So You Want to Start a Bank?

When I tell people I am starting a bank, the first two sentences that usually come out of their mouths are some variation of:

1. That’s crazy

2. I wouldn’t even know where to start

If the person happened to be a small business owner, a real estate investor, or someone with experience of applying for a bank loan they will typically add a third sentence - “I thought about starting one too.”

Shockingly, more people think about starting banks than I realized. So if the thought has ever crossed your mind, I will outline what you need to know to get started in a simple, easy-to-understand format.

The good news is that you really only have two options (in the USA):

1. Build one from nothing (the “De Novo” process)

2. Buy an existing bank

The bad news is, that regardless of the path, it will take time, patience, and capital to be successful. To successfully attract customers, banks need to insure customer deposits in the event of a loss (with so many options in the market, why would someone choose a bank if their deposits are not insured).

The Federal Deposit Insurance Corporation (“FDIC”) underwrites the risk of new bank charters and provides customers (businesses and consumers) with the insurance, trust, and confidence to bank with a new institution.

In an industry built on trust, FDIC insurance is critical. With that base knowledge context, let’s dive in.

The De Novo Process

The FDIC has a whole handbook to follow that describes the De Novo process. In general, here is what they say:

“The FDIC is committed to working with groups interested in organizing a de novo institution. New institutions with sound business plans, experienced leadership at the board and management levels, and appropriate capital support can play a vital role in serving the deposit and credit needs of their communities.”

To pick that apart, you will need 3 main things:

1. Strong content

2. An A+ team

3. A lot of capital

• Strong content - the business plan: very specific detail that includes an overview of the proposed institution’s operations; its business plan and proposed policies; details on its management team, including its board of directors; a description of the type and amount of capital to be raised, including any plans for employee stock ownership plans or stock incentives; how the institution will meet the convenience and needs of the community to be served; a description of the premises and fixed assets at inception; and a description of the information systems to be used by the institution.

• An A+ team: Experienced leadership: who will be the operators of the bank, the organizers during the de novo process (if different), and the board of directors. Specifically, you’ll need to identify a senior executive team and board with experience as senior executives or board members of a bank. If that’s not you, you’ll have to find someone and anyone that senior, who has climbed the ladder will most likely require high compensation and a strong sales pitch. Pulling that person out of a high paying executive job or convincing them to come out of retirement might not be worth the risk to them.

• Capital to support the bank: there is no hard set number, but organizers of the bank are required to provide a “tier 1 capital to assets leverage ratio of not less than 8 percent throughout the first three years.”* Submitting a high-growth business plan will require raising more capital in order to start, a lower-growth plan limits the amount you can grow. Overall, the growth and profitability will be restricted based on the approved plan from day 1, not based on the traction the bank gets in the market.

  ^{*Tier 1 capital = equity, retained earnings, reserves, reserves. Total assets can include loans and credit instruments (risk assets/revenue drivers for a bank).}

The three phases listed above could take a lot of time. And even if you have it all figured out, you must go by the FDIC’s timeline.

The FDIC wants to be a partner throughout the process and not be caught by surprise on receiving your application. This means you can fill in all the content needed for the application, and their team will poke holes in it.

You will most likely go through several iterations of your application: draft submissions, formal submissions, a field test, and capitalization. In total, the process can take 1.5-3 years before you can accept your first deposits.

Once approved for an FDIC you will be allowed to operate for years under a de novo period, where regulators will hold you to the business plan in your application.

If this process does not appeal to you, you can look to buy an existing bank.

Buy a Bank

If you don’t want to go through the de novo application process, you may look to purchase a struggling bank at a discount.

The FDIC doesn’t like to see banks fail, so a superhero flying in to save one would be welcomed in with open arms, right?

Nope. The regulators and the FDIC still need to approve the sale of the charter from one party to another. They will want to dive deep into the financial health of the buyer and are always very skeptical of buyers without the required backgrounds.

Additionally, the timeline for the acquisition can vary significantly depending on the deal. First, you must identify a bank willing to sell and agree on a price and terms. Second, purchasing an existing bank comes with baggage:

• 10% capitalization on day 1 ($100M bank requires $10M to capitalize)

• Additional growth capital for operations

• Must buy out all vendor technology contracts

• Must buy out all the director and employee contracts

• Include a gain or loss on the sale of securities

• If the charter you purchase is in a different jurisdiction (eg in another state), the directors and executives may need to move to that location

• Stuck with legacy branding, policy, and procedures

• The seller may have operations outside of your desired scope that still need servicing (eg auto loans and you don’t plan to provide auto loans)

Even if you meet all of the above requirements, the regulators will still restrict your ability to grow in your first few years of operations.

Takeaways

Starting a bank is challenging for good reason. The FDIC wants to make sure that there is a steady hand on the wheel and that the directors are good stewards of capital. Bank failures are bad for everyone so we cannot have anyone just start one.

Banks aren’t tech companies, there is much more risk involved. If the timelines or barriers to entry scare you, there is a third path: starting a Neobank. However, neobanks are a much different business model than traditional banks, as I highlighted in my last post (and as a result won’t go deeper here).

Starting a bank is not impossible. America needs ambitious entrepreneurs to innovate in this industry and come up with new models to serve underserved populations and communities.

If you are to go down the rout of starting a bank, just make sure you have clearly identified your target customer, have an all-star team with strong banking experience, enough capital to open your doors, and above all else - a ton of patience.