In a recent report, the Congressional Research Service stated that capital formation remains the largest obstacle hampering the formation of de novo banks, but regulatory and legislative changes that have been proposed could risk an increase in bank failures

“While each aspect of evaluating an application imposes a cost on the proposed bank, it is likely the capital considerations that present the largest cost and thus the biggest impediment to forming a new bank,” the CRS said in “De Novo Banks: Policy Issues for the 118th Congress.”

In the past two decades, the formation of new banks has bottomed out, the report stated.

Congress and regulators have debated ways to encourage the formation of banks, while, at the same time balancing safety and soundness concerns, the agency said. CRS, cited research from the Federal Reserve that showed they failed at double the rate of more established banks in the years leading up to the 2007-2009 financial crisis, but at the same time CRS noted that when regulators set higher capital requirements for new banks to reduce the risk of failure, it presents a barrier to entry.

In addition, the amount of time it takes regulators to approve applications presents another barrier for de novo banks. Some regulators are attempting to expedite the application process, according to the CRS. For instance, in June, the FDIC approved a resolution that automatically places an application that has been pending for more than 270 days on the next board agenda. It remains on future agendas if the agency has not acted on the application.

On the legislative front, in May, the House Financial Services Committee ordered reported H.R. 758, legislation that would implement a phase-in of capital standards for new banks over a three-year time period. It also would require regulators to establish a phase in period for the Community Bank Leverage Ratio.

“These measures would afford a new bank more time to raise the required amount of capital, thus lowering barriers to entry, the CRS said. However, the report offers a sobering warning. “Lowering the amount of capital these banks have to hold may increase their likelihood of failure,” the CRS concluded.

Ballard Spahr believes that capital need not be the only safeguard to protect de novo banks against the risk of failure. Regulators can more carefully monitor business plans that focus on aggressive growth rates and that leave a de novo institution with a non-diverse pool of assets vulnerable to a change in economic conditions. Regulators can also more carefully monitor institutions with asset concentrations. Steps like these could minimize the need for de novos to carry higher levels of capital than mature institutions.