The onerous process of getting a new charter is hurting competition in banking and pushing activity outside the regulatory perimeter, Federal Reserve Gov. Michelle Bowman said in a speech Friday afternoon.
In her remarks, delivered at the Wharton Financial Regulation Conference, Bowman called for bank regulators to take a new approach to so-called de novo banks to make the chartering process more streamlined and transparent.
"We need a viable pipeline for the creation of new banks in the United States," Bowman said, "There are troubling indications that we are falling short on this front, with a continued decline in the number of banks in the United States, the continued interest in charter strip applications, and the ongoing shift of traditional bank activities into shadow banks."
To reverse this trend, Bowman said the Fed and Federal Deposit Insurance Corp. should lower upfront capitalization requirements — which currently call for de novo banks to raise capital to meet forward-looking projections — rethink initial limitations imposed on new charters and strike a tone that tells prospective charter seekers that new applicants are welcomed.
She also called for changes to the application processes to make sure there is less overlap between agencies and put more emphasis on efficiency and consistency. She said the framework implemented by the United Kingdom's Prudential Regulatory Authority and Financial Conduct Authority is a model worth emulating. Their joint effort, the New Bank Start-up Unit, provides "transparent, single-stop resources about the life cycle of de novo bank formation," Bowman said.
In particular, she praised the British model's focus on recovery, resolution and wind-down planning instead of steep capital requirements and strict supervisory oversight.
"De novo banks often experience rapid growth, poor initial profitability, and loan quality issues that take time to emerge as the bank's portfolio matures. These factors can make de novo banks riskier than established banking franchises," she said. "The solution to potential weaknesses in de novo banks need not focus exclusively on increasing regulatory and supervisory requirements, particularly if there are lower-cost alternatives like improved transparency, and better preparation for resolvability and solvent wind-down."
Throughout her remarks, Bowman, who chairs the Fed Board of Governors' subcommittee on smaller regional and community banks, makes the case that there is a disconnect between the demand for new banking services and the supply of new banks entering the market.
Between 2002 and 2022, the number of FDIC insured banks fell from more than 9,300 to just over 4,700. Yet, at the same time, Bowman said there has been a clear desire among businesses and entrepreneurs to engage in bank-like services. This is evidenced by three trends, she said.
One is the growth of banking as a service, in which banks provide core services such as holding deposits, transmitting payments and issuing credit cards on behalf of financial technology partners. Another is the growth of bank-like activity among nonbank entities, sometimes referred to as shadow banks. This includes mortgage origination, a business line in which nonbanks have outpaced banks since 2016.
The final example she gave was the growing instance of companies seeking to purchase banks just for their charters and then implementing entirely new business models. She referred to these efforts as "charter strip applications."
Bowman said the practice of charter-stripping tends to focus on the smallest banks, most of which are located in small towns and rural areas where there is little competition. When the new owner shifts a bank's business model away from local lending, she said, consumers in these areas are left to suffer.
"Even when these legacy bank businesses continue to operate as an add-on to the new charter-strip business model, the institution as a whole tends to become riskier, jeopardizing the long-term viability of the legacy banking business and its ability to continue providing services to the local community," Bowman said.
The fact that these businesses are growing while the number of banks shrinks, she said, is an indication that there is "dysfunction" in the regulatory regime around new charters.
In a well-functioning system, she said, new entrants would either value a purchased charter and newly acquired one equally, or prefer the "clean slate" of a new bank. Similarly, the application process would also treat both approaches the same, she said, but that does not appear to be the case.
"The ongoing demand for charter strip formations, however, reveals a disparity in treatment between de novo formations and charter strips, a disparity attributable to the difference in expectations and regulatory burden between these two paths," Bowman said.
During her speech, Bowman noted that reforming the de novo chartering process is unlikely to take a high priority for regulators who are still dealing with the aftermath of two large bank failures and potential instability in the banking system.
On the topic of Silicon Valley Bank and Signature Bank last month, Bowman said she has not drawn any conclusions about what factors contributed to the failures of the two banks. She said she is waiting to see the
"We should not rush to judgment with respect to these ongoing reviews," she said. "We need a full, accurate, and thorough examination and diagnosis before we reach conclusions about solutions, to ensure that the prescribed remedy addresses the underlying symptoms."
Bowman's speech comes as fellow Trump-appointed Fed Gov. Christopher Waller
Whatever changes come from the crisis, Bowman said it will be important for regulators to consider the potential impact across the entire banking system.
"As policymakers consider the regulatory and supervisory framework in the U.S. banking system and consider specific adjustments to address identified shortcomings," she said, "we should also take into account the impact of incremental additional regulatory changes not only on de novo bank formation, but also on credit availability, competition, and the financial system."
