Jul 5, 2020
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.
- Relationship-Based
- 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.
- Fewer commercial banks in the US = less competition.
- 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.