Magazine article The Journal of Lending & Credit Risk Management

Opening a Successful Start-Up Bank Requires Careful Planning

Magazine article The Journal of Lending & Credit Risk Management

Opening a Successful Start-Up Bank Requires Careful Planning

Article excerpt

Bank of America Combines with NationsBank. Travelers Insurance and Citibank Form Citigroup. Bankers Trust Merges with Deutsche Bank.

While the headlines are full of talk of banking consolidation at the super-regional, national, and international level, there is another, less-celebrated trend in banking today. Largely led by commercial lenders, there is an explosion in the number of start-up banks.

Their stature may easily be discounted, but much like a school of very small fish with razor-sharp teeth, start-up banks collectively can take a significant bite out of major banks. Indeed, studies of various counties in Pennsylvania demonstrate that real market share has been lost to small- and medium-size independent banks.

Some start-up banks will prosper, others will flounder, and a few may even flirt with failure, but the outcome for each bank may well be predictable at its outset.

Analyzing the start-up banks of the 1980s should have taught bankers a number of valuable lessons. Always anxious to understand other business ventures, some bankers have spent less time taking a long, hard look at their own industry. Here is just a sampling of what needs to be considered.

The Marketplace

The most common location for start-up banks is the central business district of a large city or a wealthy suburban town. While both may have the cachet to be attractive to the ego of investors or management, their prominence may not be enough to support a de novo bank.

"Downtown" banks are in a tough competitive situation in most cities. They are forced to compete with flagship offices of major institutions and often with the headquarters of a number of midsize and smaller banks, all within a short distance of each other. This level of competition tends to drive up the cost of funds and often drives down the quality of loans. With a narrow net interest margin, a few problem loans can have an immediate impact on earnings.

Upscale suburbs may appear like the place to be, but they tend to bring other problems to a start-up bank. High-income retail customers today are often customers of a private banking department in a major bank. A quality private banking effort can include investment management, trust services, lending, tax planning, and many other specialties. Residents of upscale suburbs are usually clients of multiple brokerage firms and may well have private investment advisors, a tax planner, and other financial advisers. Owing to limited capital, most small start-up banks normally are not equipped to provide numerous sophisticated services, but tend to rely on basic banking deposit products with some flexibility in lending. This situation makes it more difficult to increase deposit levels, unless the bank is able to focus on a few attractive segments within the market area.

Whether the upscale suburb is a good location may depend on the size of the suburb and the competitive situation. While small business is attractive for a start-up bank (and the start-up bank is attractive to smaller businesses), it takes a significant number of these loan and deposit relationships to reach a critical mass for the bank. Thus, the number of area businesses in easy reach of the bank becomes very important.

The competitive environment is critical for every start-up bank. Just how many banks are in close proximity? What do they do well and what do they not provide? Is the community growing and how is it growing? What can a small player truly contribute to the market? How does this specifically translate into deposit and loan products?

The Investor Group

De novo banks are not a short-term investment. It frequently takes a few years to reach a solidly profitable level of operations. Normally, the number of investors is very limited, causing a lack of trading and, of course, limited liquidity. Accustomed to investing through brokers, most individuals frequently are not prepared to wait for five or more years before any significant appreciation is apparent. …

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