Banking Industry in the US yet to penetrate 8.4M households

It is estimated that banking assets were equal to 56 per cent of the US economy. The five largest banks of the US holds 40% of the US deposit market.

Definition / Scope

A bank is a financial institution that takes deposits and creates credit. The primary function of the bank is to deposit people’s money and lend that money to other people who will use that money to buy home, start a business, education, buy vehicles, etc.

Banks also provides services such as wealth management, currency exchange and safe deposit boxes. There are different types of banks with different purpose namely-

Retail Banks – These banks focuses on general customers and offers loans and credit cards. Checking and savings account are held at retail banks.

Commercial Banks – These banks focuses on business customers and transactions are done in huge amount. Businesses checking and savings accounts are held here.

Investment Banks – These banks help businesses work in financial market. They provide consultancy and underwriting services. They help companies in the process of going public.

Central Banks – It is a national bank that provides financial and banking services for the government of the country. It is responsible for managing economic activity and supervising banks.

Credit Unions – It is type of financial co-operative established by a group of people who have common interest and controlled by its members. They are more or less identical to retail and commercial banks.

Market Overview

Banking industry in US is regulated at both the federal and state level. A banking organization depending upon its organizational structure may be subject to numerous federal and state banking regulations.

The central bank of US is called Federal Reserve which was established in 1913 by the enactment of the Federal Reserve Act. The central bank is responsible to formulate monetary policy, regulate banking institutions, and maintain the stability in the financial system.

Most banks in the US are owned by bank holding companies (BHCs) which are prohibited from owning or controlling entities other than banks. A foreign banking organization (FBO) may establish banking presence in the US through branch or agency.

Many regulatory initiatives in the US are derived from the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was a vast set of reforms enacted in 2010 in response to the financial crisis of 2007-2009. The United States has complex regulatory framework that features numerous federal regulatory agencies having overlapping responsibility for banking regulation. Below are the names of relevant bank regulatory agencies-

The Board of Governors of the Federal Reserve System (Federal Reserve)
The Office of the Comptroller of the Currency (OCC)
The Federal Deposit Insurance Corporation (FDIC)
The Consumer Financial Protection Bureau (CFPB)
The Financial Stability Oversight Council (FSOC)

Market Risks

Interest Rates

An extended period of low interest rates and an increasingly competitive lending environment have led some institutions to reach for yield. This has led to heightened exposure to interest rate risk, credit risk and liquidity risk. The low interest rates since 2008 have negatively affected the bank’s profitability.

Banking Regulation

An increased banking regulation post financial crisis and Basel III norm have negative impact on the profitability of the banks. This is mainly due to the increase in cost when maintaining a larger amount of high quality capital. It is estimated that ROE for average banks will decrease by about 3 percentage points in the US due to effect of regulation.

Cyber Risk

Cyber risk has been increasing with greater interconnectedness in the banking system and rapid adoption of new technologies. Cyber attack costs financial services firms more to address than firms in any other industry at US$ 18 million per firm. Financial services firms also fall victim to cyber security attacks 300 times more frequently than businesses in other industries.

Top Market Opportunities

Digital Transformation

Digital transformation in banks can help in improved internal operations and transformations to the banking value chain. Technological innovations can help banks to move from brick and mortar channels to online and mobile channels and improve profitability.

Untapped market

As per the Federal Deposit Insurance Corporation (FDIC), 6.5 per cent of the households in the US were unbanked in 2017. This proportion represents approximately 8.4 million households. An additional 18.7 percent of households (24.2 million) were underbanked, meaning that the households had a checking or savings account but also obtained financial products and services outside of the banking system.

Consumer Credit Market

The consumer credit market in US climbed up by US$ 20.08 billion in Aug, 2018. Non-revolving credit including loans for education and automobiles went up by US$ 15.3 billion. This provides great growth opportunity for US commercial banks.

Economic Growth

The economy is slowly recovering post financial crisis and recession. The unemployment rate is declining, businesses are reviving, and corporate sector are showing positive growth. The unemployment rate in the US declined to 3.7 per cent in September 2018.

It is the lowest jobless rate since December of 1969. The GDP growth rate is projected to 2.93 per cent in 2018 which is higher than actual GDP of 2.27 per cent in 2017. The economy roared ahead in the second quarter of 2018, growing at an annual rate of 4.1 per cent, its fastest pace in four years. As a result, this will lead to healthy credit growth in US market.

Market Trends

Relaxed commercial lending terms drove lending loan volume across US banking industry. This has helped the total commercial loan portfolio for the US banking system jump to nearly US$ 2.2 trillion by the end of quarter two.
The lack of lucrative investment options has led investors to shift some of their liquid assets into interest-bearing deposits, leading US deposits to grow at well above 5 percent annually over 2012-16.
The revolving credit which includes credit card has been increasing at 9.50% on year to year basis. Steady hiring and tax cuts have helped households improve their finance, as a result consumers are spending freely.

The growth of e-commerce and fin-tech companies is disrupting the established financial intermediaries and banks in particular.Gone are the days of visiting branches, loads of paperwork and seeking approvals for opening a bank account. The impact of fin-tech companies is beginning to be felt in the banking sector.
US banks and BHCs have long been subject to risk-based capital requirements based on standards adopted by the Basel Committee.
In 2017, top 3 US banks controlled 32 per cent of deposits, and also took 50 per cent of new account openings. This high concentration in few banks discourages any one willing to enter the market.
The demand for online and mobile banking products, while an efficient and easy way for customers to access banking services, is costly to implement especially for small banks or new entrants.

Industry Challenges

Regulatory compliance challenges

Due to the financial crisis a host of new rules and regulations for capital, liquidity and resolution planning are formed. Thousands of small banks often complain that regulatory burden threatens their long-term viability. The banks are facing challenging regulatory environment, one that is complicated by decades of structural shifts.

Disruptive models and technologies

New source of competition have emerged from giant fin tech companies. The payment mechanisms have been quite easy for the customers due to innovations from fin tech companies. Banks now need to compete with these fin tech companies and become more efficient in their operations. A rapidly evolving technology delivery system for lending and making payments is raising competitive pressures and posing new security risks.

Technology Trends

80 percent of the US banking CEOs are planning to invest in digital innovations and transformations over the three years.
Cloud computing is being used to reduce the capital expense of buying software and hardware for data backup.
Artificial Intelligence is being used to automate repetitive, rule based manual tasks from money laundering to credit card fraud detection.
Mobile-only applications are helping banks to reach areas where they lack physical presence. It is also helping in effortless customer to customer one click payments and the consumer to business digital banking system.
Banks are overhauling their back-end processes through digitization and are leveraging data analytics and automation to streamline operations.

Some of the examples of US banks using technology are as follows –

JP Morgan Chase introduced a Contract Intelligence platform designed to analyze legal documents and extract important data points and clauses. Manual review of 12,000 annual commercial credit agreements normally requires 360,000 hours. With the implementation of this machine learning, the same amount of agreements could be reviewed in seconds.
Wells Fargo began piloting an AI-driven chatbot through the Facebook Messenger platform with “several hundred employees”. This virtual assistant communicates with users to provide account information and helps customers reset their passwords.

Regulatory Trends

On January 2015, the Federal Reserve released strategies for improving the US Payment System, which is a multi-layer plan focused on improving the speed, efficiency, and safety of US payment system.
US banking regulators have frequently implemented more stringent version of rules that are part of the post-financial crisis regulatory agenda established by the Dodd-Frank Act and the Basel Committee.
In July 2017, the House of Representatives passed the Financial CHOICE Act, which restricts financial regulatory discretion and reduce the ability of Federal Reserve to intervene. President Trump has issued several orders aimed at halting financial regulation.
The OCC is considering to grant special purpose banks charters to Fin tech Companies. This will allow Fintech companies to comply with single set of national standards, rather than having to comply with the regulations of multiple states.
The New York State Department of Financial Services now requires banks,insurance companies and other regulated institutions to adopt a cyber-security programme that meets certain minimum standards, with full compliance required by March 1,2019.

Market Size and Forecast

From 2006 to 2016, the number of insured depository institutions in the United States has fallen from 8,691 charters to 5,922, a decline of 2,769 charters.
As of December 31, 2017, there are 5,679 depository institutions with US$ 17.5 trillion in total assets.
There are 120 banks that have assets greater than US$ 10 billion, holding US$ 7.45 trillion.
There are 633 banks with between US$1 and US$10 billion in total assets holding US$ 1.79 trillion in assets.
86.7 per cent of the bank charters in the United States are institutions with less than US$1 billion in assets, with 675 institutions between US$ 500 million and US$1 billion in assets and 4,247 institutions less than US$500 million in assets.

Competitive Landscape

There are different types of banking institutions in US namely –

Commercial banks– Their main purpose is to provide loans to businesses.

Savings Banks– They provide a place for lower-income workers to save their money.

Savings and Loans– They are established to make it possible for lower-income workers to buy homes.

Credit Unions– They were started by people who shared a common bond to provide emergency loans for people who couldn’t afford to get loans from traditional lenders.

Key Market Players

The largest banks are JP Morgan Chase, Bank of America, Wells Fargo and Citigroup. These four largest depository institutions hold US$ 7.03 trillion as on Dec 31, 2017. These four represents 40.1 per cent of the industry’s assets.

Strategic Conclusion

US banking industry have changed dramatically over the few years. US banks are in the midst of recovering post financial crisis of 2008. Deposits and credit both are growing gradually in US market. However, bank must face multiple challenges tied to regulations, competitors, and disruptive models.