Local Banks and Big Tech

The unknown tech oligopoly squeezing Minnesota's community banks

Most are familiar with the “Too Big To Fail” banks that had to be bailed out by taxpayers during the financial crisis and have only grown larger in the years since. However, Bank of America and Citigroup are not the only titans of the financial industry. The technology that banks of all sizes rely upon has also been rolled up by monopolists and represents another threat to the future health of neighborhood banks, which means a financial sector responsive to Wall Street, not small businesses and families.

In overview hearings before the Minnesota Senate and House Commerce Committees several weeks ago, representatives for the Minnesota Bankers Association (MBA) and BankIn Minnesota (formerly the Independent Community Bankers of Minnesota) discussed the steep decline in the number of banks operating in the state. According to MBA the number of state chartered banks in Minnesota has declined from 513 in 2000 to just 263 in 2022.

Source: Minnesota Bankers Assocation

Both MBA and BankIn said the high and rising cost of technology was a major reason for the declining numbers of banks in Minnesota. What these trade associations left out, and lawmakers did not ask about, was the role an oligopoly among technology providers has played in saddling community banks not only with high costs, but predatory contract terms as well.

The Core Services Cartel

"Among banking CEOs, there is almost unanimous disdain for the core providers.” That quote is from Tim Hogan the CEO of Kony, a digital application company. The core providers Hogan is referring to are the technology vendors that provide banks with the digital tools needed for things such as deposit taking, payment facilitation, and loan origination. These vendors have become more and more critical as the world of banking has shifted increasingly online.

As recently as the 1990s banks had hundreds of vendors they could choose for these core services, but today the industry is dominated by the Big Three: Fiserv, Jack Henry & Associates and Fidelity National Information Services (FIS). For smaller banks, these three companies provide 90% of core services and unlike large banks like JP Morgan Chase that can spend billions on in-house IT expertise, over 80% of community banks rely on a core service vendor. Because of the dominance by Fiserv, Jack Henry and FIS, alternatives do not exist in a meanginful way.

In a 2022 national survey of community banks by the Conference of State Bank Supervisors, the cost of technology was listed as an extremely or very important external challenge by over 77% of bankers. This made it one of the most significant concerns among community banks. The 2021 version of the survey saw banks express dissatisfaction with core providers on the issues of cost, which for most banks is 17% of operating costs, and contract flexibility. Anecdotally, many banks also feel some of the Big Three have become “excessively focused” on making deals instead of innovating and improving their product.

Banking industry veteran Aaron Silva has been fighting back against the restrictive contracts the Big Three use to squeeze community banks. These contracts used to run 10 pages or fewer, but are now hundreds of pages of excessive legalese that lock banks into additional services for many years with stiff penalties for ending contracts or moving to a different provider.

No wonder less than 2% of banks change their core service provider in a given year although the “passive collusion” Silva has documented means changing providers would likely result in little change for struggling community banks. In response to these challenges, Silva has founded the Golden Contract Coalition, bringing together banks and credit unions to create a fair standard agreement for core service providers.

Banks Decline, Communities Suffer

As I noted earlier, you are not the only one just now learning about the Big Three. Their CEOs have not been subject to takedowns by Senator Elizabeth Warren or Congresswoman Katie Porter or suffered the popular backlash of a Ticketmaster. Part of the problem, according to Silva, is that because of the money the Big Three throw around, national and state bank associations are hestitant to call them out publicly. But while this tech oligopoly has not yet inspired any memes, the companies have not gone completely undetected.

Rohit Chopra staring down a monopolist before kicking its ass.

Rohit Chopra is the director of the Consumer Financial Protection Bureau (CFPB), a former member of the Federal Trade Commission and a trustbusting champion. The Big Three are in Chopra’s sights as he used a speech to CFPB’s Community Bank and Credit Union Advisory Councils in April to bring attention to the concentration among core service providers. Chopra also helped frame the political importance of this otherwise sleepy-sounding area of commerce. He drew a direct line from the high costs, restrictive contracts and lack of innovation hampering community banks, and the broader issue of bank consolidation.

That is why the rising power of the Big Three should concern Minnesotans. If technology costs are a key driver for the declining number of banks in our state, that in turn means the core service providers are hampering the small businesses and communities of color in Minnesota that desparately need access to local banks.

The Institute for Local Self Reliance has documented the critical role community banks play in supplying credit to small businesses. Loans to small businesses represent 13% of the assets of small banks compared to less than 2% at the largest banks. The stronger relationships to small businesses that community banks have was on display during distribution of Paycheck Protection Program (PPP) loans in the early stages of the pandemic.

ILSR found that states with higher numbers of community banks (MN ranked 8th) per 100,000 people made more PPP loans per 100,000 people (MN ranked 12th). Furthermore, an analysis by Dr. Bruce Corrie found large banks in Minnesota like Wells Fargo and US Bank made some of the fewest PPP loans to minority-owned small businesses. While PPP had its flaws, it was a critical lifeline that kept mainstreet businesses afloat in Minnesota, helping protect people’s livelihoods and it had greater success here because of our community banks.

The loss of local banks also further exacerbates the stark racial disparities in Minnesota. According to the Prosperity Now Scorecard the share of households of color that are unbanked (they do not have a checking or savings account) in Minnesota is 6.3% and underbanked (they have a checking and/or a savings account but have used non-bank services like payday loans) is 32.7%. In comparison just 0.8% of white households in Minnesota are unbanked and 9.6% are underbanked.

Community banks are critical to keeping wealth and economic power rooted in the local communities we reside in and we should be just as concerned about the core service providers stripping that power away from us as we are in when Wall Street does it.