The Determinants of De Novo Bank Survival

Abstract

The number of newly chartered, or 'de novo,' commercial banks in the U.S. has increased every year since 1994. These new banks are potentially important for preserving competition and providing credit in consolidating banking markets. However, like other new business ventures, newly chartered banks can be prone to failure. To investigate the long-run financial viability of newly chartered banks, we estimate a 'split-population' duration model for 656 commercial banks chartered in 1984 and 1985. To provide a benchmark, we estimate a similar model for 1,288 small established banks located in the same geographic markets. Our results are consistent with a 'life-cycle' theory of bank failure. Because new banks are heavily capitalized and hold portfolios of unseasoned loans, they are initially less likely to fail than established banks. But rapid asset growth, subpar profitability, and declining loan quality gradually erode their capital stocks. De novo failure rates catch up with, and then surpass, established bank failure rates within five years. After seven years, de novo banks are twice as likely to fail as established banks. We find similar determinants of failure for de novo and established banks, including adverse economic conditions, rapid asset growth, concentrations of risky and illiquid investments, large amounts of purchased funds, and excess overhead spending. For de novo banks that eventually fail, we find that failure is accelerated by concentrations of business loans, large amounts of purchased funds, low capital ratios, and excess overhead spending; failure was delayed by fast asset growth, holding company affiliation, and holding a federal charter. We find no significant evidence that de novo national banks were more likely to fail than de novo state chartered banks, which suggests that the OCC's relatively lenient chartering policies increased local market competition without materially increasing new bank failure. We find that low capital ratios accelerate failure for de novo banks that do fail, but we find that capital ratios do not significantly predict which new banks will eventually fail. Thus, requiring higher levels of capital for young banks does not reduce their probability of failure, but rather serves as a buffer that provides extra time to resolve young banks should they become troubled institutions.