Chapter Four

1. Chapter Four Establishing New Banks, Branches, ATMs, Telephone Services, and Websites

2. Key Topics • Chartering New Financial-Service Institutions • The Performance of New Banks • Establishing Full-Service Branches and In-Store Branching • Establishing Limited-Service Facilities • ATMs and Telephone Centers • The Internet and Online Banking

3. Introduction • Financial-service facilities are usually established today for the convenience of customers • For most of the history of financial-service providers, convenience has meant location • Customers’ views about what is convenient are changing rapidly partly due to technology • In deciding how they will respond to customers’ changing demands, financial firms today have several options: • Chartering new (de novo) financial institutions • Establishing new full-service branch offices • Setting up limited-service facilities

4. Chartering a New (De Novo) Financial-Service Institution • No one can start a financial firm in most countries without the express approval of federal or state authorities, sometimes both • In the case of banks, the public’s need for a new (de novo) bank in a particular location must be demonstrated • Usually the founder stockholders must supply enough start-up capital to cover several years and show that the proposed new institution will achieve adequate levels of profitability • Government chartering agencies believe financial-service providers need special scrutiny for several reasons: • They hold the public’s savings • Many financial firms are at the heart of the payments process to support trade and commerce, so their failure could disrupt business activity • They have the ability to create money (through granting credit)ding power), which suggests that chartering too many might

5. The Bank Chartering Process in the United States • Only the banking commissions in each of the 50 states and the Office of the Comptroller of the Currency (OCC) can issue a charter of incorporation to start a new U.S. bank • Generally, federal standards for receiving a bank charter are more rigorous than the rules of state banking commissions • Organizers often seek a federal bank charter for the added prestige it conveys in the minds of customers, especially large depositors • The choice between pursuing a federal or a state charter usually comes down to weighing the benefits and costs of each for the particular bank and its location(s)

6. The Bank Chartering Process in the United States (continued) • Benefits of Applying for a Federal (National) Charter • It brings added prestige due to stricter regulatory standards that may attract larger deposits • In times of trouble, the technical assistance supplied to a struggling institution by national authorities may be of better quality, giving the troubled bank a better chance to survive • Federal rules can pre-empt state laws • Benefits of Applying for a State Charter • It is generally easier and less costly to secure a state charter and supervisory fees are usually lower • The bank need not join the Federal Reserve System • Some states allow a bank to lend a higher percentage of its capital to a single borrower • State-chartered banks may be able to offer certain services that national banks may not be able to offer

7. Questions Regulators Usually Ask the Organizers of a New (De Novo) Bank • What are the population and geographic boundaries of the primary service area (PSA) from which the new financial firm is expected to generate most of its account activity? • How many competing banks, credit unions, finance companies, and other competitors are located within the service area of the proposed new financial institution? What are competitors’ services, hours of operation, and distances from the proposed new institution? • What are the number, types, and sizes of businesses in the area? • What are the traffic patterns in the area, adequacy of roads, and geographic barriers to the flow of traffic?

8. Questions Regulators Usually Ask the Organizers of a New (De Novo) Bank (continued) • What is happening to population growth, incomes, types of occupations represented, educational levels, and the age distribution of residents in the proposed service area? • The organizers often are asked to describe the financial history of the community served, the frequency with which new financial firms have appeared and their track record • Who is to own any stock issued? What amount of stock will be held by the organizers, directors, and officers? • How experienced are the organizers, management, and board of directors of the new institution? • What are the organizers’ projections for deposits, loans, revenues, operating expenses, and net income for the first few years?

9. Factors Weighing on the Decision to Seek a New Charter • External factors the organizers should consider include: • The level and growth of economic activity • The need for a new financial firm • The strength and character of competition in supplying financial services • Internal factors the organizers should consider include: • Qualifications and contacts of the organizers • Management quality • Pledging of capital to cover the cost of filing a charter application and getting under way

10. Volume and Characteristics of New Charters • The number of new depository institutions chartered in the United States annually has averaged over a hundred new banking firms in many recent years • There appears to be considerable public demand for more personalized service sometimes not available from large financial firms • Analysis of charter approvals suggests that most new banks are chartered in relatively large urban areas • As population increases relative to the number of financial firms operating in a given state, increased numbers of new charters are issued • The great recession of 2007-2009 tended to reduce bank chartering activity • Significant increases in concentration ratios tend to reduce chartering activity, as does the expansion of existing branch office networks

11. How Well Do New Charters Perform? • Launching a new financial firm entails risk • Most new financial firms grow at a moderate to rapid rate • Despite a track record of loan losses that generally exceed those of established banks, most new banks are often profitable within two to three years after opening their doors • Research also suggests that early performance is strongly tied to the experience, financial strength, and market contacts of those who put the organization together • New charterings have competitive effects that generally serve the public interest

12. How Well Do New Charters Perform? (continued) • The most recently chartered banks show evidence of being “financially fragile” and more prone to failure than established banks • New banks tend to underperform established banks in profitability and efficiency until they reach maturity • One reason for new banks’ tendency to underperform is that they appear to be more vulnerable to real estate crises • Today new banks are more closely supervised by government regulators than are established institutions and tend to be examined more frequently

13. Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches • When an established financial institution wishes to enter new markets or when its valued customers move, an important vehicle for market entry is the creation of new branch offices • Establishing branches is usually much cheaper than chartering new financial-service corporations • The branching leader in the United States, the Bank of America, has more than 6,000 U.S. offices of various kinds • The location, design, and services offered by a branch office depend upon the preferences of customers and the preferences of management and employees

14. EXHIBIT 4–1 Number of Insured Commercial Bank and Branch Offices, 1935-2009 (as of Year-End)

15. Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches (continued) • Desirable sites for full-service branch offices possess some of the following characteristics • Heavy traffic count • Large numbers of retail stores • Populations that are of above-average age • A surrounding area that encompasses substantial numbers of business owners, managers, and professional men and women at work or in residence • A steady or declining number of service facilities operated by financial-service competitors • Above-average population growth • Above-average population density • A relatively high target ratio of population per branch • Above-average levels of household income

16. Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches (continued) • To measure the target ratio of population per branch, the following equation is used • The larger the population served by each office, the more financial services are likely to be purchased, expanding revenues and enhancing operating efficiency

17. Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches (continued) • The decision of whether or not to establish a branch office is a capital-budgeting decision • Requires a large initial cash outflow to fund the purchase or lease of property and to begin operations • Branches are usually created with the expectation that future net cash inflows (NCF) will be large enough to guarantee the financial firm an acceptable return (E(r)) on its invested capital

18. Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches (continued) • Other considerations when considering possible locations for new branches: • The variance around that expected return, which is due mainly to fluctuations in economic conditions in the area served by the branch • The covariance of expected returns from the proposed new branch, existing branches, and other assets previously acquired by the offering institution • The impact of a new branch’s expected return (RB) on the offering institution’s total return (RT) from its existing branches and other assets (ROA) can be found from • W is the proportion of total resources to be invested in new branch B • (1–W) is the proportion of the offering institution’s resources invested in all of its other assets (OA)

19. Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches (continued) • The marginal impact of a new branch on overall risk measured by the variance of total return (RT): where • ρB,OA represents the correlation coefficient between the expected return from the proposed new branch and the returns from other assets of the offering institution • σB represents the standard deviation of the proposed new branch’s expected return • σOA represents the standard deviation of return from other assets held by the financial firm • Geographic diversification can reduce overall risk exposure

20. Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches (continued) • Regulation in the United States recently has made it more difficult to close full-service branch offices of depository institutions • The FDIC Improvement Act of 1991 • The Community Reinvestment Act of 1977 • Many analysts see the roles played by branch offices evolving in new directions today • Sales orientation • Cross-selling • Branches are coming to be viewed today less as mere deposit gatherers and more as sources of fee-generating service sales and for booking profitable assets

21. Establishing Full-Service Branch Offices: Choosing Locations and Designing New Branches (continued) • In-Store Branching • A significant portion of financial-service branches today are located inside supermarkets, shopping centers, and other retail establishments • These retail-oriented service facilities have only a few employees • Highly sales oriented • In-store branches typically are much less costly to build and maintain and tend to become profitable about 12 months earlier than stand-alone facilities • Operate for longer hours • Can experience more traffic flow than conventional branches

22. Establishing and Monitoring Automated Limited-Service Facilities (“Branchless Banking”) • There has been a recent spike in branchless banking due to the high cost of chartering new financial firms and setting up full-service branch offices • Point-of-sale (POS) terminals • Automated teller machines (ATMs) • Telephone banking • Internet-supplied services

23. Establishing and Monitoring Automated Limited-Service Facilities (“Branchless Banking”) (continued) • The Decision to Install a New ATM • Suppose ATMs cost $50,000 each and require $30,000 to install • A bank estimates that it will save $1.00 for each check that is not written because customers will use the machine instead • Life expectancy is 10 years and it will handle 30,000 cash transactions/year • Cost of capital to finance the ATM’s purchase is 14%

24. Banking in Homes, Offices, Stores, and on the Street • Telephone Banking and Call Centers • The telephone remains among the most popular channels for putting customers in touch with financial-service providers today • Internet Banking • Features include • Verify in real time account balances at any time and from any location • Move funds instantly from one account to another • Confirm that deposits of funds have been received, checks have cleared, and online transactions have been completed • View and print images of checks that have passed through a customer’s account • Submit an application for loans and credit cards • Carry out online bill paying

25. Financial-Service Facilities of the Future • Despite continually advancing technology, most experts seem to agree that the total number of financial-service outlets industry wide may not decline significantly for a time • The use of “digital cash” will permit customers to be their own financial-service branches for certain transactions • Service providers are likely to evaluate the success of their branch offices and limited-service facilities in terms of profits and costs per square foot • Outsourcing of financial service delivery is likely to grow

26. Quick Quiz • Why is the physical presence of a bank still important to many customers despite recent advances in long-distance communications technology? • Who charters new banks in the United States? • What are the advantages of having a national bank charter? A state bank charter? • What kinds of information must the organizers of new national banks provide the Comptroller of the Currency in order to get a charter? Why might this required information be important? • What are the key factors the organizers of a new financial firm should consider before deciding to seek a charter? • What are POS terminals, and where are they usually located? • What services do ATMs provide? What are the principal limitations of ATMs as a service provider? Should ATMs carry fees? Why?