The year is only half past, but 2016 is well on its way to joining 2011, 2012 and 2014 in a dubious distinction: a year that zero new U.S. banks were chartered. As consolidation of existing banks continues, many have observed that the lack of new banks reflects burdensome regulatory compliance, an inhospitable interest rate environment, excessive capital requirements, an insufficiently robust economy—or some mixture of all of these.
In his classic 1946 book Economics in One Lesson, Henry Hazlitt writes that economics “is the science of tracing the effects of some proposed or existing policy not only on some special interest in the short run, but on the general interest in the long run.” And thus, while the drought of de novo banks will ripple through the American economy, it will have subtle, significant and virtually unexplored long-run effects on the next generation of bank leadership.
De novo bank founders are entrepreneurs, and the entrepreneurial mindset is different from the “stewardship” mindset that characterizes many bankers, says Trey Maust, co-president and CEO of Lewis and Clark Bank in Oregon City, Ore. While stewardship can yield growth—consider Jesus’ parable of the talents, in which the steward who got the largest investment return for his master’s money was most highly commended—it also implies an inward focus, a priority on preservation rather than risk.
While it’s a good model for a mature industry like banking, every industry needs an entrepreneurial edge, a bit of ebb and flow that brings fresh perspectives, outside people and creative ideas. Since the recession, the banking industry has been all ebb and no flow.
And what will that ebb tide mean for the future of banking? Few bankers see the de novo drought ending soon. The Federal Deposit Insurance Corporation says it wants to ease the process for new bank investor groups, something that ABA Chairman Dan Blanton strongly encouraged in a recent meeting with FDIC Chairman Martin Gruenberg. But the higher compliance burdens, higher capital levels and low rates aren’t expected to go away.
“It takes a unique situation to succeed today because of the scale of all of the governance matters that the regulators require of you,” says Michael Ewing, vice chairman and CEO of Oak View National Bank in Warrenton, Va. “It’s very difficult to find people to put up enough capital to allow you get to the scale to be profitable.”
And thus, if we are to look into the effects the de novo drought “on the general interest in the long run,” we will see banks struggling to attract creative outside talent, connect with small business customers and channel innovation inside the bank.
Magnets for fresh talent
Maust knew he wanted to start a community bank just six months after he took a job as CFO at a small Portland-area community bank. He had come into community banking at an angle, following several years working in mergers and acquisitions on Wall Street. So he and a group of co-founders and investors raised $12 million in capital—a high level for the mid-2000s, calculated for growth—and launched Lewis and Clark Bank in Oregon City in 2006 as part of the last big wave of bank startups before the financial crisis.
Today, Maust notes, banks are usually expected to have $25 to $30 million in capital before being chartered—a high hurdle given the persistent low-rate environment. “Had there not been an opportunity to start one at the capital levels where I thought we could, I would have gone somewhere else to work—probably a different industry,” he says.
He’s not the only CEO who would have been lost to community banking. In 2007, Frank Sorrentino led the opening of what is now the $3.4 billion ConnectOne Bank in Englewood Cliffs, N.J., just across the Hudson River from Manhattan. Sorrentino had previously spent nearly three decades as a high-end custom home builder in New Jersey, and as a longtime bank customer as a businessman, he wanted to bring his skills to the banking industry.
When asked if he would have gotten into banking had he not been able to lead a bank startup, he flatly says “no.” “I do worry about the future of the whole industry if we’re not going to allow de novos to form,” he continues, “and the type of talent that’s going to be attracted.”
Robert Litan, an entrepreneurship expert and adjunct senior fellow at the Council on Foreign Relations, emphasizes that de novo banks need executives with relevant experience. “But banking experience alone doesn’t assure that these new banks will necessarily be innovative,” he notes. “Increasingly, firms of all types benefit from having personnel with tech, retail and social media marketing experience, and to the extent new banks can attract or be founded by individuals with such experience, the more innovative they are likely to be.”
Maust agrees. “It’s helpful to have that in the mix,” he says of the outside talent that startups can attract. “We’re going to lose the opportunity to bring in [those] who are a little more willing to look at alternatives.”
A flash of creativity
Coming into the banking industry via a startup instead of through a pre-existing bank provides more opportunities to introduce big changes because there are fewer barriers of the “that’s the way we’ve always done it” variety. Consider Vernon Hill, who as a twenty-something Wharton School graduate founded Commerce Bank in New Jersey in 1973. Drawing on lessons learned from a few innovative bankers and from the fast-food industry, Hill’s bank offered seven-day-a-week service, on-site ATM card issuance and fun features inside the branches, which he called stores. Commerce Bank grew to $51 billion in assets before it was merged into and rebranded as TD Bank in the 1990s.
While Hill is controversial among some in the industry, Commerce Bank’s innovations soon became widespread among U.S. banks. But without the entrepreneurial energy and insights of a non-banker introducing them through a new enterprise, would they have? And how quickly?
“Without entry from new organizations, firms in all industries are insulated from what is best working at the cutting edge,” says Litan. “Banking is no different. If banks themselves don’t innovate—or are not spurred to innovate by the entry of new banks— then they will be at greater risk over time of having their customer base eroded by new fintech providers.”
Sorrentino also points to the growth of nonbank fintech. “It’d be nice if we were starting banks with new ideas, right?” he asks. “There’s a whole entrepreneurial mindset that you just don’t get in a lot of banking institutions.
Credibility with business customers
One little-discussed strength of de novos is in serving small businesses—community banks’ bread and butter. “No community banker is going to understand small businesses better than someone who has started a community bank,” says Ewing, who co-founded the $173 million Oak View National Bank in 2009. “It’s a huge advantage. We can be empathetic and understand what it is they’re going through.”
Sorrentino adds that having built a de novo gives him and his staff credibility “sitting at the table with our clients who are doing similar things. ‘I’ve gone through the same challenges as you,’ is the message.”
New Jersey’s David Hanrahan echoes the sentiment. “My team and I can relate far better to commercial borrowers because we deal with the very same issues they do, like liquidity management, succession planning, regulation and customer acquisition,” he says. “We can empathize with them, and I think we’re probably a little more understanding of their needs because of that.”
All hands on deck
Going through a de novo process forces bankers to become scrappy and find urgent solutions to emergent problems. “You find yourself getting into the details of how everything works,” says Christopher McGill, who founded East River Bank in Philadelphia with an 18-member team in 2006. “Everyone was wearing a lot of different hats, and we were able to adapt when we needed to adapt.”
By contrast, in a large bank or even an established community bank, policies are in place and positions are fairly well-defined. Bankers increasingly shape their careers as specialists. Instead of a banker staying with one bank and building skills in different departments over a career, many bankers specialize and then move from bank to bank working in their specialty, whether it’s commercial lending or compliance or retail operations.
There’s nothing wrong with that for individuals. But for the industry at large, it can limit the pool of future community bank leaders. As David Hanrahan points out, “in the community banking space one must be a generalist, not a specialist. While every banker has his or her strengths and weaknesses, it would be really dangerous to run a small bank with blind spots to certain areas of a bank’s operation and risk profile.” And working in a de novo—as Hanrahan did early in his career and again as founder, president and CEO of Capital Bank of New Jersey, a 2007 startup in Vineland, N.J.—forces bankers to get that broader experience.
“Our industry is already seeing a shortage of new talent due, among other reasons, to our industry’s image problems and to the absence of management training programs,” says Hanrahan. “If we compound that problem with a prolonged shortage of de novos where young bankers can learn their craft in a well-rounded fashion, that bodes poorly for our nation’s community banks 10 and 20 years on.”
Individual bankers can’t do much about the environment that has stanched the flow of de novos. The longer the de novo pipeline remains closed, fewer bankers will have experience like Hanrahan’s or Sorrentino’s—and fewer of those inclined toward entrepreneurial innovation will enter the industry.
This is bad news, Litan says. “Directionally, it cannot be good for the future health of the banking industry not to have the dynamism typically associated with new entrants.” (But ever the economist, he cautions that “how much of an adverse effect this is—namely, its quantitative impact—may not be known for some time.”)
So what can bankers do to foster that entrepreneurial spirit within their banks? Bankers from the last big wave of de novos have a few ideas as their banks hit or approach the decade mark. Sorrentino emphasizes the role of the CEO in communicating and embracing an entrepreneurial culture. Even de novos can quickly lose that edge, he says. “The entrepreneurship of starting a bank gives you a kickstart, but if it’s not supported over time, that goes away real quick.”
In an era of increasing specialization, Hanrahan encourages bankers to make conscious efforts to expose ambitious employees to all areas of the bank. “Our young, crackerjack credit department manager recently asked to sit in on our bank’s ALCO meeting,” he says. “Interest rate risk modeling has almost nothing to do with his current job responsibilities, but I love the fact that he wants to learn more about other important aspects of Capital Bank’s business.”
For Maust—who describes his employees as “bankerpreneurs”—it’s as simple as remembering that “it doesn’t have to be done the same way it’s always been done, but it doesn’t mean it has to be a radical change or departure.” At Lewis and Clark Bank, he couldn’t stand the bank’s first website, which looked indistinguishable from other community bank websites. “I tried so hard to find a marketing and branding firm that had never done a bank’s website before, and I didn’t want it to look like a bank,” he says.
“That creativity is still something we try to instill in our lenders,” he explains. “You still have to address risk and profitability and the customer’s needs, but it doesn’t always have to be cookie cutter.” This flexibility, he notes, is what has always set community banks apart since “we can be creative in our structuring.”
Make no mistake: starting a new bank isn’t for everyone. Sorrentino says starting ConnectOne Bank was “the biggest learning curve I ever had in my life.” Meanwhile, Hanrahan cites his father’s comment on military boot camp: “I’m so glad I did it— and I never want to do it again!”
But it’s important for the future of the nation’s banks that the de novo path be viable. “It was a blast,” Hanrahan reflects. “It was such good career development for me.”
In a world without startup opportunities, bankers who want to provide that career development to the next generation of bank leaders must foster cultures of entrepreneurship and innovation inside the bank’s walls.
This article originally appeared in the July/August issue of the ABA Banking Journal.