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Economic Moats in Banks
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Banks have taken considerable advantage of their birthright as leaders in risk management. But several other factors have also led to deeper and wider economic moats. These deterrents to competition include:

•  Huge balance sheet requirements

•  Large economies of scale

3. A regional oligopoly type industry structure
4- Customer switching costs

Balance Sheet

There likely is no industry more capital-intensive than banking or, more generally, financial services. Of the 20 largest corporations by asset size in early 2003, 19 were financial conglomerates, according to Morningstar data. The only nonfinancial name to crack the top 20 was General Electric, and even General Electric generates a big chunk of its earnings from its finance arm. Heavy capital requirement is one of the primary competitive deterrents. In 2001, Citigroup, for instance, passed the $1 trillion mark of assets on its balance sheet. It is very difficult to raise an asset base that is larger than the economies of all but a handful of countries.

Economies of Scale

Hand In hand "with the capital requirements is the fact that banking offers huge economies of scale. This has been a driving factor behind the industry's pervasive consolidation, "with the number of U.S. banks declining by 44 per­ cent from 1980 through 2001. Large banks (defined as those with more than $10 billion of assets) generated $264,000 of revenue per employee in 2OO2, according to the FDIC. This was 2.2 times higher than the per-employee revenue generated by small community banks, defined as those with less than $100 million of assets. Part of this advantage stems from the fact that large bank employees were responsible for nearly double the assets on average, but big banks were also better at squeezing their customers' assets for more revenue (primarily through fees). On this front, big banks generated 23 percent more revenues per dollar of asset than small banks.

Market Oligopolies

Even though the top U.S. retail bank in 2OO2—Bank of America—still controlled a bit less than 10 percent of the country's deposits, the industry has become very concentrated on a regional level, with the biggest banks in individual cities often operating as difficult-to-penetrate oligopolies. For instance, in the 10 largest U.S. metro areas in 2OO2, the top three banks on average had 50 percent deposit market share, with the remainder often fragmented among hundreds of small community banks with no pricing power. Even in banking endeavors that have gone national, a handful of players often dominate. For Instance, In corporate syndicated lending, the top three loan arrangers—J.P. Morgan Chase, Bank of America , and Citigroup—controlled 70 percent of the underwriting market in 2OO2. In the credit card industry, Citigroup, MBNA, and Bank One carve up about half of the market share, thanks to their low-cost advantage.

Customer Switching

Another key advantage is that banks tend to have very loyal customers. U.S. Bancorp, Wells Fargo, and other large retail banks estimate that attrition runs at about 15 percent per year. In other words, 85 percent of accounts— and, therefore, revenues—recur every year, a pretty sticky business. This is partially due to branding and the desire to stick with a firm you trust.

Equally important is inertia. Most people don't switch banks, even if they feel that they're being nickeled and dimed by their current bank. For instance, a 2001 study found that 38 percent of checking account customers didn't recall the last time that the price was raised on their account. Of the remaining 62 percent, only 4 percent of those people moved banks because of the higher fees.

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