It’s likely no surprise to learn that one of the most profitable businesses around is banking. The United States alone has the largest financial marketplace, and according to a report by SelectUSA., the financial services industry (which includes banks, investment services firms and insurers) represents 7.4 percent, or 1.5 trillion dollars, of the U.S. gross domestic product. For those who are willing to scale significant barriers to entry, the rewards for opening a bank are great.
Regulations and capital are the two biggest hurdles to jump, and to be clear, starting a bank is not an easy endeavor, particularly for those unfamiliar with the industry. But with a solid, well-devised business plan and strategy, a pile of sweat equity, plentiful stores of patience and a dash of good fortune, starting your own bank is possible.
This article will show you the necessary steps to opening your own bank. We’ll explore how to determine a need and a target market, detail the elements of a good business plan that will provide the platform for your success, show you the regulations you’ll need to comply with and how to meet them, and outline the staff you’ll need to hire to provide excellent customer service and build your bank’s reputation.
Case example: Bank of America
Bank of America is a global giant with 66 million customers and operations in 35 countries worldwide. But like most multinational corporations, BoA’s story of success began with a single founder with a vision.
Bank of America actually started life as the “Bank of Italy”(surprisingly enough) when Italian immigrant Amadeo Giannini founded the bank in San Francisco in 1904. Giannini’s objective was to offer banking services to other Italian immigrants and to middle-class Americans who were often denied accounts by the larger financial institutions of that time.
Providing banking for customers who didn’t already have it was the need that Giannini’s new bank met, and he quickly gained customers from all ethnic backgrounds. His clientele mirrored the “melting pot” of early 20th century America, and so it was appropriate for him to rename his bank “Bank of America”.
It was also a bold vision that eventually became reality. Through mergers and acquisitions, Giannini’s humble bank became the U.S.’s largest bank, and a global financial powerhouse in under a century.
Your startup bank may never reach those heights, but the Bank of America story is proof that a broad, bold vision backed up with excellent customer service and exemplary corporate management can help a new bank transcend humble origins and become a dominant industry player.
You can write your own success story in banking by following these steps.
Step 1: Know the Business
Most of us are familiar with banking on some level, whether it be through checking and savings accounts, mortgages or loans, credit cards, retirement accounts or insurance policies. But behind the ATM machine or the drive-thru window are a whole host of complicated transactions that in aggregate ensure that the bank not only has money for you to withdraw, but that as a business entity it is making a profit.
If you haven’t worked in some level of the financial services industry, it’s important to get some industry experience, some specific education in finance, business or both, and some expert guidance and advice.
For the latter, there’s no better resource than your local chapter of SCORE (Service Corps of Retired Executives). This is a network of retired business executives (many from the banking/financial services world) that can provide valuable (but free) advice for entrepreneurs.
How do banks make money?
Very simply, banks make money off of the money that their customers deposit into it. Banks take deposits and loan the money out to customers, charging interest on these loans.
Banks also typically pay depositors a small amount of interest for their deposits (and will pay higher amounts of interest for long-term deposits such as a certificate of deposit (CD)).
The difference between the higher rates of interest charged to borrowers and the lower rates of interest paid to depositors is known as the interest spread, and this is the major component of bank profits.
Other sources of profits include fees charged for various services, and ancillary financial services like retirement accounts and insurance policies.
More and more banks are offering a full menu of financial services, because they are a good source of revenue and profits with little risk.
Fractional reserve banking
The overwhelming majority of banks in the U.S. operate as fractional reserve banks. This means that at any one given time, 10% of the bank’s deposits must be available for withdrawal.
This 10% of the deposit revenues is known as the fractional reserve. For instance, for every $100 that a customer deposits, the bank may use $90 to lend out to other customers (or to you, for that matter).
Low fractional reserves allow the circulation of money throughout the economy as measured by a factor called the economic multiplier, and since low fractional reserves open the money supply available to borrowers for things such as homes and cars, they are seen as instruments to maintain prosperity and a healthy national economy.
In fact, to maintain a healthy economy in response to the coronavirus pandemic, the Federal Reserve took the unprecedented step to reduce the fractional reserve requirement to zero on March 26, 2020.
The concept of the fractional reserve means that banks are counting on depositors holding the majority of their funds in their accounts and not withdrawing them all at once.
Most of the time, this is what happens. But when depositors start to withdraw from their accounts in response to a financial crisis or panic, this is known as a bank run, and they can cause the bank to become insolvent and go out of business.
Creation of the FDIC
Bank runs happened at the start of the Great Depression in the U.S., and as a result, the federal government instituted a number of regulations and insurance requirements through the Banking Act of 1933, signed into law by President Franklin D. Roosevelt.
The Banking Act of 1933 created the Federal Deposit Insurance Corporation (FDIC), which is the regulator for the U.S. banking industry, and it guarantees consumers’ checking and savings accounts up to $250,000 in the event of bank insolvency.
Banks spread out their risk of bank runs happening by accumulating large numbers of depositors. Low or non-existent fractional reserve requirements have fueled the growth of large national or multinational banks.
Again, this is mostly a good thing for the economy, but for a smaller community-based bank, particularly in a location with a single dominant industry or employer, the risks of a bank run and the ensuing insolvency and failure are much greater. This is definitely something to consider as you start your new bank.
De novo banks
Start-up banks in their first five years of operation are known as de novo banks, from the Latin word for “new”.
In addition to the economy of scale advantages that large banks enjoy, there are a couple of significant barriers to entry that new bank entrepreneurs must scale. These are 1) regulation, and 2) capitalization.
Banking is the most regulated business in the United States. According to independent banker, before the 2008 financial crisis, an average of 172 de novo banks opened each year. Since that watershed year, the number dwindled to almost nothing. A large reason for this is the greater number of regulations that banks must comply with to even open for business.
The FDIC is the regulatory agency for all banks in the United States, and their website provides information and the necessary forms that de novo banks must submit.
Once the application is in place, expect to wait anywhere from one year to eighteen months for approval.
The FDIC requires that de novo banks have anywhere from 12 -20 million dollars in startup capital. The bank must prove that it can withstand initial losses and economic downturns, and that it will operate ethically.
Underfunded de novo banks are more prone to cutting corners, and so the more startup capital you can bring to the table, the more likely it will be that the FDIC approves the bank’s application.
Can I start a bank with no money?
In theory, yes, but you’d better have friends with deep pockets and in high places. Because of the lofty capitalization requirements, most banks are formed as corporations run by a board of directors, whose investors are often local business or community leaders.
Another source of startup capital is from venture capitalists, who will invest in the bank for a share of its profits.
Step 2: Write a business plan
As the saying goes, if you fail to plan, you plan to fail. For a business like banking that involves such high regulatory and capital hurdles, a well-devised plan of action that addresses all the salient aspects of the business is essential for its success.
The document that details this plan of action is the business plan, and once you have some knowledge of and experience in the banking industry, writing your de novo bank’s business plan is the next big, critical step to take.
Your business plan is your venture’s founding document, like a constitution or the Bible, and it will be the reference point for all business decisions moving forward. For this reason, it’s important to spend great time and effort composing the business plan, and a well-written one will make business success much more likely.
Luckily, there are some good resources for entrepreneurs who are writing their own business plan, and perhaps the best one out there is the Small Business Association (SBA) of the federal government, who have their own step-by-step guide to writing your business plan.
Bank of America has their own guide to writing a business plan, with an emphasis on the financials, as you might expect.
When you apply for FDIC approval and insurance, they will examine your business plan closely, to make sure you will meet regulations and follow banking industry best practices.
Here are elements that your plan should address:
How will it make money?
We’ve discussed the two primary ways banks make money: through the interest spread, and through fees charged to customers. But as also discussed, there are products like investments and insurance that are becoming a part of the menu of offerings of more and more banks.
Whether you put all of your eggs in the basket of traditional services like checking and savings accounts and loans, or whether you offer a broader financial services portfolio, most banks yield about 10-15% net profit, with 7-10% return on investment or equity.
As a de novo bank, you are not likely to achieve these levels until you’ve been in business for a few years, which is one reason the FDIC requires sufficient capitalization.
What is the target market?
Your target market is an important consideration for your new bank, and it’s related to your scope of business. For instance, if you’re targeting a younger generation of customers, you’ll need to have a big online presence and mobile banking capability.
If you’re targeting older customers, perhaps retirees, mobile banking may be less of a consideration, but convenient branch locations with easy access and plentiful parking become critical.
Another consideration to make is whether you want to target small business firms by offering business banking, or whether you want to focus more, or solely, on consumer banking.
It can be hard to accurately describe your market, but it’s a critical assessment to make. Market research firms can gather data that either confirm or deny your own intuitions, and can help prevent you from making poor decisions early on. For these reasons, it’s worth considering hiring one.
Brick-and-mortar or online-only?
Banks that are online-only, such as Chime and Ally, are a growing presence in the banking and financial services industry.
Most banks are a combination of brick-and-mortar branches with an online banking counterpart, but the extent to which each element is promoted depends on the banking habits of your customer base.
Online-only banks save on infrastructure costs, but when starting your online bank, don’t forget to consider the enhanced cybersecurity costs you’ll incur.
And if you think that by opening a bank as an online-only business you’ll escape the regulatory scrutiny that brick-and-mortar banks endure, think again. The same charter and regulatory code that storefront banks operate under also applies to online banks.
In addition to these laws, you’ll also have to comply with other regulations designed specifically for online banking. These regulations were devised by an organization called the Federal Financial Institutions Examination Council (FFIEC), and are listed in this guide to online banking.
Define your business structure
Because in almost all cases your bank startup costs will be underwritten by a team of investors, the corporation is the prevailing business structure in the banking industry.
You’ll need to register with your state’s corporation commission or board, but beyond this, you’ll need to consider how the initial board of directors is chosen, what their terms of engagement will be, their compensation (if any), and how often they will meet (your state may mandate a minimum number of yearly meetings).
You might want to hire a law firm to form your corporation, because it’s easier to head off any problems as the business is formed than it is to go back and change your founding documents or business protocols once issues arise.
Choose your name
Your bank name can reflect your geographic origins, or it can be more abstract or even the name of one of its founders. An example of the former is Bank of America, and an example of the latter is Chase.
Choosing your bank name is an important consideration that can affect both the present and future of financial institutions.
For example, naming your bank the Bank of North Carolina may attract customers in your home state that want to do business with local financial institutions, but it may also hinder your expansion if you want to open branches in, say, Florida. Choose wisely.
Once you’ve determined your bank name, run searches at your state corporations website and also do a WHOIS domain name search via a service like ICANN. The latter is critically important for online banking, because having your bank name and website different can be devastating for business.
ICANN can also tell you if somebody currently owns the domain name you seek, and what they will charge to sell it to your business.
Address start up and operations costs
Your plan should outline the source(s) of your capital, and how and when these investors will be paid back. Your operations costs must also be carefully outlined, and the FDIC will look at your plan to ensure that operations costs are realistic and not underestimated. For a bank, there are three main sources of operations costs:
1) Regulatory/legal compliance
Almost all established banks have attorneys on staff to assist with legal and regulatory compliance, and even as a de novo bank, you should enlist the services of a lawyer.
The fines for non-compliance can be severe and far exceed legal fees. Non-compliance can also place the bank’s future in jeopardy.
KYC and AML compliance
KYC (Know Your Customer) and AML (Anti Money Laundering) regulations exist to make sure that banks are doing business with legitimate entities, and not criminal organizations.
In essence, AML mandates KYC, which is verified through having account holders submit documentation before opening accounts.
KYC and AML protect the banks from criminal liability, but adherence to these regulations isn’t cheap. “A key part of starting any financial institution is ensuring you have proper procedures set up to meet KYC and AML compliance obligations,” says Greg Pinn, Sr. Director of Merlon, which produces automated systems for regulation compliance.
“Banks can spend as much as 2.5% of their operating expenses on AML compliance, a huge expense for any bank starting out. Setting up these programs correctly can reduce that expense by a significant amount,” he says.
KYC3 has a helpful guide to understanding KYC and AML compliance and the implications for startup banks.
A brick and mortar bank branch needs a secure vault, security protocols for armored car cash deliveries, electronic security systems for the building, and sometimes armed guards on site.
Given these costly measures, it might seem like online banks have it easier in terms of security costs.
This isn’t necessarily the case. however: A 2017 survey conducted by Kaspersky Labs and B2B International found that a cyber security incident that involves online banking services costs a bank 1.75 million dollars on average.
The American Banker’s Association has some information about cybersecurity risks and some helpful links to resources for cybersecurity for small businesses in general and banks in particular.
No bank can be a sole proprietorship. Even a small bank requires a minimum of ten employees, and most banks have more than 20 full-time employees working for them. Among the types of employees banks require are:
- Bank managers
- Bank Tellers
- Loan Sales
- Personal Bankers
- Investment Consultants
Beyond the operations staff you’ll need for day to day operations, you’ll need to carefully select a management team of individuals that includes women and minority representation. This management team will be carefully scrutinized by the FDIC during the approval process, and all the members should share vast knowledge and experience in the banking and financial services industry.
Hiring competent and experienced staff that share your vision is a critical step to take, and one that requires significant thought, time and energy.
Chinese business magnate Jack Ma writes, “You’ve got to make your team have value, innovation and vision.”
How much does a bank owner make?
According to CareerTrend, a president/owner of a small bank of less than 200 employees earns between $96,000 and $194,000 per year. This compensation is normally a combination of a base salary, profit-sharing, sales commissions and bonuses.
Step 3: Raise capital
After knowledge and experience has been gained, and a solid plan for the business has been developed and written down, it’s time to start putting the pieces together.
The hardest step is usually coming up with the capital that the FDIC requires.
As for most businesses, adequate capital keeps the bank afloat during crises and hard times, and somewhere between 20-40 million dollars of capitalization is normally required just to get out of the gate and start doing business. More is better.
Most individual entrepreneurs don’t have access to this kind of capital, so you’re going to need to build a team of investors.
If you’ve had a career working for another bank, you may know colleagues who have expressed an interest in starting their own bank, so reach out to these people (but also be aware of non-competitive clauses in their current employment contracts).
If your bank will be serving a particular community or business/industry, reach out to community leaders and business owners.
If you know these leaders from your previous career working for an established bank, they will be more willing to work with you because they know your personal qualities, integrity and excellent reputation.
Community leaders in particular may be interested in creating a bank that is headquartered locally and which specifically serves local customers.
Even in the 21st century, this sort of provincialism attracts new account holders and drives customer loyalty.
But if these sources of investors don’t yield the capital that you’ll need for your new bank, you’re going to have to approach venture capitalists.
The good news is that due to the regulatory scrutiny that banks face just to open their doors, the banking industry is a relatively low-risk investment for venture capitalists.
The flip side is that you’ll have to share the profits of your bank for many years to come with your investors, but banking is also, in general, a high-yield business, so you won’t have to take an oath of poverty while paying back venture capitalists.
For an excellent overview of how venture capitalists work, read this article in the Harvard Business Review. Oracle NetSuite also offers a comprehensive guide to attracting venture capitalists that includes a downloadable e-book.
Step 4: Get a charter
According to the Federal Reserve, a de novo bank must operate under either a federal or state charter. A charter is a legal document that authorizes the bank to conduct business.
A charter includes the bank’s articles of incorporation and certificate of incorporation, which is usually issued by the state corporation commission.
Charters can be issued at the federal level by the Office of the Comptroller of the Currency (OCC), or by the state (and including the District of Columbia, Guam, Puerto Rico, and the Virgin Islands) in which the bank is incorporated, usually through its banking commission.
As with the FDIC application, federal and state charter offices will carefully evaluate the bank’s business plan, executive team, board of directors and capitalization amount.
Step 5: Apply for FDIC approval
The Federal Deposit Insurance Corporation (FDIC) evaluates, and upon approval insures and sanctions every new bank in the United States. Required elements of the application and necessary forms are available at the FDIC website. These are the necessary elements:
- Mission Statement
- Business Plan
- Financial projections for a minimum of three years
- Policy descriptions for loans, investments and insurance
Obtaining both the bank charter and FDIC approval takes some time, a minimum of 12 months and as much as 24 months. While you are waiting for approval to come through, you can move on to address succeeding steps.
Step 6: Check for any other necessary permits
Most bank charters are a sanction for the bank to conduct business, but there may be additional necessary permits or local zoning laws to comply with. The Small Business Association’s website offers easy ways to check for required state and local licenses and permits for your business:
- State – You’ll need to visit your state’s website for specific information on what permits you’ll need to start a bank there. Almost all states will require a charter, and even if it is a national charter, you’ll likely have to apply for a license through the state agency that issues bank charters. If you have some flexibility where to locate your new bank, you can visit a page at the SBA site that gives some helpful tips on how to choose where to locate your business.
- Local – Again, localities vary widely with the number of regulations that all new businesses, and especially banks, require. The general rule of thumb is that the larger the population and the amount of businesses in your location, the more permits and paperwork are required. If you have a local SBA office, visit them for advice and assistance.
If you are opening a brick and mortar bank, you’ll often need to acquire a Certificate of Occupancy. The CO certifies that all local zoning laws and building codes have been followed.
If you are renting a building, the landlord is usually responsible for the CO.
Step 7: Get customers
With all the regulatory compliance that starting a bank involves, it’s easy to lose sight of the end goal of any business: attracting and retaining new customers.
Getting customers through your new bank’s doors (or to its website) requires differentiating yourself from your competition.
Create your brand
One of the best ways to attract new customers is by creating a memorable brand image through an effective branding campaign.
Branding the process through which a company’s mission, values and image enters the public consciousness.
Get a good logo
Successful branding begins with a good logo that represents the company effectively and in a simple, easily memorable manner.
Getting the logo right is an important step towards corporate success, and if you are not a natural artist or computer graphics expert, plenty of firms offer logo design for reasonable rates. It’s a worthy investment of resources towards a bright future for your new bank.
Advertise your brand
Successful advertising happens in both traditional and social media.
The correct answer to which media you advertise in is “all of them,” but the target audience that you defined in your business plan will dictate which media forms you focus your advertising budget on.
Gain a social media presence
Younger consumers will tend to favor social media. Ellen McGovern, chief marketing officer at Massachusetts-based Clinton Savings Bank, explains the need to be on social media to attract and retain younger customers in an article at American Banker:
One of the most effective networks of promotion for this younger generation of customers are social media influencers.
In the same article, Molly Young, product marketing manager at partnership automation company Impact, explains the marketing power of influencers:
Don’t neglect traditional forms of advertising
If the newer generation of bank customers prefers the influencer network, then older consumers choose traditional media like newspapers and TV, and you certainly can’t afford to alienate this important market segment. So a full portfolio of a combination of new and traditional media is in order.
The best way to determine which media reach your targeted audience is to request a media kit from prominent local media outlets.
The best media kits will offer detailed audience information that will allow you to select those outlets whose audience most closely matches your target consumer base.
Determine your competitive advantage
Branding and advertising can all be for naught if your bank’s competitive advantage are not clearly defined. A competitive advantage is a unique service, perk or reward that differentiates your business from others.
Banking is a very competitive industry with large players that have thousands of branches across the country and an economy of scale that allows large banks to waive many fees and offer higher interest yields on checking and savings accounts.
If you can’t match the large banks on price, then perhaps your small, community-based bank can offer personalized, custom accounts to meet individual consumers’ needs, or offer free financial literacy classes for their account holders.
Links to resources about business marketing
Several other articles couple be written about marketing, advertising and PR for your new bank, but there are a couple of excellent articles that focus specifically on getting customers. Forbes offers ten ways to get customers to your new small business, and Inc. offers the same, with a focus on also increasing your sales.
For a good primer on using influencer marketing, check out this article from The Financial Brand.
Once you have customers, the competition in the financial industry means that pleasing and keeping your base of customers is also essential for success.
Jim Marous, Co-Publisher of The Financial Brand says, “Bottom line, having a customer-centric culture is more than just a good thing -it’s become a matter of survival.”
Business/Fintech influencers to follow on social media:
- Khan Academy’s Introduction to Banking
- Building a Bank by MIT Bootcamps
- Banking Explained – Money and Credit
- How to Write a Business Plan by Young Entrepreneurs Forum
- How to Start a Business by Sir Richard Branson
Starting a bank requires a high level of knowledge, a good amount of industry experience, and a lot of patience and determination to deal with the charter and FDIC approval process. It also requires an enormous amount of capital.
For these reasons, starting a bank is not recommended as your first entrepreneurial venture, but more as a capstone to a successful career in banking and financial services.
For those who successfully scale the formidable barriers to entry, the financial rewards can be great. But for many community bank owners, the real reward is in providing an essential institution that ensures the financial well-being of their community.
British business titan Sir Richard Branson sums up the essential purpose of any business: “A business is simply an idea to make other people’s lives better.”