“You’re gonna need a bigger boat.”
This is the famous quote of Roy Scheider as Police Chief Martin Brody in the movie “Jaws,” just after he catches a glimpse of the monster shark terrorizing his small vacation community. He finally vanquishes the giant killer with a bigger boat, shrewd tactics and a lot of nerve.
Small banks have similar threats from a different kind of attacker. They used to enjoy the calm waters of a normal yield curve, low credit losses and strong economic growth. This allowed them to provide financial services and earn a reasonable profit.
The stubborn low interest rate environment is making it more difficult to make money. That reality, combined with increased regulatory costs, higher capital requirements, and ongoing credit losses create an environment where small banks are being capsized in “shark-infested” waters.
Consider this: In the 1980s, there were 18,000 banks in the U.S.; we now have 6,500. In 2006, Washington state had 83 banks. We now have about 50, and that number will drop further.
Despite an abundance of alternative sources of financing, banks remain the “blood supply” of available capital for economic growth. It is important for the banking system to stabilize and complete this consolidation process to continue as a reliable source of funding for business expansion. The banks that survive these challenging economic conditions, and make it through the current consolidation phase, must also restructure for the next leg up.
Maintaining health requires a compelling strategy for transformation into organizations that can accomplish at least these three equally critical objectives:
• Achieve adequate scale — Banks need enough asset size to endure protracted low rates, higher capital requirements, more credit losses, additional regulatory costs and dramatically increased demand for technology. To meet these challenges, the banking system seems to be settling into three separately sized industry groups. Credit unions will be able to survive as smaller organizations because they enjoy tax-exempt status. Community/regional banks will need to increase asset size to above $2.5 billion, while national banks will generally operate in excess of $15 billion. Mergers will continue in all three groups until survivors emerge that can serve their respective markets effectively and make a reasonable return.
• Attract and reward investors — The bank of the future must transform itself into a great investment opportunity. It must attract, retain and reward investors who have many other appealing investment alternatives that are much less regulated and have lower risk profiles than banks. This will require the bank of the future to develop strategic plans with robust service sets, diversified revenue sources, reliable execution, and nimble responses to new market realities. These traits have not been a hallmark of most banks and will be a prerequisite for the new era in banking.
• Genuinely serve clients — Bankers must regain their status as “trusted advisers,” which they held prior to the recession. An astonishing array of financial options are available to consumers, from many different providers. Consequently, banks must provide integrated services that allow clients to enhance their financial lives with sophistication, affordability and convenience. The ability to transform into an organization that can deliver these complex financial services in a highly personalized fashion will differentiate future players. Undifferentiated banks will not survive.
Bankers will need the savvy and courage of Police Chief Brody to build a better and bigger bank for the future. This exciting transformation in banking is under way.
Nothing is certain, which means everything is possible.
Brett Bryant is the Oregon/Washington market executive for Heritage Bank.