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Community Banks

| Written by admin | No Comments | Updated on May 10, 2010 The content that follows was originally published on the Institute for Local Self-Reliance website at http://www.ilsr.org/rule/financing-local-businesses/3008-2/

Small local and regional banks (under $10 billion in assets) provide the majority of loans for small businesses. Although small and mid-sized banks control only 22 percent of all bank assets, they account for 54 percent of small business lending. The largest 20 banks, meanwhile, command fully 57 percent of all bank assets, but account for only 28 percent of small business lending. (See our graphs for more detail.)

Not surprisingly, academic research has found that regions with a robust network of local banks are home to significantly more small firms and there is much less credit available to small businesses in areas dominated by big banks. In a study published in 2007 in the Journal of Banking and Finance, Steven G. Craig and Pauline Hardee examined different regions of the country and concluded, “Credit access in markets dominated by big banks tends to be lower for small businesses than in markets with a relatively larger share of small banks.”

Why is it that community banks do so much more small business lending than their big competitors? One reason is that big banks rely on computer models to determine whether to make a loan. Because the local market conditions and the circumstances surrounding each borrower and his or her enterprise are so varied, this standardized approach does not work very well when it comes to understanding the nuances of risk associated with a particular small business.

By drawing on qualitative information — getting to know the borrower, learning about the business, and understanding the local market — small banks can better assess risk and successfully make loans to a wider group of small businesses.

Because big banks are run from afar, it’s impossible, or at least very expensive, for them to obtain the kind of qualitative information about risk that local bankers pick up naturally by being part of the community and interacting with borrowers. As a result, there are no economies of scale in small business lending; just the opposite. Small banks are, on average, more efficient small business lenders and make a better return on their assets.

All of this makes plain the fallacy of thirty years of banking policy that has fueled mergers and consolidation on the grounds that bigger banks mean greater efficiency and more growth. Banking consolidation has in fact constricted the flow of credit to the very businesses most likely to create new jobs.

More:

  • For more information on community banks, including strategies to strengthen and expand them, see our Banking Initiative.

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