, he added.
SCB's founders raised more than $19 million in capital over a couple years — $3 million more than initially targeted — from more than 200 investors who "told us they really need more community banking options," Weisz said at the time.
Eric Newell, chief financial officer at the $11.6 billion-asset
"And that's a big deal because, while the biggest banks offer a lot, they often are not backing the sole proprietor — that local small business that needs a local bank as a partner," Newell said.
Against that backdrop, Newell said that, in addition to addressing regulatory challenges, de novos and all small banks need to constantly be cognizant that larger lenders have more resources and reach. What community banks can do best is identify big lenders' credit blind spots in their markets or given industries and develop banking services to address them. His bank, for example, carved out niches in lending to companies that work with the federal government as well clients in higher education.
"We are looking to add more specialties," Newell said.
Carving out niches
Esquire Bank in Jericho, New York, is the epitome of niche banking.
The $1.6 billion-asset bank serves small businesses nationally as well as commercial and retail customers in the New York metropolitan area. It made its name, however, tailoring products and services for lawyers and their firms. These are businesses that generate irregular cash flow on a month-to-month basis — potentially a red flag for most lenders, leaving law firms underserved — yet they are often lucrative operations.
This opened the door for a bank that understands the legal industry and how to underwrite loans based on that expertise, Esquire President and CEO Andrew Sagliocca said. Lawyers and their firms also are a reliable source of deposits and, he said, prioritize digital convenience over physical branches. This enabled Sagliocca and his team to establish a one-branch bank that efficiently serves the industry nationally.
"If you are a small bank in a very big market like New York, you must have a focus," Sagliocca said. "We needed to serve an underserved market, and we needed to balance that with technology."
Nearly two decades after its founding, Esquire Bank has some of the strongest profitability metrics in the banking industry, including a net interest margin that hovers around 6% — double many of its peers. Its loans have grown at a 20% compound annual growth rate over the past five years.
"Find a niche and then do it really, really well," Sagliocca said. "And you have to find solutions for your customers, rather than driving products down their throats."
He believes the cyclical banking industry may be nearing an inflection point. "We may have seen too much consolidation, and this warrants a change," he said. "We may be seeing real need for new banks, and de novos could start to pop up. They just have to find an area in need and deliver the experience and skill necessary to address that need."
Tom McLean, regional military executive for Armed Forces Bank in Fort Leavenworth, Kansas, echoed that sentiment.
The $1.4 billion-asset unit of Dickinson Financial works with U.S. military members, providing them traditional loan and deposit services. But the bank also specializes in financial education for a cohort of Americans who often enter their profession at young ages and find themselves living overseas and growing families in the far corners of the world. They value bankers who understand their unique careers and unique life needs, McLean said.
"I think there are many underserved constituents out there," he said. "So I do think there will come a time when we have another meaningful round of de novos."
In some cases, community banks can bridge a sudden gap. For example, the $3.5 billion-asset Five Star Bancorp in Rancho Cordova, California, is hiring commercial bankers and opening a branch in San Francisco to advance the company's strategy to serve technology entrepreneurs whose banking options dwindled following the failures of Silicon Valley Bank and First Republic Bank last year.
"As we expand our team, we continue to provide the San Francisco Bay Area entrepreneurial community with the high-touch and highly personalized concierge banking experience they expect," said DJ Kurtze, Five Star's San Francisco president.
Technology is key
For community banks, partnerships may prove the key to ensuring they are tech-driven.
Small financial institutions obviously can't spend what the largest players can to build out and maintain their own technology stacks. JPMorgan Chase, the nation's largest bank,
"Partnering with the right organization to support your digital infrastructure allows you to compete with similar technology," said Marcell King, chief commercial officer at Portland, Oregon-based Tyfone, which provides digital platforms for banks and credit unions.
That's because community banks can use a pooled investment with dozens of other institutions that also pair with the same fintech to capitalize on the resulting scale. "It's giving you the ability to innovate faster," King said.
"We have small customers that don't want to adopt certain features because of the expense" and uncertainty involved with advancing tech, he said. But, increasingly, more small banks are realizing that making investments now — and taking some risks — could prove the difference between the have and have-nots in financial services.
Pierre Naude, chairman and CEO of cloud banking firm nCino in Wilmington, North Carolina, agreed. He said everything from cloud computing to AI, when combined and infused into community banks' digital platforms, "is leveling the playing field."
Small lenders "can have the same access to the best technology as the big banks," Naude said. With a well-defined business strategy and the latest tech, he added, "you have a 100% chance of survival."
He said AI, for instance, holds the potential to not only speed up loan applications and underwriting processes but also give banks' the ability to constantly review their portfolios for any new signs of stress — everything from late payments to economic headwinds that could cause issues. Banks routinely review their loan books, but comprehensive examinations are often tied to quarterly earnings.
AI could change this to a daily event without new personnel expenses, he said. Over time, the leaps made in information can drive smarter loan decisions, better underwriting and faster action when credit challenges emerge.
"I think it could give community banks a new lease on life," Naude said. "But I do think banks need to get on board or miss out. This stuff is coming fast. It's being developed at an astronomical pace."
Already, a 2024 KPMG survey found, 40% of Americans expect their banks to have AI capabilities.
Current conditions
For now, community bankers at least have favorable, albeit choppy, overall economic conditions on their side.
U.S. gross domestic product increased through the first half of this year after advancing in 2023, according to the
Investors have shifted their focus from concerns that a strong labor market would delay Fed policymakers' decision to cut interest rates to the benefits of a strong economy for banks, analysts said. The KBW Nasdaq Bank Index was up on the year through late July.
To counter cost pressures that emerged in the aftermath of the pandemic and Russia's invasion of Ukraine, the Fed hiked interest rates multiple times over the course of 2022 and last year, bringing its benchmark to the highest level of the 21st century.
That noted, officials have kept rates flat since July 2023 and continue to signal that their next move is a rate reduction, potentially as soon as September. Fed officials emphasized that inflation has dropped from a peak of 9% in 2022 to around 3% this year. The Fed is targeting 2%.
Sophie Lund-Yates, lead equity analyst at Hargreaves Lansdown, said that while more progress is needed on inflation before the Fed lowers rates, conditions are generally favorable, with the job market consistently posting solid monthly gains and the unemployment rate hovering around 4% and near 50-year lows.
"In tandem, all these points mean the U.S. economy remains pretty rock solid," she said.
Morningstar DBRS analyst Michael Heydt said the disinflationary trend is intact and the economy is on sound footing. While the Fed and other central banks "will be cautious" and any coming rate reductions are "highly data dependent," borrowers have adapted to the higher rate environment without major setbacks for banks.
In particular, small businesses continue to make loan payments on time. Community bankers and investors had entered 2024 worried that high rates would drive up borrowing costs to a point that
Yet most banks have
A Fed snapshot of lending activity in the first week of June, for example, showed banks' total loans were up 2.6% from the comparable period a year earlier. It marked the highest reading of the year. Small banks, which posted 4.3% loan growth for that week, are driving the momentum with loans to small businesses that continue to invest in growth to capitalize on economic vigor.
"The last thing community banks needed was some sort of economic calamity that resulted in bunches of loan charge-offs," said Michael Jamesson, a principal at the community bank consulting firm Jamesson Associates. "I think we've managed to escape the worst-case scenario as it relates to inflation, higher rates and so on.
"As far as the long term, I do think there is a place for community banks and a future for small banks that find their niches — really stand out in those niches — and make the most of technology to find efficiencies," Jamesson said. "I don't think scale is imperative in banking, but efficient and steady growth is critical. Having a relatively solid economy and operating environment is helpful, to say the least."
