The State and Fate of Community Banking
Marshall Lux
Senior Fellow, Mossavar-Rahmani Center for Business and Government, John F. Kennedy School of Government, Harvard University
Senior Advisor, The Boston Consulting Group
Robert Greene
Research Assistant, Mossavar-Rahmani Center for Business and Government, John F. Kennedy School of Government, Harvard University
Master in Public Policy candidate, John F. Kennedy School of Government, Harvard University
Abstract
This working paper focuses on the plight of community banks in the United States. It begins by examining different definitions of what constitutes a community bank, and goes on to review what makes these institutions unique and distinguishes them from larger regional or national peers. Our assessment of Federal Deposit Insurance Corporation data finds that community banks service a disproportionately large amount of key segments of the U.S. commercial bank lending market – specifically, agricultural, residential mortgage, and small business loans.
However, community banks’ share of U.S. banking assets and lending markets has fallen from over 40 percent in 1994 to around 20 percent today. Interestingly, we find that community banks emerged from the financial crisis with a market share 6 percent lower, but since the second quarter of 2010 – around the time of the passage of the Dodd-Frank Act – their share of U.S. commercial banking assets has declined at a rate almost double that between the second quarters of 2006 and 2010. Particularly troubling is community banks’ declining market share in several key lending markets, their decline in small business lending volume, and the disproportionate losses being realized by particularly small community banks. We review studies on the impact of regulation, consumer trends and other factors on community banks, and examine the consequences of consolidation on U.S. lending markets. We conclude with a discussion of policies that could promote a more competitive and robust banking sector.
The State and Fate of Community Banking – Introduction
The community bank is a characteristically American enterprise, existing in larger numbers than nearly anywhere else in the world, and, as Harvard Law School’s Mark Roe has written, is a financial structure shaped by the tendencies of U.S. politics toward decentralization and local control.1 But for over 40 years, these small, locally owned lenders to local businesses and consumers have shrunk in visibility, first through the culling of the savings and loan crisis in the 1980s; then through the removal of barriers to bank consolidation; then through economic breakdowns like the financial crisis of 2008.
In this study, we assessed the state of U.S. community banks in recent years using Federal Deposit Insurance Corporation (FDIC) data. We also surveyed and synthesized the research on community banks, and examined the effect of regulatory efforts like Dodd-Frank on these institutions. We tackled the question of defining a community bank, and characterized aspects of community banks that distinguish them from larger regional or national peers. We examined recent trends, particularly in regulation, and asked a series of questions: What is a community bank and why is it special? How far has consolidation gone, and what have been the effects for markets served primarily by community banks? What are the consequences of massive regulatory efforts like Dodd-Frank? And what policies need to be altered or developed to preserve vital services provided by community banks?
The full picture of community banking in the U.S. is quite complex. We found that although community banks’ share of the U.S. bank-lending market and of U.S. banking assets has declined by about 50 percent in the last two decades, the sector continues to play a vital role in key lending segments. Community banks provide 77 percent of agricultural loans and over 50 percent of small business loans. Agricultural lending, in particular, is a specialty that requires a knowledge of farming, often very specific to the region, to the farm or to the farmer, and a longer-term perspective; agricultural cycles are fairly long. Community banks also play a major role in local real estate lending, particularly for housing, another business where knowledge of local conditions and borrowers is necessary. In 2013, the default rates for loans secured by oneto four-family residential properties ran at 3.47 percent for small community banks (banks with $1 billion or less in assets) versus 10.42 percent for banks with more than $1 billion in assets.2
Community banks generally are relationship banks; their competitive advantage is a knowledge and history of their customers and a willingness to be flexible.3 (This is sometimes a problem, particularly in a regulatory system that reflects big bank processes, which are transactional, quantitative and dependent on standardization and mark-to-market accounting practices.) Their financials are different than those of the bigger banks, with less leverage and less-robust returns, and they tend to use less technology. They are not as deeply involved in the capital and securitization markets as larger banks. Their earnings stream is also less diverse, making them more vulnerable to disruption.
Community banks (defined as banks with less than $10 billion in assets) withstood the financial crisis of 2008-09 with sizeable but not major losses in market share – shedding 6 percent of their share of U.S. banking assets between the second quarter of 2006 and mid-2010, according to this working paper’s findings. But since the second quarter of 2010, around the time of the Dodd-Frank Wall Street Reform and Consumer Protection Act’s passage, we found community banks’ share of assets has shrunk drastically – over 12 percent.
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