You might have thought about how to start a bank. These financial organizations are not easy to launch as they are heavily regulated and scrutinized.
There are many legal hoops to jump through before you can open a bank. Typically, it takes bank founders well over a year of regulatory compliance and administrative work before they can even take their first deposit.
This is because banks are some of the most important institutions in a modern economy.
Their job is to keep money belonging to depositors and to lend money to clients who need it. They also help businesses run, meaning they give an economy the liquidity it needs to function.
This article will show you what is required to start a bank business. It will cover the most important factors as follows:
- The overall requirements
- The business plan
- What the founding team needs
- What regulations must be followed
- Capital requirements
- Understanding the core banking system
What you need to start a new bank
With so many banks already in operation, you might think starting a bank is easy. It’s not.
Even in the world’s biggest economy, the United States, only 20 new bank applications are made each year, according to private advisory firm Carpenter & Company.
Meanwhile, in the UK, since 2013, there have only been 4 new banks approved per year on average.
It’s such a big undertaking that many founders seek the help of outside experts and consultants to take them through the process.
Banks are heavily regulated and you will need the green light from multiple regulatory authorities, depending on your location.
Part of your representations will include comprehensive information about the founders, such as:
- Their history and expertise
- Their financial standing
- Whether they have enough capital
- How they intend to handle risk management
- A rock-solid business plan
The capital required is significant. The amount differs per regulator, but common consensus is that $15 million is a good amount of capital with which to start a bank.
Applicants who are not prepared will most likely fail.
Many investors are attracted to the relative safety of banks because they are often stable and deal with many loyal clients. This is because banks are so well-regulated that the prospects of failure after launching are reduced.
Such an appealing investment might attract speculators, but they are quickly discouraged when the difficulty of the process becomes clear.
The importance of the business plan
One of the most important parts of starting a bank is creating a comprehensive and strategic business plan.
The business plan is meant to convince regulators that the bank is a viable venture. It can also be used to attract investors.
The business plan will ideally cover the strategic aspects of the plan, as well as leading into the detail of how the bank will be run on a day-to-day basis.
Here are some of the strategic considerations of the business plan:
- What type of bank will it be – commercial, retail, or a combination?
- What is the structure of the leadership team?
- What is the experience of the leadership team?
- What are the prospects of success based on research-based market analysis?
After detailing the strategic direction of the bank, the applicants should answer some questions about the everyday running of the bank.
This could include highly detailed financial projections and scenario planning down to the finest detail.
The business plan will take into account the cost and timeline of achieving regulation, as well as showing clear plans on how to raise the capital required.
The best business plans normally look several years into the future. Here are some of the finer details the business plan will answer:
- Startup costs of the bank
- Target market and ideal customer
- Name of the bank
- Fee structure for client tiers
- Revenue earning model
Different regulators will call for slightly different information. But most, if not all, of the above information will be requested in comprehensive detail.
The founding team must be strong
Banks can only be founded by people with strong experience in the financial world.
Starting a bank is different to starting a general business where entrepreneurs with no prior experience can be successful. Regulators will not approve a team made up of non-specialist business people who are trying to start a bank. The risks are too high.
To receive a banking license, the senior management team needs to be made up of experienced people with proof of success in the banking world.
Ideally, the board of directors should be made up of subject matter experts who can fulfil a function that will benefit the new bank.
This means that not only must the leadership team have banking experience, but it must have members who can each own a functional area such as compliance, IT, or operations.
It’s not only regulators who place great emphasis on the makeup of the leadership team. Investors will be much more inclined to fund a team of proven experts than total newcomers.
Once you have started your bank, you will find that your team has a great role to play. Unless you are fully funded, which is rare, you will need to remain cost-effective.
Therefore, having internal experts will always beat outsourcing a key function such as compliance or software.
Regulation is key
Regulators in different geographies have their own rules. But one thing is clear: getting a banking license is not an easy task wherever you apply.
There are several legal and regulatory hurdles a bank must clear before it can be given permission to operate. In certain countries, there is normally one oversight body that grants the banking license.
However, regulation works in tandem, and sometimes a different oversight body must also give a separate approval before a bank can operate.
One example of this is in the US, where receiving a State Charter to open a bank is not enough to start operations. A new bank must also secure deposit insurance.
Here are some of the concerns that most regulators will be trying to lock down:
- Ensuring the safety of banks through compliance
- Fostering effective competition between industry players
- Ensuring the protection of consumer rights
- Maintaining the integrity of the financial system
Many regulators ask new applicants to approach them during what is known as a pre-application stage so the regulator can make the application requirements very clear.
However, regulation does not end once a bank has been granted a license. It must sign up to a range of legislative instruments and bodies to ensure it upholds the strict standards of the global banking system.
Banks must subscribe to some, if not all, of the additional regulations:
- Company good practices, including taxation
- Consumer safety
- Anti-money laundering
- Electronic data safety and security
- Fair trading
- Reporting standards
- Conflict of interest declarations
- Investor transparency
- Client securities
- Central Bank legislation
- Know your customer
This might explain the rise of neobanks such as Simple, Moven, and MonoBank.
To avoid many of the regulatory hurdles, these companies have not pursued their own licenses, but instead operate under the licenses of larger, more established banks.
The downside is that in many instances, they cannot refer to themselves as banks, but rather, fintech companies.
Another way to remove the administrative burden of starting a new bank could be to purchase a small bank. However, this is not as easy as it sounds because the process of transferring ownership is also onerous and time-consuming and does not improve the time to market.
New bank applicants must satisfy regulators that they have enough capital.
If they do not have all the capital they need by the time they meet the regulators, a realistic capital raising strategy should be laid out in the business plan.
Bank founders soon realize that raising money for their venture is an ongoing process. New applicants are often advised to not wait to secure all the funds before approaching the regulator.
Sometimes, securing a banking license is enough to secure fresh money from investors who realize how serious you are.
The regulator will indicate what the correct capital adequacy requirements a broker must comply with in order to operate in its market. These capital guidelines are not based on guesswork but are linked to the money required to support the bank’s risk profile, type of operations, and growth ambitions.
New banks will normally need to keep these capital levels in place until its operations become well established and profitable.
As mentioned, new bank owners are advised not to wait to raise all the capital required. The founders of Arival Bank can testify that fundraising never ends. Even before applying for a banking license, they raised $1M from venture investors. This was mostly used for operating costs in the first year. The money was spent on expenses such as salaries, legal costs, compliance consultants, and the initial payment for the core-banking system.
Anything after that was aimed at the bank’s capital and other expenses such as developing the product suite and customer support. Every new founder has dreams of disrupting the market and making waves in the industry, but in the early days, getting the simple things right are important:
- What type of bank are you?
- How much money do you have?
- Do you understand your customer segment?
- Are you set up to make a good impression on the regulators?
The importance of the core banking system
For banks, one of the most important parts of its infrastructure is the software that will underpin its day-to-day functions like deposits, withdrawals, and financial history. This underlying technology is known as the core banking system.
This software is the backbone of a modern bank. It facilitates the record keeping of client accounts, processes financial transactions, records the movement of funds inwards or outwards, and provides an array of reporting options.
It goes without saying that this system needs to be robust and failsafe.
Regulators are keen to know that the core banking system is run by a reputable and trusted system. Not many banks have chosen to develop proprietary core banking systems because of the high cost and ongoing maintenance requirements.
Many new banks purchase white label solutions that are pre-configured.
The white label option comes with the risk attached to any third-party interface. Common concerns are that there could be faulty code in the system that affects the integrity of the bank’s transactions.
Banks must consider if they should write their own code from scratch. But writing robust code is not as simple as it seems, mainly because as the bank’s line of products grows and develops, so does the work required to maintain the code.
New bank founders have a tough decision to make in this regard.
Agile Fintechs
Dealing with the core banking question is where the new breed of fintech banks can be very agile. Neobanks are examples of this. These digital only banks provide a range of convenient services, often at low cost, to retail clients and businesses alike.
Neobanks do not write their own code, but instead purchase templates based on selected fintech products that have been created across the world. These products often have established traction with users, making the choice to copy them a less risky one.
The main challenge with the fintech approach is that their individual products and services often don’t cover a traditional bank’s full product line.
In this case, the answer is simple: new fintechs can create an ecosystem of different fintech products to match the full product line of a bank. This approach can be a viable one for many new banks.
Starting a Bank: Understanding the Regulatory Environment in 2024
2023 proved to be a consequential year for US banking. In a week, two of the largest financial institutions in America — Silicon Valley Bank and Signature Bank — went from managing billions of dollars to being in resolution. Further down the line, First Republic Bank had to be placed into receivership after failing to heed FDIC concerns for years, whereas dozens of small and midsize banks reported record levels of deposit and liquidity stress. In response to these events, bank regulators are sharpening their focus on perceived regulatory weaknesses this year in a number of ways, including:
Risk Management and Regulatory Supervision
The aftermath of 2023’s bank failures exposed significant weaknesses in the intensity of regulatory supervision over the previous decade. In 2024, tighter scrutiny on how banks manage financial risk is expected to be a focal point. Consequently, individuals thinking about how to start a bank will have to cooperate closely with regulators to report liquidity, understand potential risks, and devote more resources to thorough examinations, whereas super regional banks should prepare to address critical supervisory issues in much tighter timelines.
Crypto and Digital Finance
In 2024, banks partnering with fintech or engaging in activities involving blockchain and cryptocurrency will face heightened probes from regulators. Thus, founders interested in starting a bank business need to understand how digital assets work and how they fit into existing legal frameworks so their banks can adopt these emerging technologies without crossing legal boundaries.
Basel III Endgame
Basel III Endgame is a directive aimed at applying the strictest risk-based approach to more banks by reducing the threshold from $700 billion to $100 billion in assets. By regulators’ estimates, this would entail a 6 to 19% increase in capital requirements compared to current standards.
Banking Licensing
Starting a bank is a lengthy process that may span up to a year or more due to heavy regulation and the need for approval from various regulatory authorities. Obtaining approval for a state or federal charter, then securing deposit insurance from the FDIC, and potentially undergoing further examinations from the Federal Reserve are all crucial in this process. On one hand, any state can grant its charter. On the other hand, only the Office of The Comptroller of the Currency may issue you a national charter. If you manage to secure a charter, the next step is obtaining deposit insurance from the Federal Deposit Insurance Corporation (FDIC). But bank regulation doesn’t end with licenses. Most banks are required to subscribe and devote resources to several additional regulations like Know Your Customer, reporting standards, and company good practices i.e. taxation, investor transparency, and anti-money laundering, among many others. To evade these regulatory hurdles, many prospective banks don’t acquire their licenses; rather, they operate under the license of established banks. The downside to this is that they can refer to themselves only as fintech companies, not banks.
Capital Requirements
Founders or board members of the prospective bank must prove to regulators that they have enough capital to support its operations, risk profile, and future growth and that the bank can withstand economic downturns and initial losses.
These capital requirements aren’t dictated by guesswork. Rather, regulators will consider the market you want to enter and then indicate an adequate amount of capital for operating in that market. That said, the average capital requirements for a bank are significant. According to OffShoreCompany.com, you’ll need $500,000 to $1 million in startup costs and $10 to $30 million in capital to start a bank business.
Underfinanced banks are more inclined to take shortcuts, so declaring lower capital decreases the likelihood of winning FDIC deposit insurance. However, if you do not have the required capital by the time you meet regulators, your proposed bank may be allowed to proceed with a realistic strategy for raising capital in your business plan. Building off this point, prospective bank founders should be aware that fundraising is an ongoing activity. Therefore, you shouldn’t wait until you’ve secured all funding before approaching regulators. Oftentimes, obtaining banking licenses is enough to secure funding from investors who can guarantee your operation is serious, thus fastening your time to market.
Starting a Bank: Building Your Banking Infrastructure
New banks rely on multiple hardware and software systems to carry out their operations.
Physical and Software Technologies
Banking hardware comprises phones, tablets, and computer systems used by employees and sometimes customers to conduct business operations. These include cash dispensers, automated teller machines, point-of-sale terminals, card readers, and physical security devices for multi-factor authentication, similar to cold crypto wallets.
Meanwhile, core banking software is the backbone of every modern bank business. These applications facilitate day-to-day functions, such as processing deposits and withdrawals and updating accounts and records.
Examples of core banking applications include business intelligence software:
- Artificial intelligence and Large Language Models used to mine insights from vast amounts of data;
- Customer Relationship Management (CRM) software used to manage customer experiences;
- anti-money laundering and fraud detection software used to identify and prevent financial crimes;
- loan automation software that streamlines the loan application and approval process.
As a new bank founder, you’ll also need core banking software for efficient record-keeping of client accounts, monitoring inflows and outflows, and report generation to satisfy regulations. By leveraging innovative solutions when starting a bank, the organization you build will be able to automate tedious processes, save costs, inform business decisions, and improve the customer experience, all of which drive profits and consistent growth.
Internal Processes and Compliance
Approved banks have to set up robust internal processes to ensure legal compliance and operational efficiency.
AI and Machine learning
Regulatory compliance is a critical function that costs 50% of banks 6-10% of their revenue, on average. However, the rise of artificial intelligence and machine learning algorithms is set to revolutionize the development of internal banking processes by automating repetitive tasks, identifying suspicious activity, analyzing vast loads of data, and offering real-time insight into everyday decisions.
Staff
When you think about how to start a bank, understand that no financial institution can be run by a sole founder. Even the smallest fintechs tend to have up to ten personnel, whereas most banks have 20 or more full-time employees, including accountants, personal bankers, loan originators, investment consultants, internal auditors, and other roles. However, beyond operational staff, you’ll also need to account for an FDIC-approved management team. The members of this team should share vast knowledge of banking services and financial markets to ensure effective leadership and decision-making.
Security
On the one hand, banks with physical locations must consider the costs of essential security resources like human guards, vaults, electronic security systems, cameras, and armored vehicles for cash delivery. On the other hand, fintechs or digital banks must invest in robust cybersecurity measures to keep their customers’ money safe and secure. With the various infrastructures brick-and-mortar banks need, it makes sense to think digital banks have it easier in terms of security costs. Well, think again. This study reports that the average cost of a data breach cyberattack on banks was $5.9 million in 2023, proving the cost of not complying with updated security protocols.
Conclusion
Starting a bank is a difficult process. Any new founder needs to be aware of the steep challenges they will face.
Banks are the lifeblood of an economy and are rightly safeguarded by regulators from failure. Founding teams must be prepared to face deep scrutiny of their backgrounds and their future intentions.
There are many key decisions to be taken when founders decide what type of bank they will open and what market segment they will serve.
Partnering with an established player in a key area such as the core banking system can remove much of the trouble and risk of going it alone.
