Community banks and credit unions have been a key part of the American economy since its beginning. These are the lending institutions that make loans to small sole proprietors, first time home buyers and dreamers of all kinds. Over the years, the business model for these institutions hardly varied. A review of the loan portfolios of community banks across the country will include three similar components:
· CRE– Commercial real estate loans have been one of the mainstays of the community banking business. These loans provide a viable, recognizable and reliable (usually) source of income. The return on investment for these loans have been the source of a large portion of the earnings for community banks for many years. The drawback for this type of lending is that it ties up a large portion of the capital of a bank and the return on investment takes a significant amount of time develop. A loss from one of these loans has the potential to threaten the existence of a small financial institution
· CNI – Commercial and Industrial loans have been the beating heart for community banks for many years. Very much like CRE loans, the income from these loans is recognizable and except for a few notable exceptions, reliable. Not only do these loans have the same concerns as CRE, the competition for these loans is fierce and smaller institutions often finds themselves left with the borrowers who present the highest level of risk.
· Consumer products – In the past 15 years, consumer loans have also proven to be a good source of earnings. Interest rates for consumer products have remained well above the prime rate and for a financial institution that is properly equipped, consumer products can provide a strong stream of income. Consumer products also tend to be for smaller amounts, have higher rates of losses and are heavily regulated.
This three-pronged approach to earning income has been a steady, tried and true method for earnings at small financial institutions. However, there are several factors that are coming together that have threatened this business model.
· Fintech – Financial technology (“Fintech”) companies are those companies that use software to deliver financial products. Today one of the most recognizable fintech companies is PayPal. Using just a smart phone, PayPal gives its users the ability to make payments, pay bills, deliver gift cards and conduct financial transactions with people throughout the country. For community banks, the knowledge of the existence of PayPal is interesting, but what is more critical is the reason that PayPal was developed. PayPal, and its fintech brethren exist to fill a specific need that Banks were not meeting.
· NBFI – The Operation Chokepoint program was a program spearheaded by the Justice Department that was aimed directly at Non-Bank Financial Institutions, aka Money Service Businesses. At the time the program was started, a decision was made that money service businesses represented an unacceptable money laundering risk. Ultimately, Operation Chokepoint fell into disrepute and was ended. Although Operation Chokepoint has ended, its legacy is still prevalent. MSB’s still have significant problems getting bank accounts. Despite this fact, the amount of money moved through remittances continues to grow. MSB’s continue to serve this market for a huge population of people who are unbanked and underbanked.
· Underbanked and Unbanked– The number of unbanked and underbanked families continues to grow. Unbanked families are those without a bank account and underbanked families are those that use minimal banking services. The number of people in these families totaled approximately 90 million in 2016. Equally as important as the sheer size of the unbanked and underbanked population is the reason that many of these potential customers remain that way. High fees, poor customer service and bad public image have all been contributing factors for the large population of unbanked and underbanked customers.
Customer Bases in the Future
The combination of these forces will greatly impact the future of the business model for community banks. Customers will continue to change their expectations for their financial institutions. The traditional balance has changed, instead of being forced to choose the products that financial institutions offer, customers have come to demand products from their companies.
The financial needs of customers have also changed. Electronic banking, online account opening, remote deposit capture and iPhone applications are now almost necessities. Younger customers, who make up a significant number of the unbanked and underbanked population rarely use traditional forms of community banking such as branch visits. Fast information, fast movement of money, low costs transactions and accessibility are most desirable to the potential clients of today’s financial institutions.
Implications for the Small Bank Business Model
Fintech companies, NBFI’s and the need for new and different services presented by the unbanked and underbanked population will all continue to put pressure on community bankers to begin to make a change. Change may be hard, but it is also inevitable and necessary. For community banks and credit unions now is a good time to consider NBFI’s as viable and important customers. They are a vehicle for consumers to meet their ongoing needs and they need bank accounts.
Fintech companies reason for existing is to fill the unmet needs of unbanked and underbanked. These companies have developed applications that allow everything from alternate means of credit scoring to international transfer of funds using applications. A community bank or credit union that creates a partnership with the right fintech company can offer products and services that will greatly distinguish them in the market and allow for continued growth and alternate means of income. 2018 is a great time to start thinking about a new business model.
 In our most recent survey, published in October 2016, the FDIC reported that 7 percent of households were unbanked, lacking any account relationship at an insured institution. The survey also showed that an additional one-in-five (or 19.9 percent of) households were underbanked, defined as households in which a member had a bank account, but nevertheless turned to alternative financial services providers during the year to address one or more needs for transactional services such as check cashing or credit. Altogether, the survey reported that some 90 million Americans, or nearly 27 percent of households, are unbanked or underbanked.