Commercial Banks And The 'New' Modern Corporation

by: John M. Mason

The commercial banking industry in the United States seems to be catching up with changes going on in other industries that incorporate modern information technology and more modern corporate thinking.

As a consequence, substantial changes are coming to the banking industry and these changes reflect what has taken place in other areas representative of the "new" Modern Corporation.

The major hindrance to this evolution of the banking system is the regulatory agencies because this "modernization" will result in a lot fewer banks which will dominate the industry.

Lately, I have been writing about the "new' Modern Corporation. Almost all of the analysis has been related to non-financial institutions. I hope to correct this going forward.

The two major characteristics associated with the “new” Modern Corporation has been the emphasis upon intangibles, like intellectual property, and upon financial engineering.

In terms of financial institutions, especially commercial banks, which I will primarily focus upon, I will emphasize the intangibles part of the equation and, in future posts, I will discuss the emerging financial engineering aspect of banking, something one could argue, commercial banks already engage in.

Much of my writing on commercial banks and the new era of information technology have focused upon the fact that the US commercial banking system was running behind most other industries, but was also running behind the advances of financial institutions in other parts of the world.

In May of this year, however, I wrote about how the larger banks in the US seemed to be “getting” the changes going on and was now moving more rapidly into digital banking and modern information technology.

My argument today is the banking system is now starting to show results that are not unlike other, more modern corporations, and the financial world is now taking on characteristics not unsimilar to those found in the world of the “new” Modern Corporation.

The commercial banks still have a long way to go, but they seem to be finally on their way.

During the Great Recession and the early years of the current economic recovery, many commercial banks went “out-of-business.” These banks were not in the best of financial shape and so these “weaker” banks were merged into larger, “stronger” banks.

However, in recent years, smaller commercial banks are still leaving the scene, and they do not seem to be leaving the industry because of poor financial conditions. Their reasons for leaving appear to be based upon things like inability to recruit management or to recruit management that can deal with the new technology. Furthermore, the new technology itself is expensive and the small banks cannot achieve the scale needed in order to justify systems that are large enough to compete. Consequently, more and more “smaller” banks are dropping out of the industry because they are cannot economically meet modern banking requirements.

The Great Recession ended in June 2009. At that date, there were something like 6,829 commercial banks insured by the Federal Deposit Insurance Corporation.

On June 30, 2018, there were only 4,833 commercial banks that were insured by the FDIC, representing a decline of almost 2,000 banks since the Great Recession ended. On average, there were 222 commercial banks leaving the industry every year.

Of course, there were more “leavers’ each year during the earlier years as those banks in worse financial shape left the industry. The pace of “leaving” has slowed in recent years. The number of banks on the FDIC’s list of “problem banks” has dropped to only 82, an almost insignificant level. One has to go back to before the recession began, in 2007, to find such a low number.

But, by the end of 2017, there were 194 fewer banks being insured by the FDIC than there were at the end of 2016.

At the middle of 2018, the number of banks leaving the industry was running at a pace of about 170 per year.

These commercial banks, I contend, are not leaving the industry because of poor financial conditions, but are leaving for other reasons… one of the major ones being their inability to be able to compete in terms of current technology. These banks just cannot keep up.

These changes are having a dramatic impact on the banking industry.

For one, almost one-half of all the assets in the banking system are owned by the five largest banks in the country. In the late 1990s, the top five only controlled about twenty percent.

On June 30, according to Federal Reserve statistics, the largest 25 domestically chartered banks in the US controlled 56 percent of total banking assets. If one adds to these banks, the assets of foreign-related institutions in the United States, the percentage goes up to 70 percent.

That is 4,808 commercial banks, 99.5 percent of the domestically chartered banks in the United States, own only 30 percent of the commercial banking asset in the United States.

Large, “new” Modern Corporations tend to hold a lot of cash, which gives them real opportunities.

The 25 largest domestically chartered commercial banks in the US have over $1 trillion in cash assets on September 26, 2018, which is almost 50 percent of all the cash held by all commercial banks in the US.

Note that on September 19, 2007, just before the Great Recession began, the largest 25 domestically chartered commercial banks held only $153 billion. Thus, the largest banks now hold almost seven times the amount of cash they held at the earlier dates.

Further, note that the rest of the domestically chartered commercial banks, on September 26, 2018, held only around $300 billion in cash assets, roughly only 15 percent of the total.

On September 19, 2007, the total for the smaller banks was only about $90 billion. The 4,808 banks had only a little more than three times their 2007 amount.

Something is going on in the banking system that has not been identified by the “old” model of commercial banking. Maybe we could have said something different in the early years of the current economic recovery. I don’t believe that we can now.

The United States banking system is starting to show signs of moving into the new era of information technology. The largest banks have the resources to make the move and achieve the scale that is consistent with other “new” Modern Corporations. The smaller banks will not make it. And, this is not just a matter of saving “Main Street” banks versus the “Wall Street” Giants.

Just as we are seeing scale come to dominate the world of the FAANGs, it is also coming to impact the commercial banking world. But, this is a result of the technology, not just anti-competitive behavior. As with the FAANGs, if the new banking platforms can’t achieve the scale, their technology will not be used.

Furthermore, like other areas surrounding the “new” Modern Corporation, the commercial banking industry is experiencing, more and more, smaller firms producing “applications” around the periphery of the larger institutions. As these “applications” are tested and succeed, the more dominant banks will acquire them and this will supplement the growth of the largest institutions as they evolve further into the future.

Finally, the commercial banking industry in the United States is beginning to catch up, technology-wise. More on this coming up.

Disclosure: I/we 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.