Why Are There So Few New Banks?

By Markets Fool.com

Continue Reading Below

While the financial crisis officially ended five years ago, one vestige doesn't seem likely to goaway anytime soon: the number of new bank charters.

Between 1990 and 2006, the FDIC approved an average of 152 bank and thrift charters a year. Since 2010, however, a mere 16 have been granted in total. That equates to an annual average of only 3.2.

That there were fewer applications and approvals in the wake of the financial crisis should come as no surprise, as charter volumes have a tendency to track the business and/or credit cycle.

Over the last quarter century alone, charters dropped off during the commercial real estate crisis in the early 1990s, rallied during the high-growth years leading up to the Internet bubble, briefly retreated after the turn of the century, and made a final surge in the accumulation period of the credit-fueled housing bubble.

Continue Reading Below

Still, the drought in approvals over the last five years is notable for both its length and its failure to show even the slightest hint of recovery.

There are multiple explanations for this, but underlying them all is that profitability in the industry has persistently underperformed the theoretical cost of common equity. To break even, it is generally assumeda bank must earn 10% on its common equity, which is fully explained in a previous article of mine. But over the last two years, the industry average has been closer to 9%.

Not coincidentally, it's almost axiomatic that there are too many banks in the United States given that they sell a commoditized product -- namely, money. "Given average ROE below the cost of capital, tight margins, low interest rates, tough competition and too many banks, it is no wonder why more bankers have not applied," wroteChris Nichols, chief strategy officer at CenterState Bank of Florida.

It is for this reason that the bank industry in coming years is likely to lean towardconsolidation -- which, of course, is nothing new. Since 1985, the number of FDIC-insured institutions has fallen by 11,332 units, or 63%. Some of this resulted frombank failures, but the lion's share was triggered by mergers and acquisitions.

This trend will probably continue,saidJim Marous, of The Financial Brand, a digital publication focused on marketing and strategy issues affecting retail banks and credit unions. According to a panel of bankers and consultants surveyed by Marous, consolidation could "possibly even increase in 2015."

The net result is twofold. First, while it's impossible to predict the future with precision, it seems reasonable to conclude that growth in the bank industry will be driven less by new participants and more by organic expansion at existing institutions. By the same token, it isn't far-fetched to think competition over an ever-decreasing supply of acquisition targets will push bank valuations even higher in future credit cycle upswings.

The article Why Are There So Few New Banks? originally appeared on Fool.com.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.