Too Small To Succeed?

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From “Too Big To Fail” to “Too Small To Succeed”


I’ve spent a considerable amount of time thinking about the environment faced by small and mid-sized U.S. banks. Whether it was listening to Frank Rotman’s (from QED Investors) presentation on The Copernican Revolution in Banking at LendIt, accompanying Nigel Morris at Piper Jaffray’s Financial Services Conference, or meeting with leadership teams at a variety of banks, it has become apparent to me that there is a flaw in the way we are framing the conversation around banking. Ten years removed from the Great Recession, market dynamics have taken us from “too big to fail” to “too small to succeed.” This different frame of reference allows us to stare at the future of small and mid-sized banks in the US.


Today, small and mid-sized banks largely operate as “small business banks” – the banks that are the cornerstones of the communities in which we live. While these banks primarily focus on lending to small businesses, many larger institutions have focused on investing in technological advancements. These investments allow for advancements in automated lending decisions, automated tellers, artificial intelligence servicing, and branch consolidation. Not only do these advancements cut costs over the long-term, they also drive higher Net Promoter Scores – allowing these larger institutions to gain market share from smaller banks and directly compete with the FinTech start-ups that are nipping at their heels.

The challenges of today


Each day that a bank fails to invest in technological advancements is another day in which the tech debt grows. Of course, there is also a talent variable needed to enable this technology. Smaller banks can’t attract, nor can they pay for, the talent needed to compete (and win) in this highly technical world.


Figure 1

Figure 1

When you cannot compete, you become relegated to a more simplistic structure; reliant on local small businesses not only for the loans but also for deposits. Over the past decade, the low rate, low cost of funds environment created parity between smaller banks and larger more sophisticated banks. As rates creep up to higher and higher levels, it only reasons that consumers will have more options. Those that are not managing and optimizing their deposit elasticity will see declines in deposit levels or a rising cost to retain them (Figure 1). The smallest banks lack the sample size to understand this elasticity through data, not to mention the data science expertise to address it.


Of course, there are issues beyond just deposits. The technology gap also plays on this side of the balance sheet. Banking becomes more virtual every day, and customers visit their branches with lower frequency. As fewer customers visit branches – the cornerstone asset of many smaller banks – the branch will soon become another liability. Technology capability is gaining favor and the calculus of choosing your bank for deposits is no longer just the one closest to your home, office, or favorite retail location. It is easy to see a future in which branches become liabilities.


It will only get tougher from here


By now, we’re all a little scared for these banks, and we haven’t even used the D-word yet. While nobody can predict the next downturn, we can be fairly certain that after a decade of economic growth, we’re closer to the next one than we are the last one. “Downturn” usually makes folks focus on diversification and resilience in their loan pricing – as to withstand the impending uptick in losses. Very few small banks have the capability to compete in non-mortgage consumer lending with the more sophisticated banks. It only took Capital One, Citi, Chase, AMEX (and others) two decades to turn the credit card from a local to a national scale product. Other asset classes are following suit. Personal loans, auto loans, mortgages, HELOCs, etc. are all increasingly becoming products where sophisticated banks and mature FinTechs are capturing market share. This leaves smaller banks to buy mortgages and make high concentrations of commercial and CRE loans to support their revenue streams, creating further concentration risk (Figure 2).


Figure 2

Figure 2

Carrying more risk requires more capital to protect against these risks (Figure 3). Combine more capital with reduced exposure to higher yielding consumer assets and you have the potential for below hurdle returns. Regulators will do their best to ensure that banks remain solvent and liquid, but these are unattractive conditions which will drive lower valuations. When investor returns begin to deteriorate, resources to invest in technology advancements, information and a stronger customer base disappear – creating a vicious cycle with suboptimal outcomes. This cycle will go into hyperdrive when the economy turns. We won’t see failures without substantial rises in credit risks, but it is obvious that the profitability and growth prospects of smaller banks is under siege.  


Figure 3

Figure 3

Combating the tyranny of “Too small to succeed”


If you are a small to mid-sized bank, what are you to do? The smartest banks are plowing back these returns into technology, digital and talent to ensure they can control their own destiny over the coming decades. The time for successful small banks to act is now, and this can be done by investing now in insights and strategy to strengthen your options and solidify your future.


Solidify your deposit franchise:

  • Develop consumer strategies that drive multi-product relationships and create stickiness amongst your deposit base


Formulate your optimal consumer and commercial strategy for success:

  • Harness the power of your data to reveal key performance drivers and PV positive lending segments (you cannot be all things to all people!)

  • Use advanced analytics to identify consumer products sub-segments where unit profitability is viable

  • Drive enterprise profitability through customer acquisition strategies that increase touch points with customers

  • Ensure you have a data infrastructure that enables the benefits of ongoing advanced modeling


Leverage partners to regain consumer exposure:

  • Work backwards from a great customer experience (product, pricing, and UI/UX) – identifying what you do well (and don’t do well) will reveal partnership opportunities

  • Many FinTechs have the technology and user experience that consumers love, but lack the deposit base that small and mid-sized banks have…finding the right strategic partners can create a win-win for the bank and their customers


Find an acquirer that can bring the required diversification, technology investment and overall lending scale, but act soon before your value deteriorates in the face of headwinds:

  • Banks still have a coveted bank charter and usually have a stable base infrastructure from which to build.


Here at AQN, we pride ourselves on our ability to help banks leverage their inherent assets to drive value at the margin. Our analytical and technical expertise, coupled with our deep industry knowledge and unparalleled network, allows us to be the driver of future success. It is time to recognize the tyranny of “too small to succeed” – and time to act to ensure success in the years to come.

Ben SabloffBanking, FinTech