Who Wants To Be A Commercial Banker? Who Wants To Invest In A Commercial Bank?

by: John M. Mason

I don't know why anyone would want to be a commercial banker these days.

I don't know why anyone would want to invest in a commercial bank these days.

My grandfather was a commercial banker all of his life. This is where I developed a desire to be a commercial banker. When I was eight years old I became familiar with "proof" machines, which were machines that took pictures of both the front side of a check and the back side of a check. Many times my hands were recorded for posterity, as I did not get them out of the way of the camera when the picture of the check was being taken.

I have been the president and CEO of two banks and the EVP and CFO of a third. I taught the financial management of commercial banks at the Wharton School and wrote a textbook by the same name that was used at the University of Pennsylvania, Stanford University, the University of Chicago, and Northwestern University, among other schools.

And I wouldn't want to be a banker today! I won't own stocks in any bank now. My primary financial business is not done through a bank now.

The government and the regulators have created an impossible situation for commercial banks. The latest fiasco coming from the regulatory system is the stress tests for commercial banks. "Stress tests" are supposed to determine whether or not a commercial bank is prepared to weather bad times. The tests simulate worst-case scenarios to see how a bank will survive a financial crisis.

According to a Wall Street Journal article, "the stress tests, which started in 2009 as a way to convince investors that the largest banks could survive the financial crisis, now are an annual rite of passage that determines banks' ability to return cash to shareholders."

These stress tests are mathematical constructions that depend heavily on how the models are constructed and the assumptions that are made to create the simulation. They are artificial creations that are dependent on past experience. They have very little to do with running a bank.

The models are kept secret from the banks that they are applied to. The Wall Street Journal article linked to above continues: Fed officials "don't want to hand over their models to the banks, in part because they don't want the banks to game the numbers." Some banks failed the stress tests last year, but they were never told how they were being measured -- so they had no idea why they failed the tests. That's real helpful.

When I worked in the government, we had information that had the caution "for our eyes only." These were pieces of information that we didn't want the public to see. The word inside the government, however, was that the information was so inadequate that we didn't want people to know what information it was that we were using. I feel the same way about the models being used in the stress tests.

Currently, the Wall Street Journal article states, only banks with assets that total more than $50 billion are subject to these stress tests. There are only 30 banks that fit into this range. Next year, these stress tests will be extended to commercial banks with assets in excess of $10 billion. Furthermore, the regulatory agencies are asking for more and more data to include in their tests. These requests go down to requiring information on the location of properties used as collateral for loans. Also, they are asking for quarterly data and monthly data, rather than just annual data.

So what's the value of the stress tests?

The value depends on what the regulators assume -- and you know what happens when you assume. Yet, commercial banks continue to innovate and use technology in ways that the regulators have not currently caught on to. They have done this since I was involved in banking and will continue to do this in the future. The bankers, in order to maintain profitability, will always move to get around the latest and greatest ideas the government and the regulators have.

This, however, forces them to focus on avoiding the new regulations as best they can. Yes, they want to know how they are being tested. Yes, if they know they will be tested in a certain way, they will "game the numbers." If they don't know how they are being tested, they will still "game the numbers."

In this environment, the government plays games, the regulators play games, and the bankers play games.

Why would one want to invest in commercial banks when the crucial test of the bankers is how well they can play the game? An investor just does not have enough information to choose an investment in such an environment. And the situation described above is just a part of the story.

That is why I don't invest in commercial banks. That is why I don't bank with commercial banks. That is why my attention in the financial area has shifted to "shadow banking."

I believe that the banking system is splitting three ways. First, scale is going to become more and more important to individual banking institutions, primarily driven by the benefits of information technology. The 25 largest domestically chartered commercial banks in the United States have over 60% of the banking assets in the United States. Add in the assets of foreign related institutions and you are now up to 71% of the banking assets in the United States. (Data is taken from Federal Reserve release H.8.) These are the organizations that can deal with -- and avoid -- bank regulators.

Second, I believe that non-profit credit unions will be taking over more and more of the consumer banking business in the country. These organizations will be more closely aligned with individuals with lesser amounts of wealth and fewer financial needs.

Third, the shadow banking system is going to grow. This group of institutions has thrived on finding "missing markets" in the economy and, in my estimation, will be even more productive in the future. These organizations will find ways to serve the needs of the small- and medium-sized businesses. These organizations will find ways to serve early stage companies that are bigger than those serviced by the angel investing community and those companies that are larger and are at a later stage in their development. These organizations enlarge possibilities for funds transfer that are not transactions accounts but act, in many ways, like transactions accounts.

The world is changing. We are decades away from the institutions where a young boy could get a picture taken of his hand in a bank "proof" machine. Part of our problem is that we still think of banks in this "legacy" way. We need to move into the 21st century.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.