82 - Why Banking is an Attractive Industry

Mental Models discussed in this podcast:

• Retention Rates
• Lindy Effect (Durability)

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Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode82

Key Characteristics of the banking industry which make it attractive for investors

• Fewer Banks over time in the United States
  • Over 23k commercial banks in the United States in 1966. 
  • By 2002, that number dropped to 7.8k. 
  • In 2018, there were only 4.7k FDIC-insured commercial banks in the United States.
• Number of New Banks being created has fallen to near zero
  • Before the 2008 financial crisis, about 146 new banks were created each year.
  • Since then, only 1 bank per year has been created.
• High Retention Rates
  • Relationship-Based
    • If you're a local business you may work with a dedicated banker that helps you out, offering you a loan. You'll probably also hold your personal household accounts with them, your mortgage, college savings fund, checking accounts, etc...
    • Each type of account or loan you have with a bank increases the stickiness of the customer.
    • A bank that is only a checking account is easy to switch. A bank where you have a checking account, multiple savings accounts, a debit card, credit card, mortgage, and car loan is much harder to change away from.
  • Low Competition (Hard to steal a customer)
    • Switching banks is time consuming, difficult, and there is often only a small benefit for doing so. 
• As an industry, bank efficiency is improving over time.
  • Fewer commercial banks in the US = less competition. 
    • The weaker banks are the ones failing or being acquired.
  • Fewer bank branches = higher concentration of deposits per branch
  • High retention rates = Large amount of recurring revenue, the stability of deposits, and reduced risk of bank liquidity problems. 
  • Financial service companies and the internet = lower costs to service customers, which means more profit per dollar of deposits.
• Banking is a durable industry
  • It has existed for thousands of years and will continue to exist for thousands more. 
  • Lindy Effect
• Banking as a business is very simple.
  • You collect deposits and make loans. Specifically, we're focused on commercial banking.
  • There is no R&D.
  • Product innovation is unnecessary.
  • There is no inventory that can expire and become worthless. 

Summary:

Banking is an industry with characteristics that are quite attractive to long-term investors. Properly evaluated, a bank can make a great investment. High retention rates, lower competition over time, and the durability of the industry are what attract me to bank investing.

References:

• https://ilsr.org/number-banks-u-s-1966-2014/
• https://www.statista.com/statistics/184536/number-of-fdic-insured-us-commercial-bank-institutions/
• https://ilsr.org/number-of-new-banks-created-by-year-1993-to-2013/
• https://ilsr.org/vanishing-community-banks-national-crisis/