Why community banks should stick around

Slate’s Matthew Yglesias recently published a blog post that argued against the need for community banks. He claimed that microbanks have three, basic problems: “they are poorly managed”, “they can’t be regulated” and “they can’t compete.” The policy he hopes for is to “simultaneously contain the size and leverage of the biggest banks while encouraging the second tier of regional banks to keep growing.” He says these regional banks should “swallow up local franchises and expand their geographical footprints.” 

So what is Yglesias’s ideal banking structure? Dozens instead of thousands of banks that can compete with each other on a national or regional basis.

But American Banker’s Rob Blackwell argues against Yglesias’ view in a recent article. Blackwell provides four reasons why Yglesias’ opinions are wrong:

First, he says that most small banks are in fact well managed and aren’t dumb. Blackwell says, “most small banks are run by individuals who have risen locally through the ranks or were poached from nearby institutions.” Blackwell also points out that most community banks outlasted the financial crisis, when many of the “best and brightest” did not, whether it was because of banking knowledge and exerpience or sensitivity to the local market.

Second, Blackwell states that smaller banks tend to be easier to regulate, arguing against Yglesias who stated that small banks “regularly get various kind of carve-outs from regulation.” Blackwell claims that the “vast majority of rules and regulations do, in fact, apply to small banks” and that “some of the biggest new rules required by Dodd-Frank also apply to small banks.”

Third, Blackwell argues that small banks are competitive and profitable. He agrees that many institutions under $100 million in assets are struggling, but those between $100 million and $1 billion in assets are much more competitive. Further, the $100 million to $1 billion segment of banks makes up just over 4,100 of the industry’s almost 7,000 banks. And the segment’s return on equity is 8.51 percent, which is close to the industry average of 8.92 percent.

Fourth, Blackwell says that “small banks are vital to credit availability.” These smaller banks often lend to the nation’s smallest businesses, which may lack the proper documentation or size for larger institutions. Further, data provided at the Federal Reserve’s October community banking conference shows that community banks are best to handle these types of loans. In many instances, according to Blackwell, “the loan is based more on the bankers’ understanding of the market, the borrower and the situation.” In this situation, smaller banks are usually better equipped to support relationship-based lending.

While the pending M&A movement will likely reduce the number of banks to around 5,000, Blackwell argues that the downsizing shouldn’t be encouraged. He says that small banks “pose less systematic risk and their failures are uneventful,” when compared to larger institutions. 

For more information on how to develop objective measures of credit risk and improve customer relationships, download the whitepaper: How to Balance Relationship-Based Lending & Risk Management.