As banks and their clients continue to feel the economic squeeze, regional institutions must go back to the basics to address their root challenges. A few years ago, bank leaders and board members were focused on the need to drive to scale — often a balance sheet of $300 billion or more being the marker. With macroeconomic challenges of earning cost of capital and an intensified competitive landscape, the importance of scaling these businesses is even more critical. Fintechs and other nonbank (e.g., Big Tech, telecom, consumer retail, transportation and industrial) players continue to expand their footprint into financial services, stealing market share from less nimble institutions. Emerging technologies including artificial intelligence (AI), advanced data analytics, open APIs and cloud computing offer a key lever for regional banks to scale while addressing heightened regulatory scrutiny.
M&A is not the only way to scale
In the past, the quickest path to scale was M&A, and the inherent pressures on smaller institutions create an environment where it is easy to presume bolt-ons or even mergers of equals are par for the course. Yet it is important to remember how the recent bank M&A surge after the bank failures and subsequent acquisitions in March 2023 came to be. The acquired banks were unique; they were lenders to the innovation economy, in the case of SVB; highly tailored lenders and wealth advisors, in the case of First Republic; aggressive innovators pushing into digital assets, in the case of Signature; and others that were caught in scenarios generated by contagion based on their profile. The net result was acquisition opportunities for a few well-capitalized institutions that were ready to expand their platforms. Most of them realized the intended value of these acquisitions.
The benefits for a few have come at the expense of many institutions below the $100 billion threshold. Their bank models largely focused on providing consumer, commercial and wealth services to specific regions or sectors. These banks have garnered regulatory scrutiny, which has driven up operating costs and cast doubt on indirect lending models (e.g., banking as a service), subsequently limiting growth opportunities. This has opened the door for nonbank lenders (e.g., Chime and Stripe) that are garnering customer interest and not bound by geography or technology limitations. With deposit growth for regional banks waning and increased competition, the cost of inaction is high.
Amid this backdrop, is M&A really the answer, or is it just a byproduct of midsize institutions’ inability to make strategic pivots and develop innovative propositions in a challenging regulatory environment? This creates a paradoxical situation: The strength of U.S. banks has been their ability to uniquely serve communities, customers and regions that require trusted banking partners, yet those same institutions are facing constraints that limit their ability to mature, grow and partner.
Strategic opportunities for midsize banks
Thus, the push to achieve scale is an increasing necessity for midsize banks. However, jumping to M&A as the default is not the answer. Midsize regional banks that have built their reputation and client affinity on a legacy of vertical sector know-how and strong community relationships need to focus on the following strategic avenues to scale:
- Future-back vision/strategy setting: Evaluate the macro factors and trends that are reshaping the landscape that allowed for prior success and define a vision for how the bank will adapt to excel in a future hyper-technological world; align a multiyear strategy to drive toward this destination.
- Evaluate the business, product and client portfolio: Understand not only whether the bank as it stands today is achieving the optimal capital composition and portfolio diversification, but also whether it is fit for purpose to achieve growth; if not, examine how economic capital can be redirected.
- Ecosystem partners create agility with less capital: Ecosystem and platform models will prevail as the velocity of data, digital access and AI continually accelerates. Bank partnerships, “coopetition” across platforms and strategic alignments with desired sector customers via embedded models (see Newline by Fifth Third) will become less capital-intensive means of creating agility, adaptability and new growth alternatives.
- Embrace technology and eliminate tech debt that curtails growth: Where tech debt or obsolescence is known, address it now. Reevaluate the technology investments in place and redirect them as needed to enable line-of-business growth. Understand where partnership or as-a-service models can be the key to addressing historical bank platform challenges.
- Leverage a diversity of inorganic levers: No single strategic alternative should be executed in a vacuum; institutions must consider a holistic approach encompassing diverse strategic actions (e.g., acquisitions, divestitures, ventures, alliances) to create the broader enterprise strategy and vision.
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