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Should small banks be “permitted” to survive?

Failure to see their importance means you don’t know America

Should small banks be “permitted” to survive?

In the last several days I’ve been surprised at the amount of internet comment that Slate magazine’s article on community banking’s future has generated.

Much banking-related discussion online represents little more than shameless spamming by consultants and promoters. But on this topic, the conversation seems different. The article, entitled “America’s Microbank Problem” has generated a lot of genuine interest and garnered a general “thumbs down” to the author and his views.

Assessing Slate’s attack on community banks

Matthew Yglesias, Slate’s business and economics correspondent, makes three principal assertions in his blog:

• Community banks are poorly managed.

• Community banks cannot be regulated.

• Community banks cannot compete.

For an intelligent and objective assessment on the management issue, we need to know the evaluation criteria. For example, by what metrics are community banks not well managed?

The assertion that community banks cannot be regulated seems strange on its face—especially in a time when, just for one example, the upcoming new regulatory regime in mortgage lending has been causing such change and such concern.

Did the author consult with community bank managements on their views of the regulatory impacts on their business?  Community bank depositors are recipients of FDIC insurance protection, so regulation is inherent in such an arrangement.  And what are community banks spending all that money on compliance for?

Perhaps a better way to discuss this topic might be to pose the question of what sorts of regulations are appropriate to a community bank.

Should the primary objective be safety and soundness?  If so, then there’s a lot of supervisory/regulatory activity that goes well beyond the impacts of this relatively simple focus.

However, what’s really interesting is the issue of competition. That strikes me as at the heart of the matter in considering the future of community banking as well as what benefits may accrue to the banking public.

Assessing community banks’ competitive stance

Considering that community banks are a durable part of this country’s economic history—and that there are lots of them remaining in business—we need a context in which to evaluate these issues.

Most community banks simply don’t have the resources—financial or human—to be all things to everyone. However, let’s ask something that doesn’t come up much:

How many community bank customers expect—or even need—their institutions to be all things to everyone?

To effectively execute a full range of banking services and strategies across the spectrum of customers by size, location and product specialization requires enormous resources. “Oligopoly” comes to mind in describing the sort of banking environment that is increasingly familiar in the U.S.—the concentration of economic power in a relatively limited group of participants.

This seems to me to be a potentially very important public policy matter and deserving of considerable attention in any forum dealing with the viability of community banking.

To compete effectively, don’t all banks need a niche? 

A big bank’s niche can be one of size itself. A giant bank is capable of performing and delivering any service that any customer wants or needs—anywhere. In an industrialized society and in an industrialized world, this is not only necessary but it also confers enormous benefits to the economic system.

No one has similar expectations (any service, anywhere, anytime) of a typical community bank.

But community banks frequently serve segments of the banking public that are not in the forefront of big bank business models.

Small banks live where big ones don’t tread

In fact, community banks often address geographies and loans by purpose and size that are not necessarily attractive to a large bank.

For example: Banks frequently find it difficult to extend credit to startup ventures due to the inexperience of their owners and the risk that such credits represent to the safety and soundness of the bank and ultimately the insurance fund.

Yet community banks often find ways to extend credit to borrowers possessing these characteristics due to their direct knowledge and experience with their customers. It’s also likely that any bank that derives its principal business from one or a limited number of trade areas is more likely to work harder to find and expand lending opportunities that feed its business.

Big banks generally shun the labor-intensive aspects of specialty types of product underwriting unless there are opportunities of scale. How many big banks would deliberately pursue a substantial number of owner-operated beauty parlors or barber shops? 

Yet many such credits populate the loan portfolios of community banks as such borrowers usually have a customer relationship with the bank before the credit request occurs.

In fairness, one shouldn’t expect a large bank to have the same economic incentives to build a portfolio of small loans. No, not given the substantial cost structures they must operate within to achieve an attractive economic return.

So, if local deals aren’t getting done for a dearth of community lenders, who is the loser?  What are the indirect costs? 

The latter question rarely gets asked and it may be the most important question of all.

America includes the land between the coasts

While large areas of our citizens live within metropolitan areas, a significant number don’t.

By latest count, about 17% of our population—about 54 million people—live outside of metropolitan areas defined by the Census Bureau.

Assume for the moment that banking competition is reasonably robust within these metropolitan areas. How is the remainder of the population, these 54 or so million people, to be served?

Banks, especially larger ones, seem to be closing many more branches than opening new ones in recent years. What does this portend over the long term for local banking service levels where customer density is relatively sparse?

Banking remains a business of scale and that’s the central point of this whole discussion to begin with. Does scale benefit our economic system?  The answer is “yes,” where it promotes efficiency and competition.

Would you expect that to also be true in rural areas?  If you’re not sure about the implications of this question, then you have an insight into the complexity and implications for public policy inherent in the discussion.

About 80 years ago the federal government was expanding access to electric power for rural areas. In some respects the issues of community banking access are similar. The social and economic benefits of rural electrification were enormous to our country as a whole.

One way to think of this related to banking is to consider what would happen if large segments of our country were deprived of access to community banking services?  Would big banks hurry in to fill the void?

No one expects banks to offer services at a loss. And no one should expect that the federal government will replace the many functions and services performed by community banks.

If there are market solutions to these needs, then it will be the community banks and not the government that will deliver them. This is a resource worth preserving—assuming that there is an economic return to the process.

Thinking further on community banks’ future

The subject of community banking’s future is much broader than the long standing issues relating to urban vs. rural or the relative merits of size or types an availability of services. We can address these topics in more detail in coming weeks.

Do we have consensus that community banks cannot be managed or regulated or are not economically competitive?  These are important questions and we should develop thoughtful answers. Sound-bite-sized exchanges are not appropriate on matters of this gravity.

What do you think? Share your views in the comment section at the end of this webpage.


Editor’s Note: The cover story in the December Banking Exchange, “Wait, it gets better…” offers five bankers’ realistic take on the future of the industry, including community banks’ part of it.

Read it on this website here or in our Digital Magazine here. The article is far from an obituary, observing that “Banking faces many challenges. It isn’t down, and it isn’t out—but it is changing.”

Ed O’Leary

Banking Exchange Contributing Editor Ed O'Leary, a veteran lender and workout expert, spent nearly 50 years in bank commercial credit and related functions, working with both major banks as well as community banking institutions. His last job before retiring was as the CEO of a regional bank headquartered in Alburquerque, N.M. He earned his workout spurs in the dark days of the 1980s and early 1990s in both oil patch and commercial real estate lending. O'Leary began his banking career at The Bank of New York in 1964, and worked at banks in Florida, Texas, Oklahoma, and New Mexico. He served as a faculty member and thesis advisor at ABA's Stonier Graduate School of Banking for more than two decades, and served as long as a faculty member for ABA's undergraduate and graduate commercial lending schools. Today he works as a consultant and expert witness, and serves as instructor for ABA e-learning courses. You can e-mail him at [email protected]. O'Leary's website can be found at

In mid-2016 O'Leary's "Talking Credit" blog received a bronze excellence award for the Northeastern Region from the American Society of Business Publication Editors.

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