Banking industry consolidation continues

BY JOE WITT

Many industries have seen significant consolidation over the past few decades. Look at the airline industry. In the Midwest we had lots of carriers that have now merged out of existence. Republic Airlines was taken over by Northwest Airlines. TWA was purchased by American Airlines. Both Western and Pan Am became part of Delta. Northwest and Delta then merged to create the world’s biggest airline. Later, Continental and United merged to become the world’s new biggest airline. Now, US Airways and American Airlines might merge, which would create the latest version of the world’s biggest airline.

That same type of industry consolidation is also hitting the banking industry. In 2000, Minnesota had 502 bank charters. That is not the number of bank branches; it was the number of separate financial institutions. As of year-end 2012, the number of Minnesota charters had dropped to just 379. In those 12 years, 25 percent of the Minnesota charters were merged out of existence.

The percentages in South Dakota and North Dakota are similar. South Dakota saw a 22 percent reduction, from 101 in 2000 to 79 in 2012. North Dakota saw a 20 percent reduction, going from 113 in 2000 to 90 in 2012.

What are the main factors driving banking industry consolidation, and is it likely to continue? There are a couple main drivers. First, banking is a heavily regulated industry. Bank owners, bank boards of directors and bank senior management all understand that they operate within an intense regulatory environment. But the current regulatory burden on banks, and especially on small banks, has become extremely difficult to manage. Over the past 15 years, there have been dozens of new, extremely costly regulations with which banks must comply. Most recently, Congress passed the Dodd-Frank Act, which was originally intended to reign in Wall Street abuses and prevent future federal government bailouts. While the small community banks dotted across the Midwest were never the intended targets of this law, they now must comply with thousands of pages of new, costly regulations. Small banks have an especially difficult time absorbing these new costs.

The second driver of banking industry consolidation is unfair competition. Two entities which the banks directly compete against, credit unions and the Farm Credit System lenders, have significant marketplace advantages.

Credit unions are completely exempt from both federal and state income taxes, and federal credit unions do not pay state sales taxes. That’s an incredible advantage. Credit unions are also exempt from several important laws with which banks must comply, saving them additional overhead expenses. A mutually owned federal savings bank just completed a conversion to a credit union charter. The president of the new credit union estimated that changing from a tax-paying, more heavily regulated bank to a credit union would save the credit union over $2 million in tax expenses and operating costs per year. The institution did not change its customer base or its products and services in any way. The savings simply came from changing its charter.

Farm Credit System lenders also have significant advantages over banks. They, too, have tax advantages. They pay federal income taxes on just a small fraction of their operations, and they are exempt from state income taxes and state sales taxes. They and their borrowers are exempt from state mortgage registry taxes. Farm Credit System lenders also have funding and regulatory advantages.

The combination of increasing regulatory burden plus intense pressures from competitors that have significant competitive advantages will mean that further banking industry consolidation will occur. I do not like the idea of further consolidation, as it limits choices for consumers, small businesses and farmers. But it is easy to understand why consolidation is happening. At this point, Congress is picking winners and losers in the marketplace through tax and regulatory policy decisions. And the local banks are clearly not the winners. It is sad to see, but you can understand why the owners of second-, third- and fourth-generation family banks are deciding to get out of the business. PB

Joe Witt President/CEO, Minnesota Bankers Association Joew@minnbankers.com