Is the Megabank Model Dead?

Includes: BAC, C, IYF, JPM, KBE, XLF
by: Markham Lee

Here is a look at the comments from a notable banking analyst (one of the few that wasn't asleep at the wheel) who says that the big bank model is dead:

(From the WSJ): "The big-bank model isn’t going to last much longer, banking industry analyst Meredith Whitney said at the Journal’s Future of Finance Initiative, and said a more sustainable approach would be bigger regional banks.

Whitney, famous for foreseeing the troubles facing Citigroup (NYSE:C), suggested that key parts of the big banking model made them susceptible to the types of problems that caused the financial crisis. One issue is the physical distance between loan originators and borrowers. Good lending results from a relationship with borrowers, and regional banks are in a better position to take advantage of those relationships. She added that five banks controlling two-thirds of mortgage origination and credit cards is fundamentally unbalanced.

Instead, she suggested “supercharging” regional lenders. One possibility is that if stress tests help healthy banks and lead them to return TARP money, some of those funds could be transferred to local banks to encourage consolidation (on a smaller scale) in that sector. She also sees the potential for regional banks to take on business from nonblank lenders who were decimated by the subprime crisis."

In terms of the death of the big banking model, in addition to whether or not it should even exist, I think that there are multiple issues to consider/deal with:

Regulation: the relative health of the Canadian and Spanish banks more or less proves how tighter regulation can protect a nation's banking system, even when they're operating in an environment where their peers in other nations are falling apart at the seams. Our nation's regulators need to well, regulate, and remember that their key mission is to protect both the nation's banking system and the economy overall. While I don't deny that a better regulatory framework is needed, it doesn't change the fact that a lot of damage could've been prevented if our regulators weren't behaving as if the banks were their customers.

Incentives: it's not so much that the big banking model is inherently flawed per se, it's that the persons running them are incentivized to think short-term and take on risks that are rather dangerous to the economy. Change the nature of the incentives and major banking executives are likely to make smarter decisions.

Approach: I have consumer lending accounts with a small local bank (that's only in the state of Washington) and others with the so called megabanks, and I don't think the former has a better relationship with me than the megabank. I just think their executives have less leeway to take on big risks, and aren't being incentivized to do so in the first place. At the end of the day the application processes weren't any different, it's just that my local bank is taking a different approach to banking in general.

The point of the above is that the big banking model isn't inherently flawed per se, it's just that the government isn't overseeing it properly and the executives running it are being encouraged to make bad decisions. Remove these things from the mix and our banks would be a lot healthier right now. However the fact that it's possible to create an environment where big banks can remain healthy despite a credit crunch may very well be their saving grace, but that still doesn't mean that having 5 megabanks controlling 2/3rds of consumer lending is a good idea.

Sustainability and Safety: at the end of the day it's not in the best interest of our banking system (or the economy in general), to allow a small number of financial institutions to control an overwhelming precentage of our nation's banking activity. The health of our economy shouldn't be dependent on a small number of executives making smart decisions, especially given how interconnected the major banks are.

The goal of regulators and public policy around banking shouldn't be to enable Megabank ABC to grow like a weed, the goal should be to build a sustainable banking system that spreads risk around instead of allowing it to be concentrated in one place.

The Future: while I think a combination of their poor financial state and populist rage will definitely put some large dents in the armor of the big banks, I'm not convinced they'll disappear unless the will exists to redesign our banking system. At best they'll probably just get broken up into smaller institutions that will (along with present day regional banks) inevitably become the mega banks of tomorrow. Megabanks may not function quite like they do now, but the problem of a small number of banks with dominant market share will probably be with us for some time.

You can read more here.


The WSJ: "Regional Banks Are The Future" -- Phil Izzo, March 24, 2009

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

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