RETHINKING THE
BUSINESS MODEL FOR COMMUNITY BANKING
Community banks and credit unions have been a key part of
the American economy since its beginning.
These are the lending institutions that make loans to small sole
proprietors, first time home buyers and dreamers of all kinds. Over the years, the business model for these
institutions hardly varied. A review of
the loan portfolios of community banks across the country will include three
similar components:
·
CRE-
Commercial real estate loans have been one of the mainstays of the community
banking business. These loans provide a
viable, recognizable and reliable (usually) source of income. The return on investment for these loans have
been the source of a large portion of the earnings for community banks for many
years. The drawback for this type of
lending is that it ties up a large portion of the capital of a bank and the
return on investment takes a significant amount of time develop. A loss from one of these loans has the
potential to threaten the existence of a small financial institution
·
CNI –
Commercial and Industrial loans have been the beating heart for community banks
for many years. Very much like CRE
loans, the income from these loans is recognizable and except for a few notable
exceptions, reliable. Not only do these
loans have the same concerns as CRE, the competition for these loans is fierce
and smaller institutions often finds themselves left with the borrowers who
present the highest level of risk.
·
Consumer
products - In the past 15 years,
consumer loans have also proven to be a good source of earnings. Interest rates for consumer products have
remained well above the prime rate and for a financial institution that is
properly equipped, consumer products can provide a strong stream of
income. Consumer products also tend to
be for smaller amounts, have higher rates of losses and are heavily
regulated.
This three-pronged approach to earning income has been a
steady, tried and true method for earnings at small financial
institutions. However, there are several
factors that are coming together that have threatened this business model.
·
Fintech
– Financial technology (“Fintech”) companies are those companies that use
software to deliver financial products.
Today one of the most recognizable fintech companies is PayPal. Using just a smart phone, PayPal gives its
users the ability to make payments, pay bills, deliver gift cards and conduct
financial transactions with people throughout the country. For community banks, the knowledge of the
existence of PayPal is interesting, but what is more critical is the reason
that PayPal was developed. PayPal, and
its fintech brethren exist to fill a specific need that Banks were not
meeting.
·
NBFI
– The Operation Chokepoint program was a program spearheaded by the Justice
Department that was aimed directly at Non-Bank Financial Institutions, aka Money
Service Businesses. At the time the
program was started, a decision was made that money service businesses
represented an unacceptable money laundering risk. Ultimately, Operation Chokepoint fell into
disrepute and was ended. Although Operation
Chokepoint has ended, its legacy is still prevalent. MSB’s still have significant problems getting
bank accounts. Despite this fact, the
amount of money moved through remittances continues to grow. MSB’s continue to serve this market for a
huge population of people who are unbanked and underbanked.
·
Underbanked
and Unbanked- The number of
unbanked and underbanked families continues to grow. Unbanked families are those without a bank
account and underbanked families are those that use minimal banking
services. The number of people in these
families totaled approximately 90
million in 2016[1]. Equally as important as the sheer size of
the unbanked and underbanked population is the reason that many of these
potential customers remain that way.
High fees, poor customer service and bad public image have all been
contributing factors for the large population of unbanked and underbanked
customers.
Customer Bases in the Future
The combination of these forces
will greatly impact the future of the business model for community banks. Customers will continue to change their
expectations for their financial institutions.
The traditional balance has changed, instead of being forced to choose
the products that financial institutions offer, customers have come to demand
products from their companies.
The financial needs of customers have also changed. Electronic banking, online account opening,
remote deposit capture and iPhone applications are now almost necessities. Younger customers, who make up a significant
number of the unbanked and underbanked population rarely use traditional forms
of community banking such as branch visits.
Fast information, fast movement of money, low costs transactions and
accessibility are most desirable to the potential clients of today’s financial
institutions.
Implications for
the Small Bank Business Model
Fintech companies, NBFI’s and the need for new and different
services presented by the unbanked and underbanked population will all continue
to put pressure on community bankers to begin to make a change. Change may be
hard, but it is also inevitable and necessary.
For community banks and credit unions now is a good time to consider NBFI’s
as viable and important customers. They
are a vehicle for consumers to meet their ongoing needs and they need bank
accounts.
[1] In
our most recent survey, published in October 2016, the FDIC reported that 7
percent of households were unbanked, lacking any account relationship at an
insured institution. The survey also showed that an additional one-in-five (or
19.9 percent of) households were underbanked, defined as households in which a
member had a bank account, but nevertheless turned to alternative financial
services providers during the year to address one or more needs for
transactional services such as check cashing or credit. Altogether, the survey
reported that some 90 million Americans, or nearly 27 percent of households,
are unbanked or underbanked.
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