Explaining the Decline in the Number of Banks

The financial crisis of 2007– 08 significantly altered the banking landscape. From 2007 through 2013, the number of commercial banks in the United States fell by more than 800, a 14 percent decline. This drop was highly concetrated among small community banks (banks with less than $50 million in assets), which saw their numbers shrink by 41 percent.1 Although many banks failed during the crisis and its after- math, this decline was driven largely by a lack of new banks. The number of newly formed banks (called de novo banks) has fallen sharply since 2010. In 2012, there were no de novos, and in 2013 there was only one: Bank of Bird-in-Hand, formed in Lancaster County, Pa., to serve the Amish community.

This collapse in new bank entry has no precedent during the past 50 years, and it could have signi- fi cant economic repercussions. In particular, the decline in new bank entry disproportionately de- creases the number of community banks because

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March 2015, EB15-03 Economic Brief

EB15-03 – Federal Reserve Bank of Richmond

Explaining the Decline in the Number of Banks

since the Great Recession

By Roisin McCord, Edward Simpson Prescott, and Tim Sablik

The fi nancial crisis of 2007–08 was a major shock to the U.S. banking sector.

From 2007 through 2013, the number of independent commercial banks

shrank by 14 percent—more than 800 institutions. Most of this decrease was

due to the dwindling number of community banks. While some of this decline

was caused by failure, most of it was driven by an unprecedented collapse in

new bank entry. The rate of new-bank formation has fallen from an average

of about 100 per year since 1990 to an average of about three per year since

2010. If this change persists, it will have a large impact on the composition

of the banking sector as well as the fl ow of credit in the economy.

Page 1

most new banks start small. Since small banks have a comparative advantage in lending to small businesses, their declining number could aff ect the allocation of credit to diff erent sectors in the economy.2 This Economic Brief compares recent events to historical trends and explores some possible explanations for the sharp decline in new community banks.

Historical Trends

For most of U.S. history, banks were barred from opening branches across state lines, and some states even prohibited intrastate branch- ing. These policies led to a banking system composed largely of thousands of small, inde- pendent banks. From 1960 to 1980, there were between 12,000 and 13,000 independent banks in the United States.3

Starting in the 1970s, however, states began relaxing branching restrictions. This process continued throughout the 1980s and early










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1990s, culminating in the Riegle-Neal Interstate Banking and Branching Effi ciency Act of 1994, which removed most of the remaining restrictions on inter- state branching.4 As a result, the number of banks in the system declined, as weaker or smaller banks were acquired by stronger or larger institutions and banks took advantage of economies of scale. By 2000, the number of independent commercial banks had fallen to less than 7,000. (See Figure 1.)

Despite this trend, however, the industry has histori- cally been highly dynamic. Institutions regularly merge or fail, others grow or shrink, and—at least in the past—new banks join the system. Indeed, periods of accelerated bank exits are also typically marked by increased bank entries, as layoff s increase the supply of experienced bankers available to start new institutions.5 At fi rst glance, the past fi ve years do not appear markedly diff erent from previous pe- riods. The decline in the total number of banks could be viewed as a continuation of the trend that began in the 1980s, and exit rates do not diff er sharply from previous periods. (See Figure 2.) Indeed, despite the severity of the fi nancial crisis, the exit rate did not signifi cantly change from the pre-crisis period, although more banks did exit due to failure than merger or acquisition. However, a closer examination

reveals a striking decline in new bank entry not seen in previous periods: From 2009 through 2013, entry falls to almost zero.

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