COUNTER-INTUITIVE TRUTHS ABOUT BANKING

Three challenges to conventional wisdom.

“There are times when speed is most commendable, but there are other times when you should make haste cautiously.”

-Peter Drucker-

Just because something is considered conventional wisdom doesn’t make it true. Here are three examples.

1. Inertia, not innovation, is a surer key to survival

The prevailing wisdom in banking holds that innovation is the ally of survival while inertia is its enemy. Yet, the annals of banking tell a different story — one in which inertia, not innovation, is cast as protagonist.

On April 9, 1906, a half-page article in The New York Times heralded “an innovation that is without precedent in business methods but has long been in demand.” The world’s first 24-hour bank would open for business the next day.

Banking had changed forever. Or had it?

Not long after copycat institutions began opening in every major city between Boston and Los Angeles, they started to flounder. The Day and Night Banks in Los Angeles, Memphis, Little Rock and Charleston were among the most prominent failures.

In less than five years, even the original Day and Night Bank had ceased to exist after it was acquired in 1911 and rebranded as the Harriman National Bank. Not a single Day and Night Bank exists today.

This is one of many similar parables of innovation.

The first interstate bank. The first one-bank holding company. The first thrift to embrace commercial real estate. The first internet bank. None have stood the test of time.

It’s not that innovation doesn’t matter, because it does. But in an industry like banking it should be pursued thoughtfully and without haste.

2. Capital isn’t king — it’s court jester

It’s a common refrain in banking that capital is king. Yet, history is replete with instances in which an abundance of capital incentivized banks to take bolder risks than dictated by prudence.

A study of New England thrift failures in the 1980s and 90s concluded that, “high capital ratios put pressure on managements to find investment projects with high payoffs in order to provide adequate return to the new stockholders,” resulting in a higher rate of failure.

At the same time that Columbia Savings & Loan was boasting in advertisements throughout the 1980s about having three times as much capital as it was required to hold, it was stockpiling billions of dollars worth of junk bonds. (It later failed.)

When Washington Mutual failed on September 25, 2008, after concentrating its balance sheet in risky, non-conventional residential mortgages, it boasted the highest tier one common capital ratio among the country’s six biggest banks.

Most recently, Silicon Valley Bank failed in March of this year, just two days after a presentation to analysts characterized its capital position as ‘strong,” and shared a chart showing that the bank held nearly twice as much capital as it was required to hold by regulators.

3. Skin in the game both moderates and emboldens risk-taking

Skin in the game helps moderate risk-taking in theory, while it often enables and emboldens risk-taking in real life.

Seventy-seven percent of ANB Financial’s outstanding stock was owned by its employees, officers and directors when the Arkansas-based bank began financing commercial real estate projects in remote resort communities in Idaho and Wyoming that ultimately led to its failure on May 9, 2008.

Forty-three percent of Corus Bankshares’ outstanding stock was owned by the Glickman family when CEO Bob Glickman concentrated the bank’s balance sheet in out-of-market condominium construction loans that led to its failure on September 11, 2009. 

Finally, the Goldberg family owned nearly 80 percent of AmTrust Bank when CEO Peter Goldberg tripled its portfolio of risky acquisition, development and construction loans that caused it to fail on December 4, 2009.