Why Some Banks Thrived and Others Failed After the Crisis

Second of three parts

Yes, bankers should read "The Future of Community Banks: Lessons Learned from Banks That Thrived during the Recent Financial Crisis," written by researchers from the Federal Reserve Bank of St. Louis. But bankers may be even better served by asking the commissioners of Major League Baseball and the National Football League why they are so reluctant to grant new franchises.

What do baseball and football have to do with banking? You’ll see.

Like the St. Louis Fed, I have been studying banks and banking in this country. After a 31-year career in the industry, I retired to spend time examining why more than 3,400 banks failed during my career. However, unlike the Fed, my research considered both bank failures and successes.

Not surprising to me, the Fed study revealed that banking in the U.S. is lopsided. Ten states are host to the vast majority of "thriving" banks (i.e., great banks with Camels composite ratings of 1) while another 10 states have hardly any thriving banks. According to the Fed researchers, the states with great banks tend to be states that are heavily linked to the agricultural and energy businesses. Of the top 10 states, only Massachusetts would not be considered as a state connected to either business. (West Virginia is an energy state by virtue of its coal interests.)

However, where the Fed study breaks down is its failure to explain why some states with heavy agricultural interests, most notably California (the leading ag state in the country), North Carolina (No. 8), Florida (No. 10), Georgia (No. 12) and Washington (No. 14), have virtually no thriving banks. If ag and rural markets are truly the key to being a great bank, would it not stand to reason that a representative sample of banks in these states would have qualified for a top Camels rating in the Fed study? The Fed did not answer this critical question in its study.

Though bank size, location, and asset mix may be of some importance to bank performance, my research shows another factor to be the most critical determinant of why some banks failed while others succeeded from 2008 to 2012.

The answer is one that the NFL and MLB understand better than bankers and regulators: New franchises and banks can weaken the system.

Here are a few highlights from my research.

The Fed identified 10 states as the top homes for thriving banks. When I compared those 10 to data in my research, seven were among the eight states that had the lowest new-bank formation rates in the country from 2000 to 2007. And the three others – Massachusetts, Texas, and West Virginia – were not far behind. In fact, my data shows that not one of these 10 states experienced a growth rate in new-bank formation from 2000 to 2007 greater than 9% of the number of banks in the state in the year 2000.

How about the states identified as laggards in the Fed study? The story is just the opposite: The states that experienced the highest rates of growth in new bank formation between 2000 and 2007 were the worst performing states in bank performance from 2008 to 2012. Arizona, Nevada, North Carolina, Utah, Florida, California, Connecticut, New Jersey, Oregon, Washington, Georgia, and Idaho all had growth rates in new bank formation at a minimum of four times, and in some cases ten times, the rate of the best performing states in the country.

As detailed in the appendix to my book "Broke: America’s Banking System – Common Sense Ideas to Fix Banking in America," the profitability of the banks in a state in 2009 was inversely correlated to new bank formation rates from 2000 to 2007, the years leading to the crisis. The strength of the correlation is remarkably strong.

When new bank formation rates from 2000 to 2007 are compared to bank failures and problem banks by state as of 2011, the correlation rates are meaningful. These findings should have profound implications for how U.S. banking is practiced in the future.

Is it possible that U.S. and state bank regulators do not understand the influence new bank formation played on bank failures during the past five years? Is it possible that bankers and regulators need to study the barriers of entry into banking just as seriously as the NFL and Major League Baseball consider new franchises for football and baseball?

Richard J. Parsons is the author of "Broke: America’s Banking System – Common Sense Ideas to Fix Banking in America," published 2013 by the Risk Management Association. He spent 31 years at Bank of America.