When it comes to statistical analysis to help drive banking decisions, it helps to know the "shape" of your challenge. As we have said, ROE among different sized banks largely follows a bell shaped curve, implying a normal distribution. The strategic implication of this is that there are many ways to produce superior ROE in a downturn - specializing in a lending class, being in a certain geographical area, becoming larger, shedding assets, etc.
Another distributive shape is an asymmetric distribution. The return on loans is like that. Banks can either gain money (interest) or can lose it all (principal default). Here, the strategy is to find ways to increase profits, while decreasing risk. Instituting warrants, prepayment penalties and additional fees for superior performance, allows bankers to capture more upside (thereby "normalizing" the return on loans).
Yet another distribution is the "power curve." A power curve, like the example on the right in our graphic, is characterized by a concentration of outcomes. The classic power curve in banking is deposit market share. Here, the large national banks control 90% of all deposits and 80% of deposits below $100k. The disparity between large and small has grown over the years, due to less regulation and more competition - an interesting concept if you think about it.
You see, power curves are often the result of free market dynamics in situations where scale is important. The removal of interstate banking laws back in 1994, for example, resulted in an accelerated shift from a near-normal distribution of deposit market share to a power shape. Industry openness and profitability, such as those found in software or biotech, often lead to power distributions. The ironic part is that many of the regulations or anti-regulatory positions that the ABA or ICBA support are often counterproductive when it comes to certain competitive parts of the business (like deposit gathering). The current financial crisis will surely result in additional regulations (such as executive compensation limits), that while painful to see enacted, will result in community banks being more competitive.
Power curves aren't bad things and aren't immutable. However, instead of fighting industry dynamics, it helps to embrace it. Strategically, banks that fight for market share for the sake of market share are fighting an uphill battle. The far better strategy is to segment the market and go after deposits with profitable characteristics. By executing a niche attack, community banks can turn the power curve to their advantage.
We will be discussing power curves and how to better compete against national banks at our upcoming Executive Management Conference in San Francisco during May 3rd to 6th. Our analysis, based on hundreds of top and bottom performing banks, is a graduate-level education that you can't afford to miss. By spending 4 days with us, you will gain insight to help you compete. Register at: http://www.pcbb.com/2009Conf_Summary.asp