Can We Bank on American Banks?

With 157 banks completely shutting shop in 2010, the U.S banking industry doesn't appear to be moving in the right direction.

Last year, for the first time in more than a decade, banks closed more branches than they opened. If you trust former Oppenheimer & Co. analyst Meredith Whitney (many of whose calls on the financial crisis have proved spot-on), you'll heed her estimate that U.S. banks will close 5,000 branches by mid-2012. According to the Federal Deposit Insurance Corp., bank branches in the U.S fell to 98,517 in 2010 from 99,550 in 2009. The number of FDIC-backed banks estimated to be at risk of failure is 11.5%.

However, there is an underlying fact that may be hard to spot here, which is absolutely critical in understanding modern banking strategy and the state of American financial institutions in general. In spite of closing branches, banks are, in fact, expanding on an absolute basis. While on the one hand they are shutting doors in poorer areas, they are adding branches in the more affluent locales. It's an interesting dynamic with profound ramifications.

De-branching -- a smart move?
According to SNL Financial via The New York Times, large banks such as Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) have shuttered branches in low- and moderate-income communities and opened new branches in the wealthier areas. Bank of America closed 25 branches in poor areas and opened 14 in the wealthy areas whereas Citigroup opened three branches in upper-income areas and closed two in underserved neighborhoods. Smaller banks such as Regions Financial (NYSE: RF  ) and Zions Bancorp (Nasdaq: ZION  ) have followed suit.

And other banking institutions with smaller physical footprints in retail locations, like TD Bank (NYSE: TD  ) and Charles Schwab (Nasdaq: SCHW  ) , are also slowly expanding their physical retail bank locations but have been extremely selective about where they are located -- often only in bustling business districts and richer neighborhoods.

There's a clear trend emerging in the marketplace.

Impact of the exodus
The implications of this trend are not to be glossed over. While many members of the well-heeled will have the luxury of a choice of branches near their homes and offices, the not so privileged will have to walk that extra mile. This trend will likely result in reduced spending and investment in lower-income communities and lead to a breach of community confidence. So as bankers rethink their costs and general strategy, the count of unbanked households will rise.

This is not a good situation for all sorts of reasons. It also implies a lot about the greater income equality situation in the United States. But ultimately, banks have the freedom to do business where they please, and these numbers are proof that banks are seeing growth in some areas -- just in ones that may not be best served by it. Plus, it may not be their fault.

On the other hand
The trend of shuttering branches in poorer neighborhoods is a direct function of banks attempting to mitigate lost revenues that arise as a result of restrictions on overdraft fees and other charges that banks use to derive revenue from customers (particularly to lower income ones).

Regulators' decision to limit practices like overdraft fees definitely increases costs on regular services like checking and others. Thus, the irony of the situation is that some of the very same people who encouraged banks to open locations in poorer neighborhoods in the first place (through the Community Reinvestment Act and other legislation) have been instrumental in speeding up their departure from them.

The Foolish bottom line
From an investment standpoint, these are shrewd moves on the part of banks and are a reasonably good sign that things are moving in the right direction -- at least in the short term. U.S. banks posted a profit for the fourth straight quarter and valiantly cut back their loan loss reserves. Considering FDIC projections that more and more banks are becoming vulnerable to risk of failure, if some banks are safeguarding themselves from the impending dangers by appealing to more affluent customers, they are clearly making the right decision by themselves.

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