Strategic Growth in a Challenging Environment

It is a challenging time for many banks.

The rapid, sustained increase in interest rates is making it more difficult for banks to maintain margins. The high-profile bank runs in spring 2023 have resulted in increased regulatory scrutiny in many areas, including liquidity and risk management. Merger and acquisition activity has been subdued. As a result of these challenges, some banks are hunkering down until the economic environment turns more favorable.

However, these challenges also present opportunities for strategic growth. Regardless of a bank’s particular situation, it is a good time to review strategic positioning and options, including opportunities afforded by a bank holding company and new customer acquisition channels.

Holding Company Advantage
Many banks are directly owned by a holding company. This structure can be an advantage that executives and directors should consider as part of a bank’s strategic planning. For one, a holding company allows nonbanking activities to be conducted “outside the bank.” Some banks might find it advantageous, for example, to separate noninterest income-generating business lines, such as trust, investment advisory or insurance, from their core banking business by holding these businesses in separate subsidiaries of the bank’s holding company. Others might find the ability to have separate banks owned by a single holding company helps facilitate a strategic acquisition of another bank.

Keeping an acquired bank legally separate — even if only temporarily — can allow for a measure of autonomy and brand separation that may be attractive to a bank that is otherwise hesitant to be acquired.

Bank holding companies also have the ability to make noncontrolling investments in companies engaged in activities that may not be permissible for a bank. This can be particularly useful when a bank wishes to affiliate with a fintech company through a joint venture or in a manner that might result in a direct equity investment in the fintech company.

Bank holding companies also have the advantage of being able to raise capital by borrowing, with the loan proceeds treated as Tier 2 capital at the holding company and Tier 1 capital if contributed to the bank. For qualifying bank holding companies with less than $3 billion in consolidated assets, the flexibility regarding leverage afforded by the Federal Reserve’s Small Bank Holding Company Policy Statement can make subordinated debt a particularly attractive option for financing acquisitions and other growth investments. Although current interest rates make raising capital through borrowing relatively unattractive, when the interest rate environment improves, banks may wish to bolster their Tier 1 capital through subordinated debt offerings by their holding companies.

Customer Acquisition Channels
New customer acquisition is as important — and as challenging — as ever for many banks. Some banks are tackling this challenge by narrowing their scope. Niche banking, where a bank focuses its products, services and marketing efforts on a certain segment of customers (usually other than based on geography alone), is becoming more pervasive and is proving to be an effective strategy for some banks in attracting and retaining customers.

Other banks are focusing heavily on the online market by partnering with companies that help funnel prospective customers to a bank’s existing brand or, in some cases, to a separately branded online bank within the bank. This latter approach may allow a bank to offer specialized products and services to prospective customers outside of its existing market through an online-only platform, without the cost of a branch network.

Fintech partnerships, especially those that give a bank access to low-cost deposits at scale, are steadily increasing in number and prevalence in banks’ strategic plans. Earlier this year, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency jointly issued guidance on risk management of banks’ third-party relationships. This guidance sets the guideposts for how banks can effectively evaluate, structure and monitor relationships with their current and prospective fintech partners.

The current interest rate environment and economic uncertainty are accelerating disruption and uncertainty in the banking industry. While this creates real, and in some cases existential, challenges for some banks, it also creates opportunity. The number of possible strategic paths a bank could pursue has never been greater.