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82 - Why Banking is an Attractive Industry

The DIY Investing Podcast

Release Date: 07/05/2020

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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.

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More Episodes

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: