De novo banking bill could pose a threat to existing small banks

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In January, Representative Andy Barr introduced HR 478, a bill that suggests a three-year phase in period for de novo banks in rural areas. In 2024, a report by the Congressional Research Service noted that there were fewer than 5,000 banks today compared to over 18,000 in the 1980s. While the bill will serve the interests of some communities by allowing them greater access to hitherto unavailable banking services, it could also work to the detriment of existing small banks in some rural areas, already under pressure from their larger counterparts. The bill is substantially the same as one introduced on the same day by Sen. Cindy Hyde-Smith titled "Promoting New Bank Formation Act of 2025."

Empirical evidence from academic studies shows that small banks have performed less well than their larger counterparts in the current century. Changes in legislation like the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, the Financial Services Modernization Act of 1999, and others have negatively impacted small-bank performance. Should the bill on de novo banks become law, existing community banks could be forced to compete for the same customers as de novo banks. De novo banks would have no choice but to follow aggressive strategies to establish a market presence. One of the interesting aspects of the proposed legislation is that new banks in rural areas would get capital relief, allowing them to maintain a leverage ratio of 8% during the first three years after becoming an insured depository institution. This hands de novo banks a competitive advantage, because existing community banks have a leverage ratio greater than 9%. By allowing lower capital requirements, the ROE of a de novo bank will essentially be higher than the ROE of an existing community bank, effecting an unjust and inequitable benefit.

In addition to the factors mentioned above, one other thing traditional brick-and-mortar community banks realize is that de novos appears to be more adept at the digital delivery of lending and deposit services. This factor should be considered when existing community banks make decisions regarding future operations.

Existing community banks also have to consider the demographic trends in their area of operations. If a community bank is located in an area with an increasing population, it might be able to coexist with a de novo bank. However, community banks operating in areas with steady or declining populations would be impacted adversely. With an advantage in leverage ratio and a good marketing plan, a de novo bank could take market share from existing banks. In anticipation of this, an existing commercial bank might be obliged to make riskier loans than it would otherwise to ensure that its market share is not impacted. Thus, in some scenarios, a current bank's asset portfolio would be adversely affected, quality-wise, leading to potentially more significant loan losses in the long run.

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On the liabilities side, existing community banks might have to increase their deposit rates to stay competitive with de novo banks. This, combined with riskier loan portfolios, could adversely affect their net interest margin.

At present, in the absence of de novo banks, the value of a community bank is high, as new charters are rare. At the present time, the opportunity cost of getting a new charter ensures that current banks intending to divest or merge would fetch a reasonable price. Should the bill become law, this advantage would be lost for existing community banks.

In the present scenario, the best course for community and local banks is to develop closer relationships with their existing clientele. This includes both their loan seekers and depositors. These banks need to take a realistic view of the future and look to market themselves more aggressively. Should the proposed bill become law, they should prepare themselves to accept comparatively lower profits and margins for at least a few years. They should note and prepare for the demographic changes in their service areas. If they are unwilling or unable to do this, they could also consider a merger or sale, as they are likely to get better terms at the present time than in the future.