Endangered financial species: U.S. community banks
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
NEW YORK — It’s the time of year when families gather to watch Jimmy Stewart play George Bailey, the small-town banker who with a little angelic intervention extends credit to his neighbors in “It’s a Wonderful Life.” Yet though Bailey remains emblematic of a benign banking system, most Americans probably don’t realize he’s the most endangered species in finance.
Hundreds of community banks, a fixture of small-town America, have failed or sold out to bigger rivals in the past year. But many more of the country’s 7,700-odd smaller banks will disappear in the next few years — a consequence, unintended or otherwise, of government and regulatory decisions codifying the biggest banks as infallible.
And yet as sad as that may sound it may not be such a disaster after all for regulators, shareholders and, perhaps surprisingly, even consumers. That’s not to say the extinction of a species is to be blithely welcomed. Policymakers should certainly be asking whether there is a net negative consequence to rules and regulations that hasten the demise of the small, independent financial institution.
In some respects the recent spike in banks disappearing — as many as 300 this year — simply represents a return to a long-term shift towards ever larger institutions that had slowed during the boom years of the past decade. At the beginning of the 1990s, the Federal Deposit Insurance Corp oversaw 16,074 institutions. Within a decade that had fallen to 10,222 — an average net loss of some 585 banks or thrifts per year.
Over the next 10 years, however, the decline slowed. At the end of 2007, the number of institutions overseen by the FDIC was shrinking by an average of around 240 annually, mostly a result of M&A. The pace accelerated from 2008, largely thanks to failures, of which there have been 157 this year compared to three in 2007.
The beneficiaries of this trend have been the biggest banks. At the start of the 1990s there were 59 institutions with more than $10 billion of assets holding 31.8 percent of the nation’s stock of banking assets. Today, their ranks have nearly doubled to 109, while their share of assets has marched upward to 78.6 percent.
It won’t stop there. For one, the FDIC’s troubled bank list covers 860 institutions — including many of the 600 or so that have yet to pay back bailout funds. While not all of them will be seized, many will wind up in the arms of larger, better-capitalized rivals. But even healthy community banks are in for leaner times.
One of the reasons fewer banks vanished in the years leading up to the financial crisis was their reliance on commercial and residential property loans, which worked just fine when prices were rising. But now they’re being hit with big writedowns on those loans — and can’t see where they can profitably deploy future funds.
At the same time, their costs are rising, and earnings hit, by more regulation. Just last week the Independent Community Bankers of America came out screaming against the Federal Reserve’s capping of debit interchange fees to comply with the Dodd-Frank financial reform act, saying it will disadvantage small banks and make “the concept of ‘free checking’ a thing of the past.”
Big banks are also dealing with more red tape, but their size, diversity of businesses and loan portfolios give them economies of scale to absorb these higher expenses without doing away with free checking or toasters for new depositors. From a policy perspective it’s arguably terrible that mega-banks bailed out during the crisis are now luring away customers from the George Baileys of the world.
But look at it another way: having a few, heavily-regulated banks might actually be safer. Canada has just five giant institutions. But because they were regulated like utilities, the country’s financial system averted the need for big bailouts. It’s also more profitable for shareholders. According to the FDIC’s third-quarter industry survey, big banks have better efficiency ratios and generate higher returns on assets and equity.
Finally, consumers might benefit from a smaller universe of stronger banks competing for their affections. At the very least, there might be more credit available to them. In the third quarter, for every dollar of deposits customers stowed in the vaults of big banks, 96 cents were extended to borrowers, according to SNL Financial. Smaller banks lent out just 84 cents for every dollar of deposits.
George Bailey may have been a nice banker. But he might have been even more effective working as a senior loan officer for Bank of America.